6.1 Accounting for the Effects of Modifications
ASC 718-10 — Glossary
Modification
A change in the terms or conditions of a
share-based payment award.
ASC
718-20
Modification of an Award
35-2A An entity shall account for
the effects of a modification as described in paragraphs
718-20-35-3 through 35-9, unless all the following are
met:
- The fair value (or calculated value or intrinsic value, if such an alternative measurement method is used) of the modified award is the same as the fair value (or calculated value or intrinsic value, if such an alternative measurement method is used) of the original award immediately before the original award is modified. If the modification does not affect any of the inputs to the valuation technique that the entity uses to value the award, the entity is not required to estimate the value immediately before and after the modification.
- The vesting conditions of the modified award are the same as the vesting conditions of the original award immediately before the original award is modified.
- The classification of the modified award as an equity instrument or a liability instrument is the same as the classification of the original award immediately before the original award is modified.
The disclosure requirements in
paragraphs 718-10-50-1 through 50-2A and 718-10-50-4 apply
regardless of whether an entity is required to apply
modification accounting.
35-3 Except
as described in paragraph 718-20-35-2A, a modification of
the terms or conditions of an equity award shall be treated
as an exchange of the original award for a new award. In
substance, the entity repurchases the original instrument by
issuing a new instrument of equal or greater value,
incurring additional compensation cost for any incremental
value. The effects of a modification shall be measured as
follows:
- Incremental compensation cost shall be measured as the excess, if any, of the fair value of the modified award determined in accordance with the provisions of this Topic over the fair value of the original award immediately before its terms are modified, measured based on the share price and other pertinent factors at that date. As indicated in paragraph 718-10-30-20, references to fair value throughout this Topic shall be read also to encompass calculated value. The effect of the modification on the number of instruments expected to vest also shall be reflected in determining incremental compensation cost. The estimate at the modification date of the portion of the award expected to vest shall be subsequently adjusted, if necessary, in accordance with paragraph 718-10-35-1D or 718-10-35-3 and other guidance in Examples 14 through 15 (see paragraphs 718-20-55-107 through 55-121).
- Total recognized compensation cost
for an equity award shall at least equal the fair
value of the award at the grant date unless at the
date of the modification the performance or service
conditions of the original award are not expected to
be satisfied. Thus, the total compensation cost
measured at the date of a modification shall be the
sum of the following:
-
The portion of the grant-date fair value of the original award for which the promised good is expected to be delivered (or has already been delivered) or the service is expected to be rendered (or has already been rendered) at that date
-
The incremental cost resulting from the modification.
Compensation cost shall be subsequently adjusted, if necessary, in accordance with paragraph 718-10-35-1D or 718-10-35-3 and other guidance in Examples 14 through 15 (see paragraphs 718-20-55-107 through 55-121). -
- A change in compensation cost for an equity award measured at intrinsic value in accordance with paragraph 718-20-35-1 shall be measured by comparing the intrinsic value of the modified award, if any, with the intrinsic value of the original award, if any, immediately before the modification.
35-3A An
entity that has an accounting policy to account for
forfeitures when they occur in accordance with paragraph
718-10-35-1D or 718-10-35-3 shall assess at the date of the
modification whether the performance or service conditions
of the original award are expected to be satisfied when
measuring the effects of the modification in accordance with
paragraph 718-20-35-3. However, the entity shall apply its
accounting policy to account for forfeitures when they occur
when subsequently accounting for the modified
award.
35-4
Examples 12 through 16 (see paragraphs 718-20-55-93 through
55-144) provide additional guidance on, and illustrate the
accounting for, modifications of both vested and nonvested
awards, including a modification that changes the
classification of the related financial instruments from
equity to liability or vice versa, and modifications of
vesting conditions. Paragraphs 718-10-35-9 through 35-14
provide additional guidance on accounting for modifications
of certain freestanding financial instruments that initially
were subject to this Topic but subsequently became subject
to other applicable generally accepted accounting principles
(GAAP).
