6.11 Cancellations

ASC 718-20

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.

35-9 A cancellation of an award that is not accompanied by the concurrent grant of (or offer to grant) a replacement award or other valuable consideration shall be accounted for as a repurchase for no consideration. Accordingly, any previously unrecognized compensation cost shall be recognized at the cancellation date.

A cancellation may be accompanied by a concurrent grant of (or offer to grant) a new (or replacement) award. Because the entity is in effect granting (or offering to grant) an award to replace the canceled award, a cancellation accompanied by a concurrent grant of (or offer to grant) a replacement award is accounted for in the same manner as a modification. That is, the entity must record the incremental value, if any, conveyed to the holder of the award as compensation cost on the cancellation date (for vested awards) or over the remaining employee requisite service period or nonemployee’s vesting period (for unvested awards). The incremental compensation cost is the excess of the fair-value-based measure of the replacement award over the fair-value-based measure of the canceled award on the cancellation date.

By contrast, a cancellation without a concurrent replacement is viewed as the settlement of an award for no consideration. As a result, if an entity (or grantee) cancels an unvested award without a replacement award, any remaining unrecognized compensation cost would generally be recognized immediately on the cancellation date. Note that a cancellation differs from a forfeiture. As discussed in Section 3.4.1, a forfeiture represents an award for which the employee’s requisite service is not rendered or the nonemployee’s goods or services are not delivered (e.g., because of termination of employment or termination of an arrangement with a nonemployee). Therefore, an award that will not vest because of the grantee’s inability to satisfy a service condition is accounted for as a forfeiture rather than as a cancellation.

A cancellation, however, represents an award for which the employee’s requisite service is expected to be rendered or the nonemployee’s goods or services is expected to be provided but is canceled. Accordingly, for a forfeiture, an entity reverses any compensation cost that it has previously recognized, whereas it does not reverse any previously recognized compensation for a cancellation. As noted above, any remaining unrecognized compensation cost is generally recognized immediately on the cancellation date.

Example 6-35

On January 1, 20X1, Entity A grants 1,000 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 cancels the options and concurrently issues replacement options. The service period of the replacement options covers the remaining one-year service period of the canceled options. The fair-value-based measure of the replacement award is $7, and the fair-value-based measure of the canceled award is $4 on the date of cancellation.

During the first three years of service, A records cumulative compensation cost of $6,750 (1,000 options × $9 grant-date fair-value-based measure × 75% for three of four years of services rendered). On the cancellation date (i.e., the modification date), A computes the incremental compensation cost as $3,000, or ($7 fair-value-based measure of replacement options – $4 fair-value-based measure of canceled options on the date of cancellation) × 1,000 options. The $3,000 incremental compensation cost is recorded over the remaining year of service of the replacement options. In addition, A records the remaining $2,250 of compensation cost over the remaining year of service attributable to the canceled options. Therefore, total compensation cost associated with these options is $12,000 ($9,000 grant-date fair-value-based measure + $3,000 incremental fair-value-based measure) recorded over four years of required service for both the canceled and replacement options.

Example 6-36

Assume all the same facts as in the example above, except that Entity A cancels the original options with no concurrent issuance of (or offer to issue) replacement options. Six months later, A issues 1,000 new at-the-money employee stock options, each with a grant-date fair-value-based measure of $12. The options vest over the remaining six-month service period attributable to the canceled options.

During the first three years of service, A records cumulative compensation cost of $6,750 (1,000 options × $9 grant-date fair-value-based measure × 75% for three of four years of services rendered). On the cancellation date, the options are treated as though they are fully vested. Accordingly, A records the remaining $2,250 of compensation cost attributable to the canceled options. Therefore, total compensation cost associated with the canceled options is the $9,000 grant-date fair-value-based measure.

For the options issued six months later, A records $12,000 (1,000 options × $12 grant-date fair-value-based measure) of compensation cost over the remaining six-month service period of the options. Therefore, total compensation cost associated with these options is the $12,000 grant-date fair-value-based measure.

Because A did not account for the cancellation of the original options and issuance of the new options as a cancellation and concurrent replacement (and therefore did not apply modification accounting), A records total compensation cost of $21,000 (i.e., $9,000 for the canceled options and $12,000 for the options issued six months later). By contrast, if A had canceled and replaced the original options concurrently for options worth $12 per option (and therefore modification accounting was applied), A would record only total compensation cost of $17,000, which is equal to the grant-date fair-value-based measure of the canceled options ($9,000) and the incremental value conveyed to the holders of the replacement options ($8,000), or ($12 fair-value-based measure of replacement options – $4 fair-value-based measure of canceled options on the date of cancellation) × 1,000 options.

Example 6-37

Assume all the same facts as in Example 6-35, except that on January 1, 20X4, Entity A’s stock price is significantly less than the strike price, and the options are out-of-the-money. In addition, the grantee (an executive-level officer) voluntarily agrees to cancel all 1,000 stock options because they are not material to the executive’s overall compensation and she would like the shares to be used to grant new employee awards under A’s stock incentive plan (rather than modifying the existing award to adjust the options’ strike price).

The “return” of the options is voluntary; it is not caused by the employee’s inability to satisfy the service condition and vest in the awards (i.e., employment was not terminated, and it is assumed that the requisite services would have otherwise been rendered over the vesting period). Therefore, the return of the unvested options is treated as a cancellation rather than a forfeiture. As a result, the remaining unrecognized compensation cost of $2,250 (remaining 25 percent of compensation cost that would have been recognized in 20X4) is recognized upon cancellation of the options, and the previously recorded compensation cost of $6,750 is not reversed.

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.