Estimated Forfeiture Rate
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Could someone share with me the process they use for a new analysis for the estimated forfeiture rate at the beginning of each year?
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Scotty C.,
A key starting point is ensuring you have updated forfeiture data at the beginning of the year (or end of last year). You then need to determine some sort of weighted average outstanding period (opportunity period) and apply the forfeiture rate formula to come up with an annualized forfeiture rate.
As you may know, the new FASB guidance that came out in March 2016 under ASU 2016-09 allows the option to account for forfeitures when they occur (therefore, using a 0% forfeiture rate). While this approach may be simplified and require a cumulative expense catch up, it will result in higher expense (basically no haircut since the forfeiture rate is 0%) and should a participant leave and forfeit their awards, you will see an expense credit for any unvested shares in the period of forfeiture. So there is some volatility there, but it is much simpler hence why the guidance was released :-).
If you need further assistance, don't hesitate to reach out to us at info@sos-team.com or 408-979-8700
Bill Storey, CPA
Manager, Outsourcing Services
Stock & Option Solutions
I agree with everything Bill said. I also think that choosing NOT to apply a rate makes everything simpler and easier, but that said, if you do want to calculate one and your system uses an annualized rate, here is the process I use:
I run a report for all time that has tranche-level data with shares granted and shares forfeited and the vest date. Then I use the vest date at the tranche level to get the lesser of the time to vest vs. time outstanding (I compare to the end of period date with a MIN() function in Excel then subtract the grant date from the lesser of the two dates and divide by 365.25. You can also use the yearfrac() function. This is your opportunity period. Then you multiply by the shares in the tranche - this is your weighted opportunity period.)
(Depending on the system you are using sometimes I start with the system forfeiture rate report and then remove a totals line for each grant or sometimes there is a vest schedule report that gives you one row for each tranche in the grant.)
Then I use sumifs to sum the shares granted in each year (2006, 2007, 2008, etc.) An another sumifs to sum the shares forfeited from grants made in each year (not shares forfeited in that year, shares forfeited from GRANTS MADE in that year - you need to compare apples to apples). Next I divide forfeited by granted for each year - this is your aggregate forfeiture rate. Now you need to annualize it using the opportunity period from above.
First, you sumifs the weighted opportunity period for each year, then divide by shares granted for the year. This is your weighted average opportunity period for each year. Then use this formula to annualize the aggregate rate: =1-((1-A2)^(1/B2)) where A is the aggregate forfeiture rate and B is the opportunity period. This is a standard annualization formula.
(You could replace the sumifs with pivot tables if you like them better - some pivot love pivots and hate formulas, I'm the opposite.)
The first time I do this for a company I do ALL the years (back to 2006) so you can see trends and decide which data you should include going forward. Most of the time you can see that the data from 8 or 10 years ago really isn't relevant anymore and you can make an argument to only use data from the last 4 or 5 years. Then you can do a straight average or a weighted average of those years and there is your forfeiture rate.
This may sound difficult, but once you've done it once it's pretty quick and easy - should only take half and hour or so and most of that is just running reports and exporting to excel.
I've used this method for YEARS for DOZENs of clients and never had an auditor question it. So I think it's pretty solid. I've done it with data from Equity Edge Online, Shareworks, Equiview, and a couple of other systems, so most of the systems have the data you need.
Let me know if you have questions or get stuck somewhere along the line, I'm happy to help.
Elizabeth
Equity Plan Solutions, LLC
edodge@equityplansolutions.net
www.equityplansolutions.net
650.995.7771