6.3 Impact of Vesting Conditions
ASC 718-20
Example 14: Modifications of Awards With Performance and Service Vesting Conditions
55-107 Paragraphs 718-10-55-60 through 55-63 note that awards may vest based on service conditions, performance conditions, or a combination of the two. Modifications of market conditions that affect exercisability or the ability to retain the award are not addressed by this Example. A modification of vesting conditions is accounted for based on the principles in paragraph 718-20-35-3; that is, total recognized compensation cost for an equity award that is modified 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. If awards are expected to vest under the original vesting conditions at the date of the modification, an entity shall recognize compensation cost if either of the following criteria is met:
- The awards ultimately vest under the modified vesting conditions
- The awards ultimately would have vested under the original vesting conditions.
55-108 In contrast, if at the date of modification awards are not expected to vest under the original vesting conditions, an entity should recognize compensation cost only if the awards vest under the modified vesting conditions. Said differently, if the entity believes that the original performance or service vesting condition is not probable of achievement at the date of the modification, the cumulative compensation cost related to the modified award, assuming vesting occurs under the modified performance or service vesting condition, is the modified award’s fair value at the date of the modification. The following Cases illustrate the application of those requirements:
- Type I probable to probable modification (Case A)
- Type II probable to improbable modification (Case B)
- Type III improbable to probable modification (Case C)
- Type IV improbable to improbable modification (Case D).
A modification that changes an award’s vesting conditions is accounted for in
the same manner as any other modification; that is, it is “treated as an exchange of
the original award for a new award” in accordance with ASC 718-20-35-3. Generally,
total recognized compensation cost of a modified award 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 met). Therefore, in many
circumstances, total recognized compensation cost attributable to an award that has
been modified is (1) the grant-date fair-value-based measure of the original award
for which the vesting conditions have been met (i.e., the number of awards that have
been earned) or is expected to be met and (2) the incremental compensation cost
conveyed to the holder of the award as a result of the modification.
If, on the date of modification, it is expected (probable) that an award will
vest under its original vesting conditions, an entity records compensation cost if
it determines that the award ultimately (1) vests under the modified vesting
conditions or (2) would have vested under the original vesting conditions. That is,
for a modification of an award whose vesting was probable under the original vesting
conditions on the modification date, an entity that is determining the ultimate
compensation to recognize would need to consider not only whether the award actually
vests under the modified vesting conditions but also whether the award would have
vested under its original terms. See Type I and Type II modifications in the table
below.
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By contrast, if it is not expected
(improbable) on the date of modification that the award will
vest under its original vesting conditions, an entity
records compensation cost only if the award vests under the
modified vesting conditions. That is, if the entity did not
expect an award to vest on the basis of the original vesting
conditions on the date of modification, it would not have
recorded any cumulative compensation cost. If the award
vests under the modified vesting conditions, total
recognized compensation cost is based on the number of
awards that vest under the modified vesting conditions and
the fair-value-based measure of the modified award on the
date of modification. The grant-date fair-value-based
measure of the original award is not considered. See Type
III and Type IV modifications in the table below.
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The various types of modifications, their accounting results, and the basis for
recognition of compensation cost are summarized in the table below (along with
cross-references to the applicable implementation guidance in ASC 718-20-55 and
Deloitte guidance).
Type of Modification | Accounting Result | Basis for Recognition of Compensation Cost | ASC 718 Guidance | Deloitte Guidance |
|---|---|---|---|---|
Probable-to-probable (Type I modification) | Record compensation cost if the award ultimately (1) vests under the modified
terms or (2) would have vested under the original terms | Grant-date fair-value-based measure plus incremental fair-value-based measure conveyed on the modification date, if any | ASC 718-20-55-111 and 55-112 | |
Probable-to-improbable (Type II modification) | Record compensation cost if the award ultimately (1) vests under the original
terms or (2) would have vested under the modified terms | Grant-date fair-value-based measure plus incremental fair-value-based measure conveyed on the modification date, if any | ASC 718-20-55-113 through 55-115 | See Section 6.3.2
for an example in
ASC 718-20 (Type
II modifications
are expected to
be rare) |
Improbable-to-probable (Type III modification) | Record compensation cost if the award vests under the modified terms | Modification-date fair-value-based measure | ASC 718-20-55-116 and 55-117 | |
Improbable-to-improbable (Type IV modification) | Record compensation cost if the award vests under the modified terms | Modification-date fair-value-based measure | ASC 718-20-55-118 and 55-119 |
Section 6.3.7 addresses the unit-of-account
determination in the assessment of modification type.