Cancellation and
Replacement
35-8 Except as described in
paragraph 718-20-35-2A, cancellation of an award accompanied
by the concurrent grant of (or offer to grant) a replacement
award or other valuable consideration shall be accounted for
as a modification of the terms of the cancelled award. (The
phrase offer to grant is intended to cover situations
in which the service inception date precedes the grant
date.) Therefore, incremental compensation cost shall be
measured as the excess of the fair value of the replacement
award or other valuable consideration over the fair value of
the cancelled award at the cancellation date in accordance
with paragraph 718-20-35-3. Thus, the total compensation
cost measured at the date of a cancellation and replacement
shall be the portion of the grant-date fair value of the
original award for which the promised good is expected to be
delivered (or has already been delivered) or the service is
expected to be rendered (or has already been rendered) at
that date plus the incremental cost resulting from the
cancellation and replacement.
The guidance in this chapter primarily applies to modifications of
equity-classified share-based payment awards. Since liability awards are remeasured
at their fair value at the end of each reporting period, an entity does not need to
apply special guidance when accounting for modifications of such awards if their
classification does not change. See Section 6.8 for a discussion of modifications
that result in a change in classification, and see Section 7.4 for a discussion of modifications
of liability-classified awards.
ASC 718-10-20 defines a modification as “[a] change in the terms or
conditions of a share-based payment award.” However, an entity is not required to
apply modification accounting if certain factors are the same immediately before and
after the modification. As shown below, the three criteria in ASC 718-20-35-2A must
be met for a change in the terms or conditions of a share-based payment award not to
be accounted for as a modification under ASC 718-20-35-3.
1
Compare calculated value or intrinsic value, rather than
fair value, if such an alternative measurement method is used. See
Section
6.1.1 for additional discussion of the determination of
whether the fair value (or calculated or intrinsic value) of the
modified award equals that of the original award immediately before the
change occurs in the terms and conditions of the agreement.
A modification under ASC 718 is viewed as an exchange of the
original award for a new award, typically one with equal or greater value because
(1) share-based payment awards are meant to incentivize (rather than disincentivize)
employees and (2) the legal form of such an award may prevent the grantor from
modifying it without the consent of the grantee, and a grantee is not likely to
agree to a modification that results in an award of lesser value. However, if the
award is for stock options, the fair-value-based measure may be less than the
fair-value-based measure of the original award because a shorter vesting period may
result in a shorter expected term.
Any incremental value of the new (or modified) award generally is
recorded as additional compensation cost on the modification date (for vested
awards) or over the remaining vesting period (for unvested awards). The incremental
value (i.e., incremental compensation cost) is computed as the excess of the
fair-value-based measure of the modified award on the modification date over the
fair-value-based measure of the original award immediately before the
modification.
In addition to considering whether a modification results in
incremental compensation cost that must be recognized, an entity must determine
whether it should recognize the award’s original grant-date fair-value-based measure
for equity-classified awards. Total recognized compensation cost attributable to an
equity award that has been modified is, at least, the grant-date fair-value-based
measure of the original award unless the original award is not expected to vest
under its original terms (i.e., the service condition, the performance condition, or
neither is expected to be achieved). (See Sections 6.3.3 and 6.3.4 for illustrations of awards that have
been modified and are not expected to vest under the original vesting conditions.)
Therefore, total recognized compensation cost attributable to an award that has been
modified is generally the sum of (1) the grant-date fair-value-based measure of the
original award for which vesting has occurred or is expected to occur and (2) the
incremental compensation cost conveyed to the holder of the award as a result of the
modification, if any. However, if the original award is not expected to vest under
its original terms, any compensation cost recognized is based on the
modification-date fair-value-based measure of the modified award (i.e., the
grant-date fair-value-based measure of the original award is disregarded).
Examples 12 and 16 in ASC
718-20-55-93 and ASC 718-20-55-134, respectively, illustrate the application of
modification accounting to equity-classified awards and are based on Example 1 in
ASC 718-20-55-4 through 55-9:
ASC
718-20
Example 1: Accounting for Share
Options With Service Conditions
55-4 The following Cases illustrate
the guidance in paragraphs 718-10-35-1D through 35-1E for
nonemployee awards, paragraphs 718-10-35-2 through 35-7 for
employee awards, and paragraphs 718-740-25-2 through 25-3
for both nonemployee and employee awards, except for the
vesting provisions:
- Share options with cliff vesting and forfeitures estimated in initial accruals of compensation cost (Case A)
- Share options with graded vesting and forfeitures estimated in initial accruals of compensation cost (Case B)
- Share options with cliff vesting and forfeitures recognized when they occur (Case C).
