Under ASC 718, the difference between market and non-market vesting conditions comes down to two mechanics: whether the probability of hitting the vesting hurdle is built into the grant-date fair value, and whether expense already recorded can be reversed if the target is missed. Market conditions (stock price or total shareholder return targets) are priced into fair value upfront through a Monte Carlo or lattice model, and the expense stays on the books as long as the employee renders the required service, even if the target is never met. Non-market conditions (performance and service) are ignored in the fair value calculation, tracked through a probability assessment or forfeiture estimate over time, and reversed in full if the condition is ultimately not satisfied.
That asymmetry drives most of the financial statement impact and most of the errors that show up in restatements.
The Three Condition Categories
ASC 718 recognizes three types of conditions that can govern whether an employee earns a share-based award. Each has a specific definition in the ASC Master Glossary, and the category a condition falls into determines every downstream accounting question.
A market condition is tied to achieving a specified share price or a specified amount of intrinsic value indexed to the issuer’s shares. A target framed in terms of the stock price relative to a peer group or index also qualifies. Absolute price hurdles and relative TSR targets are the two most common forms.
A performance condition requires both continued service and the achievement of a target defined by reference to the company’s own operations. Revenue milestones, EBITDA thresholds, and completion of a liquidity event like an IPO all fall here. A performance target can also reference the same metric at another entity or group of entities.
A service condition depends solely on the employee remaining employed for the required period. A three-year cliff or a four-year ratable schedule with a one-year cliff are straightforward examples. Acceleration provisions triggered by death, disability, or termination without cause are also classified as service conditions.
One subtlety trips people up: ASC 718 does not treat a market condition as a vesting condition. The codification states explicitly that an award is not deemed forfeited solely because a market condition goes unmet.1Deloitte Accounting Research Tool. ASC 718-10 – Market Condition That classification is the root of the accounting difference the rest of this article walks through.
Why treat market conditions differently? Because management cannot directly steer the outcome. Stock prices reflect market fluctuations, investor sentiment, and macroeconomic conditions in a way that internal revenue or EBITDA targets do not. ASC 718 responds to that lack of control by pricing the risk of failure into the award upfront rather than tracking it period by period.
Fair Value at the Grant Date
The first place the two categories diverge is measurement.
Market Condition Awards
When an award contains a market condition, the probability of hitting the stock price or TSR target is baked directly into the grant-date fair value. Valuation models like Monte Carlo simulations or lattice models run thousands of simulated stock price paths, and the grant-date fair value reflects the average outcome across all those paths, including the ones where the target is never met.2BDO. Share-Based Payments Under ASC 718
A common misconception is that Monte Carlo always produces a fair value lower than the grant-date stock price. For absolute price hurdles with no upside multiplier, that can be true because failed paths drag down the average. But for relative TSR awards with payout leverage (say, 0 to 200% of target shares depending on peer-group ranking), the Monte Carlo value frequently exceeds the face value of the underlying shares. The upside on strong-performance paths more than offsets the paths that pay nothing. The award’s specific design drives the outcome, not the model.
Performance and Service Condition Awards
For awards with only performance or service conditions, the fair value is not discounted for the likelihood of hitting the target. Restricted stock units are typically valued at the closing stock price on the grant date. Stock options with performance or service conditions use a standard option pricing model like Black-Scholes-Merton.2BDO. Share-Based Payments Under ASC 718 Either way, the fair value calculation ignores the performance hurdle entirely. Whether the company has a 10% or 90% chance of hitting its revenue target, the grant-date fair value is the same. Probability enters the picture later, during expense recognition.
Derived Service Period
When an award has a market condition but no explicit service period (the employee just has to stay employed until the price target is met), ASC 718 requires a service period derived from the valuation model itself. In a lattice model, the derived service period is the median duration across all simulated stock price paths on which the market condition is satisfied.3Deloitte Accounting Research Tool. Requisite Service Period for Employee Awards Compensation expense is spread over that derived period. If the condition is satisfied earlier than expected, any remaining unrecognized expense is recognized immediately. If the condition is never satisfied but the employee serves through the entire derived period, the expense stands.
This concept has no equivalent for non-market conditions. Performance and service conditions always have an explicit or implicit service period stated in the award agreement.
Expense Recognition Over Time
This is the practical heart of the distinction, and it is where most of the financial statement impact shows up.
Market Conditions
Compensation cost for a market-condition award is fixed at the grant date and recognized over the requisite service period (whether explicit or derived). The expense goes on the books as long as the employee continues to render service, regardless of whether the stock price target is ever reached.1Deloitte Accounting Research Tool. ASC 718-10 – Market Condition If the stock languishes and the award expires worthless, the company does not reverse the expense. The only circumstance that triggers reversal is if the employee leaves before completing the requisite service period.
The logic is straightforward once you see it. The risk of the market target going unmet was already priced into the fair value. The Monte Carlo or lattice model that produced the grant-date value accounted for all the scenarios where the stock fell short. Reversing the expense on top of that discount would double-count the risk of failure.
Performance Conditions
Expense recognition for a performance-condition award is probability-driven and recalibrated every reporting period. No expense is recorded until you conclude it is probable (defined consistently with ASC 450 as “likely to occur”) that the performance target will be achieved. Once that threshold is crossed, you begin recognizing cost over the service period, applying a cumulative catch-up for any periods that have already elapsed.