6.3.1 Probable to Probable Modifications
The example below is based on the same facts as in Example 1 in ASC 718-20-55-4
through 55-9 (see Section
6.1).
ASC 718-20
Example 14: Modifications of Awards With Performance and Service Vesting Conditions
55-109 Cases A through D are all based on the same scenario: Entity T grants 1,000 share options to each of 10 employees in the sales department. The share options have the same terms and conditions as those described in Example 1 (see paragraph 718-20-55-4), except that the share options specify that vesting is conditional upon selling 150,000 units of product A (the original sales target) over the 3-year explicit service period. The grant-date fair value of each option is $14.69 (see paragraph 718-20-55-9). For simplicity, this Example assumes that no forfeitures will occur from employee termination; forfeitures will only occur if the sales target is not achieved. Example 15 (see paragraph 718-20-55-120) provides an additional illustration of a Type III modification.
55-109A
Cases A through D (see paragraphs 718-20-55-111 through
55-119) describe employee awards because the Cases use
the terms and conditions of the employee awards
presented as part of Example 1 of this Subtopic (see
paragraph 718-20-55-4). However, the principles about
determining the cumulative amount of compensation cost
that an entity should recognize because of a
modification to an employee award provided in Cases A
through D are the same for nonemployee awards that are
modified. Consequently, the guidance in paragraphs
718-20-55-111 through 55-119 should be applied to
determine the cumulative amount of compensation cost
that an entity should recognize because of a
modification to a nonemployee award.
55-109B Any additional
compensation cost should be recognized by applying the
guidance in paragraph 718-10-25-2C. That is, an asset or
expense must be recognized (or previous recognition
reversed) in the same period(s) and in the same manner
as if the grantor had paid cash for the goods or
services instead of paying with or using the share-based
payment awards. 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.
55-110 Cases A through D assume that the options are out-of-the-money when modified; however, that fact is not determinative in the illustrations (that is, options could be in- or out-of-the-money).
Case A: Type I Probable to Probable Modification
55-111 Based on historical sales patterns and expectations related to the future, management of Entity T believes at the grant date that it is probable that the sales target will be achieved. On January 1, 20X7, 102,000 units of Product A have been sold. During December 20X6, one of Entity T’s competitors declared bankruptcy after a fire destroyed a factory and warehouse containing the competitor’s inventory. To push the salespeople to take advantage of that situation, the award is modified on January 1, 20X7, to raise the sales target to 154,000 units of Product A (the modified sales target). Notwithstanding the nature of the modification’s probability of occurrence, the objective of this Case is to demonstrate the accounting for a Type I modification. Additionally, as of January 1, 20X7, the options are out-of-the-money because of a general stock market decline. No other terms or conditions of the original award are modified, and management of Entity T continues to believe that it is probable that the modified sales target will be achieved. Immediately before the modification, total compensation cost expected to be recognized over the 3-year vesting period is $146,900 or $14.69 multiplied by the number of share options expected to vest (10,000). Because no other terms or conditions of the award were modified, the modification does not affect the per-share-option fair value (assumed to be $8 in this Case at the date of the modification). Moreover, because the modification does not affect the number of share options expected to vest, no incremental compensation cost is associated with the modification.
55-112 This paragraph illustrates the cumulative compensation cost Entity T should recognize for the modified award based on three potential outcomes:
- Outcome 1 — achievement of the modified sales target. In Outcome 1, all 10,000 share options vest because the salespeople sold at least 154,000 units of Product A. In that outcome, Entity T would recognize cumulative compensation cost of $146,900.
- Outcome 2 — achievement of the original sales target. In Outcome 2, no share options vest because the salespeople sold more than 150,000 units of Product A but less than 154,000 units (the modified sales target is not achieved). In that outcome, Entity T would recognize cumulative compensation cost of $146,900 because the share options would have vested under the original terms and conditions of the award.