55-4A
Cases A through C (see paragraphs 718-20-55-10 through
55-34G) describe employee awards. However, the principles on
accounting for employee awards, except for the compensation
cost attribution, are the same for nonemployee awards.
Consequently, all of the following in Case A are equally
applicable to nonemployee awards with the same features as
the awards in Cases A through C (that is, awards with a
specified time period for vesting):
- The assumptions in paragraphs 718-20-55-6 through 55-9
- Total compensation cost considerations (including estimates of forfeitures) in paragraphs 718-20-55-10 through 55-12
- Changes in the estimation of forfeitures in paragraphs 718-20-55-14 through 55-15
- Exercise or expiration considerations in paragraphs 718-20-55-18 through 55-21 and 718-20-55-23.
Therefore, the guidance in
those paragraphs may serve as implementation guidance for
nonemployee awards. Similarly, an entity also may elect to
account for nonemployee award forfeitures as they occur as
illustrated in Case C (see paragraph
718-20-55-34A).
55-4B
Nonemployee awards may be similar to employee awards (that
is, cliff vesting or graded vesting). However, the
compensation cost attribution for awards to nonemployees may
be the same as or different from employee awards. That is
because an entity is required to recognize compensation cost
for nonemployee awards in the same manner as if the entity
had paid cash in accordance with paragraph 718-10-25-2C.
Additionally, valuation amounts used in the Cases could be
different because an entity may elect to use the contractual
term as the expected term of share options and similar
instruments when valuing nonemployee share-based payment
transactions.
55-4C
Because of the differences in compensation cost attribution,
the accounting policy election illustrated in Case B (see
paragraph 718-20-55-25) does not apply to nonemployee
awards.
55-5 Cases
A, B, and C share all of the assumptions in paragraphs
718-20-55-6 through 55-34G, with the following
exceptions:
- In Case C, Entity T has an accounting policy to account for forfeitures when they occur in accordance with paragraph 718-10-35-3.
- In Cases A and B, Entity T has an accounting policy to estimate the number of forfeitures expected to occur, also in accordance with paragraph 718-10-35-3.
- In Case B, the share options have graded vesting.
- In Cases A and C, the share options have cliff vesting.
55-6 Entity
T, a public entity, grants at-the-money employee share
options with a contractual term of 10 years. All share
options vest at the end of three years (cliff vesting),
which is an explicit service (and requisite service) period
of three years. The share options do not qualify as
incentive stock options for U.S. tax purposes. The enacted
tax rate is 35 percent. In each Case, Entity T concludes
that it will have sufficient future taxable income to
realize the deferred tax benefits from its share-based
payment transactions.
55-7 The
following table shows assumptions and information about the
share options granted on January 1, 20X5 applicable to all
Cases, except for expected forfeitures per year, which does
not apply in Case C.
55-8 A
suboptimal exercise factor of two means that exercise is
generally expected to occur when the share price reaches two
times the share option’s exercise price. Option-pricing
theory generally holds that the optimal (or
profit-maximizing) time to exercise an option is at the end
of the option’s term; therefore, if an option is exercised
before the end of its term, that exercise is referred to as
suboptimal. Suboptimal exercise also is referred to as early
exercise. Suboptimal or early exercise affects the expected
term of an option. Early exercise can be incorporated into
option-pricing models through various means. In this Case,
Entity T has sufficient information to reasonably estimate
early exercise and has incorporated it as a function of
Entity T’s future stock price changes (or the option’s
intrinsic value). In this Case, the factor of 2 indicates
that early exercise would be expected to occur, on average,
if the stock price reaches $60 per share ($30 × 2). Rather
than use its weighted average suboptimal exercise factor,
Entity T also may use multiple factors based on a
distribution of early exercise data in relation to its stock
price.
55-9 This
Case assumes that each employee receives an equal grant of
300 options. Using as inputs the last 7 items from the table
in paragraph 718-20-55-7, Entity T’s lattice-based valuation
model produces a fair value of $14.69 per option. A lattice
model uses a suboptimal exercise factor to calculate the
expected term (that is, the expected term is an output)
rather than the expected term being a separate input. If an
entity uses a Black-Scholes-Merton option-pricing formula,
the expected term would be used as an input instead of a
suboptimal exercise factor.