The assessment runs both directions. If a revenue target that once looked achievable becomes unlikely due to a market downturn or operational setback, you reverse all previously recognized expense for that award in the current period. If the target is never met, the final cumulative expense is zero. The financial statements ultimately reflect only the cost of awards that actually vest.
Liquidity-event awards deserve a note here. They are performance conditions, but the probability threshold behaves differently in practice: liquidity events are typically not considered probable until they actually occur.2BDO. Share-Based Payments Under ASC 718 A company filing its S-1 and entering an IPO roadshow is still not at the “probable” threshold under prevailing practice. No compensation expense is recognized until the IPO closes or the acquisition is consummated, at which point a catch-up expense hits the financial statements. For pre-IPO companies with large option pools, that catch-up can be significant.
Service Conditions
Service-condition awards follow a more predictable pattern. Expense is recognized ratably over the vesting period, adjusted only for actual or estimated forfeitures. If the employee departs early, previously recognized expense for that person’s award is reversed. There is no probability assessment to run each quarter since the only question is whether the person stays employed.
The Bottom Line
A missed market condition still produces a recognized expense. A missed performance or service condition does not. That asymmetry is the single most important distinction between market and non-market conditions under ASC 718, and it flows directly from the difference in how fair value is measured at the grant date.
Awards With Multiple Conditions
Many awards combine conditions. A grant might require both a three-year service period and a TSR hurdle, or both a revenue milestone and a stock price target. The accounting depends on whether the conditions are connected by “and” (all must be met) or “or” (any one suffices).
When all conditions must be satisfied, the requisite service period is the longest of the explicit, implicit, or derived service periods. You recognize expense over that longest period, but only if it is probable that any performance condition will be achieved. Even if the probability assessment for the performance condition flips to “not probable,” the market condition’s effect on fair value remains embedded in the grant-date measurement.4Deloitte Accounting Research Tool. Multiple Conditions for Employee Awards
When only one condition needs to be satisfied, the requisite service period is the shortest of the applicable periods, because the employee can vest as soon as any single condition is met. Awards with “or” structures are less common but come up in retention arrangements where the board wants to give employees multiple paths to vesting.
The governing principle: if any market condition is present, expense recognition cannot be reversed solely because that market condition fails. If an award has both a market condition and a performance condition that must both be met, you can stop recognizing expense if the performance condition becomes not probable, but you cannot reverse expense already recognized solely because the stock price target looks unreachable.
Graded Vesting Attribution
Awards that vest in installments (for example, 25% per year over four years) can use either of two attribution methods when the award has only a service condition. The graded vesting method treats each tranche as a separate award and front-loads expense. The straight-line method spreads total cost evenly over the full vesting period. This is an accounting policy election that must be applied consistently.
That policy choice disappears when market or performance conditions enter the picture. Awards with market or performance conditions that vest in tranches must use the graded vesting (accelerated) attribution method. The straight-line option is not available. Each tranche is treated as a separate award with its own fair value, probability assessment, and service period, which results in higher expense in the early years of the vesting schedule.
Modifications
When a company changes the terms of an outstanding award, ASC 718 treats the modification as an exchange of the old award for a new one. The accounting requires comparing the fair value of the modified award to the fair value of the original award, both measured at the modification date. Any excess is incremental compensation cost.5Deloitte Accounting Research Tool. Accounting for the Effects of Modifications
The type of condition being modified changes the calculation. When a market condition is changed, both the original and modified fair values are computed using Monte Carlo or a lattice model that incorporates the respective market targets, and the incremental cost reflects the change in the probability-weighted outcome. When a performance condition is changed and the original condition was not expected to be met at the modification date, the grant-date fair value of the original award is disregarded entirely; total compensation cost is then based on the modification-date fair value of the modified award, which can produce substantially higher expense than a simple incremental calculation. Extending the service period alone creates no incremental fair value (the fair value of an option or RSU doesn’t increase just because vesting takes longer), but the expense is spread over the new, longer period.
Any incremental cost from a modification is recognized immediately if the award has already vested, or over the remaining service period if it has not. Modifications are one of the areas where the market/non-market distinction has real teeth: swapping a performance condition for a market condition in a modification doesn’t just change the probability assessment, it changes whether the expense can ever be reversed going forward.
When a Condition Falls Outside All Three Categories
Not every condition attached to an equity award fits neatly into the market, performance, or service framework. If an award vests or becomes exercisable based on a condition that falls outside all three categories (sometimes called an “other” condition), the entire award must be classified as a liability rather than equity. Liability classification fundamentally changes the accounting: the award is remeasured to fair value every reporting period, with changes running through the income statement, rather than being fixed at the grant-date value.
Cash-settlement features, put rights that let employees sell shares back to the company without bearing ownership risk for at least six months, and net-settlement provisions that withhold shares in excess of the employee’s maximum statutory tax rate can all trigger liability classification. Awards linked to conditions outside the entity’s own operations or the grantee’s performance (for example, vesting contingent on a regulatory approval that is not a performance target) may also fall into the “other” category. When designing awards, every vesting condition should map cleanly to market, performance, or service. Conditions that don’t fit may force liability treatment and the ongoing income statement volatility that comes with it.