- Outcome 3 — failure to achieve either sales target. In Outcome 3, no share options vest because the modified sales target is not achieved; additionally, no share options would have vested under the original terms and conditions of the award. In that case, Entity T would recognize cumulative compensation cost of $0.
Example 6-8
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 only if
A’s cumulative net income over the succeeding four-year
period is greater than $5 million. Because the options
are expected to vest, A begins to recognize compensation
cost on a straight-line basis over the four-year service
period. See the journal entries below.
On January 1, 20X4, A believes that it is probable that the performance condition will be achieved. To provide additional retention incentives to the employees for the fourth year of service, A modifies the performance condition to decrease the cumulative net-income target to $4.5 million. After the modification, A continues to believe that the options are expected to vest on the basis of the revised cumulative net income target. The modification does not affect any of the options’ other terms or conditions.
If the modified performance condition ($4.5 million) is subsequently met, A will
ultimately record total compensation cost ($9,000) on
the basis of the number of options expected to vest
(1,000 options if there are no forfeitures) and the
grant-date fair-value-based measure of the options of $9
over the vesting period.2 Because the modification does not affect any of
the options’ other terms or conditions, presumably the
fair-value-based measure before and after the
modification will be the same. Accordingly, there is no
incremental value conveyed to the holder of the options
and, therefore, no incremental compensation cost has to
be recorded in connection with this modification. See
the journal entry below.
Alternatively, if the modified performance condition ($4.5 million) is not
subsequently met, the options would not have vested
under either the original or the modified terms.
Accordingly, A should not recognize any cumulative
compensation cost for these options (i.e., any
previously recognized compensation cost should be
reversed). See the journal entry below.
6.3.2 Probable-to-Improbable Modifications
As discussed in Section 6.1, share-based
payment awards are designed to incentivize (rather than disincentivize)
employees. In addition, the legal form of share-based payment awards may prevent
modification without the consent of the grantee. Therefore, a company is not
likely to make a change in a vesting condition that would result in a Type II
(probable-to-improbable) modification, and for this reason, such modifications
are rare.
The example below is based on the same facts as in ASC 718-20-55-109 through
55-110 (see Section
6.3.1).
ASC 718-20
Example 14: Modifications of Awards With Performance and Service Vesting Conditions
Case B: Type II Probable to Improbable Modification
55-113 It is generally believed that Type II modifications will be rare; therefore, this illustration has been provided for the sake of completeness. Based on historical sales patterns and expectations related to the future, management of Entity T believes that at the grant date, it is probable that the sales target (150,000 units of product A) will be achieved. At January 1, 20X7, 102,000 units of product A have been sold and the options are out-of-the-money because of a general stock market decline. Entity T’s management implements a cash bonus program based on achieving an annual sales target for 20X7. The options are neither cancelled nor settled as a result of the cash bonus program. The cash bonus program would be accounted for using the same accounting as for other cash bonus arrangements. Concurrently, the sales target for the option awards is revised to 170,000 units of Product A. No other terms or conditions of the original award are modified. Management believes that the modified sales target is not probable of achievement; however, they continue to believe that the original sales target is probable of achievement. Immediately before the modification, total compensation cost expected to be recognized over the 3-year vesting period is $146,900 or $14.69 multiplied by the number of share options expected to vest (10,000). Because no other terms or conditions of the award were modified, the modification does not affect the per-share-option fair value (assumed in this Case to be $8 at the modification date). Moreover, because the modification does not affect the number of share options expected to vest under the original vesting provisions, Entity T would determine incremental compensation cost in the following manner.
55-114 In determining the fair value of the modified award for this type of modification, an entity shall use the greater of the options expected to vest under the modified vesting condition or the options that previously had been expected to vest under the original vesting condition.
55-115 This paragraph illustrates the cumulative compensation cost Entity T should recognize for the modified award based on three potential outcomes:
- Outcome 1 — achievement of the modified sales target. In Outcome 1, all 10,000 share options vest because the salespeople sold at least 170,000 units of Product A. In that outcome, Entity T would recognize cumulative compensation cost of $146,900.