Example 12: Modifications and
Settlements
55-93 The
following Cases illustrate the accounting for modifications
of the terms of an award (see paragraphs 718-20-35-3 through
35-4) and are based on Example 1, Case A (see paragraph
718-20-55-10), in which Entity T granted its employees
900,000 share options with an exercise price of $30 on
January 1, 20X5:
- Modification of vested share options (Case A)
- Share settlement of vested share options (Case B)
- Modification of nonvested share options (Case C)
- Cash settlement of nonvested share options (Case D).
55-93A
Cases A through D (see paragraphs 718-20-55-94 through
55-102) describe employee awards. Specifically, each case is
an extension of Case A in Example 1. However, the principles
on how to account for the various aspects of employee
awards, except for the compensation cost attribution and
certain inputs to valuation, are the same for nonemployee
awards. Consequently, the methodology for determining the
additional compensation cost that an entity should recognize
upon modification or settlement in paragraphs 718-20-55-94
through 55-102 is equally applicable to nonemployee awards
with the same features as the awards in Cases A through D
(that is, awards with a specified period of time for
vesting). Therefore, the guidance in those paragraphs may
serve as implementation guidance for similar nonemployee
awards.
55-93B
All aspects of Case A (see paragraph 718-20-55-94) and Case
B (see paragraph 718-20-55-97) that illustrate a
modification and share settlement of vested share options,
respectively, including the immediate recognition of any
additional compensation cost, should be the same for both
employee awards and nonemployee awards.
55-93C
The compensation cost attribution for awards to nonemployees
may be the same or different for employee awards in Case C
(see paragraph 718-20-55-98), which illustrates the
modification of a nonvested share option. That is because an
entity is required to recognize compensation cost for
nonemployee awards in the same manner as if the entity had
paid cash in accordance with paragraph 718-10-25-2C.
55-93D
All aspects of Case D (see paragraph 718-20-55-102), which
illustrates a cash settlement of a nonvested share option,
including the immediate recognition of any additional
compensation cost, should be the same for both employee
awards and nonemployee awards. That is because the cash
settlement of a nonvested share option effectively vests the
share option.
Case A: Modification of Vested Share Options
55-94 On
January 1, 20X9, after the share options have vested, the
market price of Entity T stock has declined to $20 per
share, and Entity T decides to reduce the exercise price of
the outstanding share options to $20. In effect, Entity T
issues new share options with an exercise price of $20 and a
contractual term equal to the remaining contractual term of
the original January 1, 20X5, share options, which is 6
years, in exchange for the original vested share options.
Entity T incurs additional compensation cost for the excess
of the fair value of the modified share options issued over
the fair value of the original share options at the date of
the exchange, measured as shown in the following paragraph.
A nonpublic entity using the calculated value would compare
the calculated value of the original award immediately
before the modification with the calculated value of the
modified award unless an entity has ceased to use the
calculated value, in which case it would follow the guidance
in paragraph 718-20-35-3(a) through (b) (calculating the
effect of the modification based on the fair value). The
modified share options are immediately vested, and the
additional compensation cost is recognized in the period the
modification occurs.
55-95 The
January 1, 20X9, fair value of the modified award is $7.14.
To determine the amount of additional compensation cost
arising from the modification, the fair value of the
original vested share options assumed to be repurchased is
computed immediately before the modification. The resulting
fair value at January 1, 20X9, of the original share options
is $3.67 per share option, based on their remaining
contractual term of 6 years, suboptimal exercise factor of
2, $20 current share price, $30 exercise price, risk-free
interest rates of 1.5 percent to 3.4 percent, expected
volatility of 35 percent to 50 percent and a 1.0 percent
expected dividend yield. The additional compensation cost
stemming from the modification is $3.47 per share option,
determined as follows.
55-96
Compensation cost already recognized during the vesting
period of the original award is $10,981,157 for 747,526
vested share options (see paragraphs 718-20-55-14 through
55-17). For simplicity, it is assumed that no share options
were exercised before the modification. Previously
recognized compensation cost is not adjusted. Additional
compensation cost of $2,593,915 (747,526 vested share
options × $3.47) is recognized on January 1, 20X9, because
the modified share options are fully vested; any income tax
effects from the additional compensation cost are recognized
accordingly.
