The graded straight line attribution recognizes the same amount of expense throughout the service period of each respective vesting tranche, as if each vesting increment is its own award. The traditional straight line (sometimes called true straight line) attribution recognizes the same amount of expense throughout the entire service period of the entire award.
A traditional straight line approach may result in recognizing too little expense, especially when there are multiple vesting tranches and more shares vest earlier within the service period.
Accounting principles for straight line attribution:
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Expense should be recognized throughout the award's service period, which often starts on the grant date
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The aggregate amount of expense recognized must be be at least to the fair value of what has legally vested (sometimes called the 'floor' concept)
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Scenarios under the IFRS standard cannot use the straight line attribution
It is common for an award to have graded vesting where shares vest in multiple increments instead of fully vesting on a single date. To ensure that at any given period the minimum amount of expense recognized is at least equal to the fair value of what has vested, Carta's reports takes a graded straight line approach by treating each vesting increment as if it's own award.
For example, let's assume a new hire award award for 36,000 options begins vesting on the hire date of December 15, 2021. The company's quarterly board meeting has already occurred so the option grant does not receive board approval until March 15, 2022 which is also the grant date. 9,000 options will vest annually for 4 years until all 36,000 options vest on December 15, 2026. The fair value is $1.00 per option bringing the total fair value to $36,000 and is recognized throughout the service period, starting on the grant date.
Carta's report will first separate each vesting tranche and define the service period for each. The service period start date will either be the grant date (shown in green) or the vest date of the prior tranche (shown in blue). The service period end date is the vest date of that tranche.
The total expense recognized for 2022 (January 1, 2022 to December 31, 2022) is $9,394.52 (shown in orange). This consists of the fair value of 9,000 options that vested on December 15, 2022 (shown in grey) and an accrual of 16 days of service for the fair value of 9,000 options that will vest on December 15, 2023 (shown in yellow).
Under the traditional straight line method, expense is measured equally throughout the entire service period of the award which is 1,371 service days (shown in yellow) from the grant date of March 15, 2022 to the final vest date of December 15, 2025. This results in $26.26 of expense per day (shown in grey) which is determined by dividing the total fair value of $36,000 by 1,371 service days. The total expense recognized for 2022 (January 1, 2022 to December 31, 2022) is $7,641.14 (shown in orange) which represents the 291 service days provided in the period.
The minimum amount of expense the company has to recognize as of December 31, 2022 is the fair value of what has vested at the time, $9,000 (9,000 options * $1 fair value per option). The company will have recognized an additional $1,358.86 of expense ($9,000 - $7,641.14) to comply with the 'floor' concept.
Let's look at a similar award where more options vest earlier in the service period. Instead of equal annual vesting increments, the award will now vest 50% at the first anniversary and 16.6% annually thereafter until December 15, 2025.
The total expense recognized for 2022 (January 1, 2022 to December 31, 2022) is $18,263.01 (shown in orange). This consists of the fair value of 18,000 options that vested on December 15, 2022 (shown in grey) and an accrual of 16 days of service for the fair value of 6,000 options that will vest on December 15, 2023 (shown in yellow).
Under the traditional straight line method, expense is measured equally throughout the entire award's service period so the expense recognized to date is the same $7,641.14 (shown in orange) which represents the 291 service days provided in the period also at $26.26 per day.
The minimum amount of expense the company has to recognize as of December 31, 2022 is the fair value of what has vested at the time, $18,000 (18,000 options * $1 fair value per option). The company will have recognized an additional $10,358.86 of expense ($18,000 - $7,641.14) to comply with the 'floor' concept.
Finally, let's look at an example where vesting may begin after the award's grant date or when more vesting occurs later in the service period (sometimes referred to as box-car vesting). A top performing employee (assume it is not the same person in previous examples) joined the company on December 15, 2021. To recognize the employee's contributions, a refresh award of 36,000 options was board approved and granted on March 15, 2022. However, it was agreed that vesting would not commence until after the employee's first anniversary on December 15, 2022. 9,000 options vests annually over four years.
The total expense recognized for 2022 (January 1, 2022 to December 31, 2022) is $18,263.01 (shown in orange). This consists of the fair value of 18,000 options that vested on December 15, 2022 (shown in grey) and an accrual of 16 days of service for the fair value of 6,000 options that will vest on December 15, 2023 (shown in yellow).
Under the traditional straight line method, the later vest date results in a longer 1,736 service period results in a lower $20.74 expense to recognize per day. With expense being measured equally throughout the entire award's service period, the expense recognized to date is $6,034.56 which represents the 291 service days provided in the period. Note that the start of the service period is still the grant date and not the later vesting start date because service provided as of the grant date is a requirement for the options to vest.
Nothing has actually vested so the 'floor' concept doesn't apply here. However, it should be noted that the graded straight line methodology is recognizing less expense in 2022 than the traditional straight line method. The difference will increase as vesting as more vesting occurs later in the service period. If the graded straight line method is not recognizing enough expense, it may be appropriate to instead use the FIN28 approach which recognizes more expense earlier in the service period.
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Did you find this post helpful or have any further questions? Please reach out Carta's dedicated Financial report team with any comments or feedback by emailing us at 718@carta.com.
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