- Outcome 2 — achievement of the original sales target. In Outcome 2, no share options vest because the salespeople sold more than 150,000 units of Product A but less than 170,000 units (the modified sales target is not achieved). In that outcome, Entity T would recognize cumulative compensation cost of $146,900 because the share options would have vested under the original terms and conditions of the award.
- Outcome 3 — failure to achieve either sales target. In Outcome 3, no share options vest because the modified sales target is not achieved; additionally, no share options would have vested under the original terms and conditions of the award. In that case, Entity T would recognize cumulative compensation cost of $0.
6.3.3 Improbable-to-Probable Modifications
The example below is based on the same facts as in ASC 718-20-55-109 through
55-110 (see Section
6.3.1).
ASC 718-20
Example 14: Modifications of Awards With Performance and Service Vesting Conditions
Case C: Type III Improbable to Probable Modification
55-116 Based on historical sales patterns and expectations related to the future, management of Entity T believes at the grant date that none of the options will vest because it is not probable that the sales target will be achieved. On January 1, 20X7, 80,000 units of Product A have been sold. To further motivate the salespeople, the sales target (150,000 units of Product A) is lowered to 120,000 units of Product A (the modified sales target). No other terms or conditions of the original award are modified. Management believes that the modified sales target is probable of achievement. Immediately before the modification, total compensation cost expected to be recognized over the 3-year vesting period is $0 or $14.69 multiplied by the number of share options expected to vest (zero). Because no other terms or conditions of the award were modified, the modification does not affect the per-share-option fair value (assumed in this Case to be $8 at the modification date). Since the modification affects the number of share options expected to vest under the original vesting provisions, Entity T will determine incremental compensation cost in the following manner.
55-117 This paragraph illustrates the cumulative compensation cost Entity T should recognize for the modified award based on three potential outcomes:
- Outcome 1 — achievement of the modified sales target. In Outcome 1, all 10,000 share options vest because the salespeople sold at least 120,000 units of Product A. In that outcome, Entity T would recognize cumulative compensation cost of $80,000.
- Outcome 2 — achievement of the original sales target and the modified sales target. In Outcome 2, Entity T would recognize cumulative compensation cost of $80,000 because in a Type III modification the original vesting condition is generally not relevant (that is, the modified award generally vests at a lower threshold of service or performance).
- Outcome 3 — failure to achieve either sales target. In Outcome 3, no share options vest because the modified sales target is not achieved; in that case, Entity T would recognize cumulative compensation cost of $0.
Example 6-9
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 only if
A’s cumulative net income over the succeeding four-year
period is greater than $5 million. Entity A believes
that it is probable that the performance condition will
be met (i.e., the options are expected to vest).
Accordingly, A begins to recognize compensation cost on
a straight-line basis over the four-year service period.
See the journal entries below.
On December 31, 20X3, on the basis of its financial performance over the preceding three years, A does not believe that it is probable that the performance condition will be met (i.e., the options are not expected to vest). Accordingly, A should reverse any previously recognized compensation cost associated with these options. That is, because A does not expect the options to vest, cumulative recognized compensation cost as of December 31, 20X3, is zero (0 options expected to vest × $9 grant-date fair-value-based measure):
On January 1, 20X4, to restore retention incentives to employees for the fourth year of service, A modifies the performance condition to decrease the cumulative net income target to $3 million. The fair-value-based measure of the modified award as of the modification date is $12. After the modification, A believes that the options are expected to vest on the basis of the revised cumulative net income target. The modification does not affect any of the award’s other terms or conditions. Accordingly, A will record total compensation cost ($12,000) on the basis of the number of options expected to vest (1,000 options if there are no forfeitures) and the modification-date fair-value-based measure of the options of $12 over the remaining year of service. As demonstrated in Case C of Example 14 in ASC 718-20-55-116 and 55-117, since it is improbable that the options will vest before the modification, the compensation cost is based on the modification-date fair-value-based measure of the modified options. See the journal entries below.
Alternatively, if the modified performance condition ($3 million) subsequently
is not met, the options will not vest, and A should not
recognize any cumulative compensation cost for them
(i.e., it should reverse any compensation cost related
to the modified award that was previously recognized in
20X4).
The example below illustrates the accounting for an award that is modified to
continue vesting in conjunction with a termination of employment.