Case B: Share Settlement of Vested Share
Options
55-97 Rather
than modify the option terms, Entity T offers to settle the
original January 1, 20X5, share options for fully vested
equity shares at January 1, 20X9. The fair value of each
share option is estimated the same way as shown in Case A,
resulting in a fair value of $3.67 per share option. Entity
T recognizes the settlement as the repurchase of an
outstanding equity instrument, and no additional
compensation cost is recognized at the date of settlement
unless the payment in fully vested equity shares exceeds
$3.67 per share option. Previously recognized compensation
cost for the fair value of the original share options is not
adjusted.
Case C: Modification of Nonvested Share Options
55-98 On January 1, 20X6, 1 year
into the 3-year vesting period, the market price of Entity T
stock has declined to $20 per share, and Entity T decides to
reduce the exercise price of the share options to $20. The
three-year cliff-vesting requirement is not changed. In
effect, in exchange for the original nonvested share
options, Entity T grants new share options with an exercise
price of $20 and a contractual term equal to the 9-year
remaining contractual term of the original share options
granted on January 1, 20X5. Entity T incurs additional
compensation cost for the excess of the fair value of the
modified share options issued over the fair value of the
original share options at the date of the exchange
determined in the manner described in paragraphs
718-20-55-95 through 55-96. Entity T adds that additional
compensation cost to the remaining unrecognized compensation
cost for the original share options at the date of
modification and recognizes the total amount ratably over
the remaining two years of the three-year vesting period.
Because the original vesting provision is not changed, the
modification has an explicit service period of two years,
which represents the requisite service period as well. Thus,
incremental compensation cost resulting from the
modification would be recognized ratably over the remaining
two years rather than in some other pattern.
55-99 The
January 1, 20X6, fair value of the modified award is $8.59
per share option, based on its contractual term of 9 years,
suboptimal exercise factor of 2, $20 current share price,
$20 exercise price, risk-free interest rates of 1.5 percent
to 4.0 percent, expected volatilities of 35 percent to 55
percent, and a 1.0 percent expected dividend yield. The fair
value of the original award immediately before the
modification is $5.36 per share option, based on its
remaining contractual term of 9 years, suboptimal exercise
factor of 2, $20 current share price, $30 exercise price,
risk-free interest rates of 1.5 percent to 4.0 percent,
expected volatilities of 35 percent to 55 percent, and a 1.0
percent expected dividend yield. Thus, the additional
compensation cost stemming from the modification is $3.23
per share option, determined as follows.
55-100 On
January 1, 20X6, the remaining balance of unrecognized
compensation cost for the original share options is $9.79
per share option. Using a value of $14.69 for the original
option as noted in paragraph 718-20-55-9 results in
recognition of $4.90 ($14.69 ÷ 3) per year. The unrecognized
balance at January 1, 20X6, is $9.79 ($14.69 – $4.90) per
option. The total compensation cost for each modified share
option that is expected to vest is $13.02, determined as
follows.
55-101 That
amount is recognized during 20X6 and 20X7, the two remaining
years of the requisite service period.
Example 16: Modifications Regarding
an Award’s Classification
Case B: Equity to Equity Modification
(Share Options to Shares)
55-134
Equity to equity modifications also are addressed in
Examples 12 (see paragraph 718-20-55-93) and 14 (see
paragraph 718-20-55-107). This Case is based on Example 1,
Case A (see paragraph 718-20-55-10), in which Entity T
granted its employees 900,000 options with an exercise price
of $30 on January 1, 20X5. At January 1, 20X9, after 747,526
share options have vested, the market price of Entity T
stock has declined to $8 per share, and Entity T offers to
exchange 4 options with an assumed per-share-option fair
value of $2 at the date of exchange for 1 share of nonvested
stock, with a market price of $8 per share. The nonvested
stock will cliff vest after two years of service. All option
holders elect to participate, and at the date of exchange,
Entity T grants 186,881 (747,526 ÷ 4) nonvested shares of
stock. Entity T considers the guidance in paragraph
718-20-35-2A. Because the change in the terms or conditions
of the award changes the vesting conditions of the award,
Entity T applies modification accounting. However, because
the fair value of the nonvested stock is equal to the fair
value of the options, there is no incremental compensation
cost. Entity T will not make any additional accounting
entries for the shares regardless of whether they vest,
other than possibly reclassifying amounts in equity;
however, Entity T will need to account for the ultimate
income tax effects related to the share-based compensation
arrangement.