ASC 718-20
Example 15: Illustration of a Type III Improbable to Probable Modification
55-120 This Example illustrates the guidance in paragraph 718-20-35-3.
55-120A
This Example (see paragraph 718-20-55-121) describes
employee awards. However, the principle provided in
paragraph 718-20-55-121 is the same for nonemployee
awards that are modified. Consequently, that guidance
should be applied to determine the cumulative amount of
compensation cost, if any, that an entity should
recognize because of a modification to a nonemployee
award.
55-120B
Any additional compensation cost should be recognized by
applying the guidance in paragraph 718-10-25-2C. That
is, an asset or expense must be recognized (or previous
recognition reversed) in the same period(s) and in the
same manner as if the grantor had paid cash for the
goods or services instead of paying with or using the
share-based payment awards. Additionally, valuation
amounts used in this Example 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.
55-121 On January 1, 20X7, Entity Z issues 1,000 at-the-money options with a 4-year explicit service condition to each of 50 employees that work in Plant J. On December 12, 20X7, Entity Z decides to close Plant J and notifies the 50 Plant J employees that their employment relationship will be terminated effective June 30, 20X8. On June 30, 20X8, Entity Z accelerates vesting of all options. The grant-date fair value of each option is $20 on January 1, 20X7, and $10 on June 30, 20X8, the modification date. At the date Entity Z decides to close Plant J and terminate the employees, the service condition of the original award is not expected to be satisfied because the employees cannot render the requisite service. Because Entity Z’s accounting policy is to estimate the number of forfeitures expected to occur in accordance with paragraph 718-10-35-3, any compensation cost recognized before December 12, 20X7, for the original award would be reversed. At the date of the modification, the fair value of the original award, which is $0 ($10 × 0 options expected to vest under the original terms of the award), is subtracted from the fair value of the modified award $500,000 ($10 × 50,000 options expected to vest under the modified award). The total recognized compensation cost of $500,000 will be less than the fair value of the award at the grant date ($1 million) because at the date of the modification, the original vesting conditions were not expected to be satisfied. If Entity Z’s accounting policy was to account for forfeitures when they occur in accordance with paragraph 718-10-35-3, then compensation cost recognized before December 12, 20X7, would not be reversed until the award is forfeited. However, Entity Z would be required to assess at the date of the modification whether the performance or service conditions of the original award are expected to be satisfied.
6.3.3.1 Modification in Connection With a Change in Status
When a grantee’s employment status changes, an entity must consider whether
the grantee continues to provide substantive ongoing services as part of the
status change. It is common for an employee to terminate his or her
employment and enter a nonemployee consultant contract that allows the
grantee to continue to vest in his or her existing awards. Often, the terms
of the existing awards also permit the employee to continue to vest in such
awards upon a change in employment status (e.g., employee to a nonemployee
consultant). In these circumstances, an entity should evaluate the substance
of the ongoing services to determine whether the existing awards have been
modified under ASC 718. When determining whether the ongoing services are
substantive, an entity should consider whether the consultant has specific
duties and deliverables that are subject to management supervision and
oversight during the consulting term. Ongoing services that are generally
considered nonsubstantive include on-call consulting agreements for a
minimal number of hours per week (or per month) to transition the employee’s
replacement or to respond to questions raised by the entity.
Example 6-10
On January 1, 20X1, Entity A granted stock options to
its CEO that vest over four years on the basis of
the CEO’s continuous services. The terms of the
original equity plan permit the CEO to continue to
vest in the stock options upon a change in
employment status.
On January 1, 20X3, the CEO resigns and
contemporaneously enters into a separation and
consulting agreement that allows the CEO to continue
to vest in the stock options over the consulting
agreement’s term. While the consulting agreement
provides for a minimal number of hours of on-call
services per month to transition the CEO’s
replacement, A does not expect the CEO‘s replacement
to significantly use the former CEO’s consulting
services. That is, the consulting agreement was
executed primarily for protective purposes (i.e., to
minimize disruptions in A’s day-to-day business
operations during the transition period). Entity A
therefore concludes that the consulting services are
nonsubstantive.
The above transaction is accounted for as an
improbable-to-probable modification (Type III).