Example
6-1
On January 1, 20X1, Entity A grants 1,000 equity-classified at-the-money
employee stock options, each with a grant-date
fair-value-based measure of $9. The options vest at the end
of the fourth year of service (cliff vesting). On January 1,
20X4, A modifies the options, which does not affect their
remaining requisite service period. The fair-value-based
measure of the original options immediately before
modification is $4, and the fair-value-based measure of the
modified options is $6.
Over the first three years of service, A records $6,750 (1,000 options × $9
grant-date fair-value-based measure × 75% for three of four
years of services rendered) of cumulative compensation cost.
On the modification date, A computes the incremental
compensation cost as $2,000, or ($6 fair-value-based measure
of modified options – $4 fair-value-based measure of
original options immediately before the modification) ×
1,000 options. The $2,000 incremental compensation cost is
recorded over the remaining year of service. In addition, A
records the remaining $2,250 of compensation cost over the
remaining year of service attributable to the original
options. Therefore, total compensation cost associated with
these options is $11,000 ($9,000 grant-date fair-value-based
measure + $2,000 incremental fair-value-based measure)
recorded over four years of required service for both the
original and modified options.
Example
6-2
Assume all the same facts as in the example above, except that the options
contain a graded vesting schedule (i.e., 25 percent of the
options vest at the end of each year of service). In
accordance with the accounting policy it has elected under
ASC 718-10-35-8, A records compensation cost on a
straight-line basis over the total requisite service period
for the entire award.
For the first three years of service, Entity A records $6,750 (1,000 options ×
$9 grant-date fair-value-based measure × 75% for three of
four years of services rendered) of cumulative compensation
cost. On the date of modification, A computes the
incremental compensation cost as $2,000, or ($6
fair-value-based measure of modified options – $4
fair-value-based measure of original options immediately
before the modification) × 1,000 options. Entity A records
$1,500 of incremental compensation cost immediately because
75 percent of the options have vested.
The remaining
$500 of incremental compensation cost is recorded over the
remaining year of service. In addition, A records the
remaining $2,250 of compensation cost over the remaining
year of service attributable to the original options.
Therefore, total compensation cost associated with these
options is $11,000 ($9,000 grant-date fair-value-based
measure + $2,000 incremental fair-value-based
measure).
Example
6-3
Entity B grants to its employees RSUs that are classified as equity and have a
fair-value-based measure of $1 million on the grant date.
Before the awards vest, B subsequently modifies them to add
a contingent fair-value repurchase feature on the underlying
shares. Assume that the addition of the repurchase feature
does not change the
fair-value-based measure of the awards or their
classification and that the fair-value-based measure on the
modification date is $1.5 million (both immediately before
and after the modification). In addition, there are no other
changes to the awards (including their vesting conditions).
In accordance with ASC 718-20-35-2A, B would not apply
modification accounting because the fair-value-based
measure, vesting conditions, and classification of the
awards are the same immediately before and after the
modification. Accordingly, irrespective of whether the
awards are expected to vest on the modification date, any
compensation cost recognized will continue to be based on
the grant-date fair-value-based measure of $1 million.
6.1.1 The Fair Value Assessment
Modification accounting is not required if certain conditions
are met, one of which is that the fair-value-based measure (or calculated value
or intrinsic value if such an alternative measurement method is used) must be
the same immediately before and after the modification.
6.1.1.1 Determining Whether a Fair Value Calculation Is Required
An entity will not always need to estimate the
fair-value-based measure of a modified award. An entity might instead be
able to determine whether the modification affects any of the inputs used in
the valuation technique performed for the award. For example, if an entity
changes the net-settlement terms of its share-based payment arrangements
related to statutory tax withholding requirements, that change is not likely
to affect any inputs used to value the awards. If none of the inputs are
affected, the entity would not be required to estimate the fair-value-based
measure immediately before and after the modification (i.e., the entity
could conclude that the fair-value-based measure is the same).