While the original equity plan permits the CEO to
continue to vest in the awards upon a change in
employment status (e.g., converting from an employee
to a consultant), the modification conclusion should
be based on the substance of the future services
provided under the consulting agreement rather than
the legal form of the original plan documents.
A similar conclusion would be reached if the CEO’s
employment status was retained but the CEO continued
to vest in the original award even though the CEO
was longer required to provide services to the
entity (e.g., did not have to report to work and had
no ongoing work responsibilities or employment
activities).
6.3.3.2 Modification in Connection With a Termination — Entity Elects to Estimate Forfeitures
As discussed above, for an entity that has a policy of
estimating forfeitures in accordance with ASC 718-10-35-3, any previously
recognized compensation cost is reversed if a grantee is expected to
terminate employment or a nonemployee arrangement to provide goods or
services and the vesting requirements in an award are no longer expected to
be met. If the award is modified to accelerate vesting, compensation cost
will be recognized on the basis of the modification-date fair-value-based
measure of the award.
Example 6-11
On January 1, 20X1, Entity A grants
1,000 equity-classified at-the-money employee stock
options to its CEO, each with a grant-date
fair-value-based measure of $9. The options vest if
the CEO is employed for a five-year period (cliff
vesting). In addition, A has a policy of estimating
forfeitures, and it recognizes compensation cost on
a straight-line basis over the five-year service
period. Entity A records the following journal entry
each year:
On July 1, 20X3, the CEO decides to
terminate employment. The CEO and A reach a
severance agreement that permits the CEO to vest in
the options upon termination as long as the CEO
continues to provide service through December 31,
20X3, while A searches for a new CEO. On July 1,
20X3, it is no longer probable that the service
condition of the original award will be met.
Accordingly, A should reverse previously recognized
compensation cost of $4,500 associated with the
original options (1,000 options × $9 grant-date
fair-value-based measure ÷ 5-year vesting period ×
2.5 years of service). That is, because A does not
expect the options to vest, cumulative recognized
compensation cost as of July 1, 20X3, should be zero
(0 options expected to vest × $9 grant-date
fair-value-based measure). See the journal entry
below.
The fair-value-based measure of the
modified award as of the modification date is $15.
The modification does not affect any of the other
terms or conditions of the award, and A believes
that the CEO will provide the requisite service
period of six months. Accordingly, A will record
total compensation cost of $15,000 on the basis of
the number of options expected to vest (1,000
options) and the modification-date fair-value-based
measure of the options of $15 over the remaining
service period (i.e., six months). Since it is
improbable that the options will vest before the
modification and probable that the options will vest
after the modification, compensation cost is based
on the modification-date fair-value-based measure of
the modified options. See the journal entry
below.
6.3.3.3 Modification in Connection With a Termination — Entity Elects to Account for Forfeitures When They Occur
As discussed in Section 3.4.1, ASC 718-10-35-3 permits
an entity to elect to account for forfeitures as they occur. However, the
vesting of an award upon the satisfaction of a service condition may become
improbable as a result of a planned future termination of employment or a
nonemployee arrangement to provide goods or services (e.g., a plant shutdown
or executive separation agreement). If the award is modified on the
termination date to accelerate vesting, previously recognized compensation
cost is not reversed until the termination date, and compensation cost will
continue to be recognized on the basis of the original award’s grant-date
fair-value-based measure until the termination date. On the termination and
modification date, previously recognized compensation cost is reversed, and
compensation cost is recognized on the basis of the modified award’s
modification-date fair-value-based measure.
However, an award may be modified before termination to
accelerate vesting upon the planned future termination event. On the basis
of discussions with the FASB staff, there are two acceptable views regarding
the accounting for these improbable-to-probable modifications:
-
View 1 — The original award is substantively forfeited upon modification. Because the award is modified and will be vested upon termination (i.e., the original award no longer exists and has been replaced by a new award), forfeiture does not occur on the termination date. In addition, the guidance in ASC 718-10-35-1D and ASC 718-10-35-3 allows entities to elect, as a policy, to account for forfeitures when they occur, but it was not intended to change the accounting for modifications. Therefore, previously recognized compensation cost for the original award should be reversed on the modification date. Compensation cost for the modified award should be determined on the basis of the modification-date fair-value-based measure and recognized over the employee’s remaining service period or nonemployee’s vesting period.