6.1.1.2 Considering Whether Compensation Cost Recognized Has Changed
The evaluation of whether the fair-value-based measure has
changed should not be based on whether the compensation cost recognized has
changed. If an entity makes a modification that changes the fair-value-based
measure of an award, modification accounting would be applied. An entity’s
assessment of whether to apply modification accounting does not take into
account a change in recognized compensation cost. For example, if a
modification changes the fair-value-based measure of an award but it is not
probable that the award will vest both immediately before and after the
modification (a “Type IV improbable-to-improbable” modification), there may
be no change in compensation cost recognized on the modification date
because there is no compensation cost before and after the modification
(compensation cost is recognized only if it is probable that the award will
vest). However, modification accounting would be required (and a new
measurement determined as of the modification date) because the
fair-value-based measure has changed; the new measurement should be used if
it becomes probable that the modified award will subsequently vest.
6.1.1.3 Determining the Unit of Account
In paragraphs BC19 and BC20 of ASU 2017-09, the
FASB discusses the unit of account an entity would apply in determining
whether an award’s fair-value-based measure is the same immediately before
and after a modification. The discussion addresses questions from
stakeholders about whether an entity should compare the value of an award
immediately before and after a modification on the basis of (1) “the total
instruments in an award to [a grantee] that are modified” or (2) “each
individual instrument awarded to [a grantee] that is modified.” The Board
indicates that the unit of account should be consistent with that applied
under other guidance in ASC 718 and with the definition of an award in the
ASC master glossary. That is, an entity should use as the unit of account
the total of all modified instruments in the award rather than each
individual modified instrument awarded to the grantee.
Example 6-4
Entity C grants 10,000 stock options that become
significantly out-of-the-money after the grant date.
To retain the award’s original fair value, C
modifies it by lowering the options’ exercise price
and reducing their quantity to 5,000. If C were to
compare the fair-value-based measure of a single
stock option in the original award immediately
before the modification with the fair-value-based
measure of a single stock option in the modified
award immediately after the modification, the
measure immediately before would be less than the
measure immediately after the modification. If a
single stock option were the unit of account, C
would be required to apply modification accounting.
However, C must base its assessment on the ASC
master glossary’s definition of an award. Although
this award contains multiple instruments, the unit
of account on which C performs the fair value
assessment is the total of all modified instruments
awarded to the employee. Accordingly, C compares the
fair-value-based measure of the original 10,000
stock options with the fair-value-based measure of
the modified 5,000 stock options. In accordance with
ASC 718-20-35-2A, C would not apply modification
accounting if the fair-value-based measure, vesting
conditions, and classification of the awards are the
same immediately before and after the
modification.
Example 6-5
Entity D grants 1,000 equity-classified stock options to an employee. All 1,000
options are granted at the same time and contain the
same terms and conditions. In accordance with the
definition of “award” in the ASC master glossary,
the employee’s award consists of 1,000 options.
After the grant date, the options become
significantly out-of-the-money, so D decides to
reprice 500 of them by reducing their exercise
price. However, D retains the original exercise
price for the other 500 options. Accordingly, the
500 modified options are now the award as well as
the unit of account in D’s assessment of whether it
must apply modification accounting. Because the
fair-value-based measure of the 500 modified options
has increased, D applies modification accounting.
However, because the other 500 stock options were
not modified, that portion of the award is not
subject to modification accounting and continues to
be recognized on the basis of its grant-date
fair-value-based measure. While all 1,000 stock
options were the award and the unit of account when
granted, only the 500 modified stock options are the
award and the unit of account for modification
accounting purposes because they were the only
instruments modified. In accordance with the
definition of “award” in the ASC master glossary,
“[r]eferences to an award also apply to a portion of
an award.”
6.1.1.4 Determining Whether the Fair Value Is the Same Before and After Modification
In determining whether modification accounting is
appropriate, some practitioners have expressed uncertainty about whether the
fair-value-based measure of an award must be exactly the same
immediately before and after the modification (i.e., a binary assessment) or
whether they can apply judgment on the basis of the significance of the
change in the fair-value-based measure. The FASB explained in ASU 2017-09
that it decided not to establish specific requirements regarding the use of
judgment in this assessment, observing that entities must use judgment to
apply other aspects of ASC 718 and do so without relying on specific
guidance. Accordingly, an entity may need to use judgment in certain
circumstances to determine whether the fair-value-based measure of an award
is the same immediately before and after a modification. For example, as a
result of using judgment, an entity may reasonably conclude that the
fair-value-based measure is the same when a difference is de minimis and the
facts and circumstances indicate that the intent of the modification was to
retain the award’s original fair value.
Example 6-6
Entity E grants to an employee 1,000 equity-classified stock options that become
significantly out-of-the-money after the grant date.
To retain the award’s original fair value, E decides
to replace the 1,000 stock options with 423 RSUs.
The fair-value-based measure of the 1,000 stock
options immediately before the modification is
$100,000, and the fair-value-based measure of the
423 RSUs is $100,010. The difference is de minimis
and solely attributable to E’s having rounded up the
423 RSUs, which E does because it is precluded from
issuing fractional shares. Accordingly, E concludes
that the fair-value-based measure of the award is
the same immediately before and after the
modification.
6.1.2 Examples of Changes for Which Modification Accounting Would or Would Not Be Required
The Background Information and Basis for Conclusions of ASU
2017-09 provides examples (that “are educational in nature, are not
all-inclusive, and should not be used to override the guidance in paragraph
718-20-35-2A”) of changes to awards for which modification accounting generally
would or would not be required. The table below summarizes those examples.
|
Examples of Changes for Which Modification Accounting
Would Not Be Required
|
Examples of Changes for Which Modification Accounting
Would Be Required
|
|---|---|
|
|
Share-based payment plans commonly contain clawback provisions
that allow an entity to recoup awards upon certain contingent events (e.g.,
termination for cause, violation of a noncompete provision, material financial
statement restatement), as discussed in Section 3.9. Under ASC 718-10-30-24, such clawback provisions
generally are not reflected in estimates of the fair-value-based measure of
awards. Accordingly, the addition of a clawback provision to an award would
typically not result in the application of modification accounting because such
clawbacks generally do not change the award’s fair-value-based measure, vesting
conditions, or classification.
Example 6-7
Entity F grants 100,000 equity-classified stock options
to its CEO. A year after the grant date, F modifies the
award to add a well-defined, objective, and
nondiscretionary clawback provision related to a
material restatement of F’s financial statements. Entity
F concludes that the modification does not change the
award’s fair-value-based measure, vesting conditions, or
classification. In assessing whether the award’s
fair-value-based measure changes as a result of the
modification, F determines that the addition of the
clawback provision does not affect any of the inputs
used in the valuation technique since clawback
provisions generally are not reflected in estimates of
the fair-value-based measure of awards. As a result, F
concludes that it is not required to apply modification
accounting.
6.1.3 Tax Effects of Award Modifications
Modification of a share-based payment plan may have unintended tax
consequences. For example, a modification may affect the U.S. federal tax treatment
of a nonstatutory option (i.e., an NQSO) under IRC Section 409A, which could have
significant tax consequences for the grantee of the share-based payment award (see
Section 4.12.2 for
additional information on nonstatutory options and IRC Section 409A) or result in a
disqualifying event of an ISO (see Section 6.5.1.2).
In addition, modification of a share-based payment plan may change
the deductibility of awards issued to a “covered employee” under IRC Section 162(m)
and how the limitations are applied for income tax purposes. IRC Section 162(m)
applies differently to (1) compensation arrangements entered into before November 2,
2017 (that have not been materially modified on or after that date), and (2)
compensation arrangements entered into on or after November 2, 2017. Compensation
arrangements that were in place before this date are effectively “grandfathered”
(i.e., legacy requirements apply). However, if a modification occurs on or after
this date, the award may no longer qualify for this exception. See Section 10.2.3 of Deloitte’s
Roadmap Income
Taxes for additional information.
Given the potential for unintended tax consequences associated with
modifications to share-based payment plans, entities are urged to consult with their
tax advisers.
Footnotes
1
Compare calculated value or intrinsic value, rather than
fair value, if such an alternative measurement method is used. See
Section
6.1.1 for additional discussion of the determination of
whether the fair value (or calculated or intrinsic value) of the
modified award equals that of the original award immediately before the
change occurs in the terms and conditions of the agreement.