-
View 2 — A forfeiture of the original award has not occurred upon modification (i.e., since employment has not yet been terminated or the nonemployee arrangement has not yet been terminated, the original award is not forfeited). Previously recognized compensation cost should not be reversed on the modification date. Instead, the modification-date fair-value-based measure of the modified award less the previously recognized compensation cost should be recognized over the employee’s remaining service period or nonemployee’s vesting period. If the modification-date fair-value-based measure of the modified award is lower than the previously recognized compensation cost, no further compensation cost is recognized, and that difference should be reversed upon termination when forfeiture of the original award has occurred.
If an award whose vesting becomes improbable as a result of
a planned future termination is not modified, previously recognized
compensation cost should not be reversed, and compensation cost should
continue to be recognized until the award is forfeited (i.e., upon
termination). Upon termination, previously recognized compensation cost is
reversed.
Example 6-12
Assume the same facts as in
Example
6-11, except that Entity A has a policy
of recognizing forfeitures when they occur.
If A applies View 1 above, it would
record the same journal entries as it did in
Example
6-11.
If A applies View 2, it would
recognize compensation cost on a straight-line basis
over the five-year service period (as it did in
Example 6-11) and record the following
journal entry each year:
On July 1, 20X3, the award is
modified. Because the original award has not been
forfeited, previously recognized compensation cost
is not reversed. Entity A will recognize the
modification-date fair-value-based measure of the
modified award of $15,000 (1,000 options × $15
modification-date fair-value-based measure) less the
previously recognized compensation cost of $4,500
(1,000 options × $9 grant-date fair-value-based
measure ÷ 5-year vesting period × 2.5 years of
service) over the remaining service period (i.e.,
six months). See the journal entry below.
6.3.4 Improbable-to-Improbable Modification
The example below is based on the same facts as in ASC 718-20-55-109 through
55-110 (see Section
6.3.1).
ASC 718-20
Example 14: Modifications of Awards With Performance and Service Vesting Conditions
Case D: Type IV Improbable to Improbable Modification
55-118 Based on historical sales patterns and expectations related to the future, management of Entity T believes that at the grant date it is not probable that the sales target will be achieved. On January 1, 20X7, 80,000 units of Product A have been sold. To further motivate the salespeople, the sales target is lowered to 130,000 units of Product A (the modified sales target). No other terms or conditions of the original award are modified. Entity T lost a major customer for Product A in December 20X6; hence, management continues to believe that the modified sales target is not probable of achievement. Immediately before the modification, total compensation cost expected to be recognized over the 3-year vesting period is $0 or $14.69 multiplied by the number of share options expected to vest (zero). Because no other terms or conditions of the award were modified, the modification does not affect the per-share-option fair value (assumed in this Case to be $8 at the modification date). Furthermore, the modification does not affect the number of share options expected to vest; hence, there is no incremental compensation cost associated with the modification.
55-119 This paragraph illustrates the cumulative compensation cost Entity T should recognize for the modified award based on three potential outcomes:
- Outcome 1 — achievement of the modified sales target. In Outcome 1, all 10,000 share options vest because the salespeople sold at least 130,000 units of Product A. In that outcome, Entity T would recognize cumulative compensation cost of $80,000 (10,000 × $8).
- Outcome 2 — achievement of the original sales target and the modified sales target. In Outcome 2, Entity T would recognize cumulative compensation cost of $80,000 because in a Type IV modification the original vesting condition is generally not relevant (that is, the modified award generally vests at a lower threshold of service or performance).
- Outcome 3 — failure to achieve either sales target. In Outcome 3, no share options vest because the modified sales target is not achieved; in that case, Entity T would recognize cumulative compensation cost of $0.
Share-based payment awards may contain a performance condition that requires an
IPO to occur before the awards can vest. Compensation cost for such awards
typically is not recognized before the IPO because an IPO generally is not
considered probable until it occurs (see Section 3.4.2.1). Before and in
contemplation of the occurrence of an IPO, entities may modify the terms and
conditions of these types of awards. For example, an award that vests upon an
IPO and a specified service period could be modified to reduce the specified
service period. Although the modification is made in anticipation of the IPO, at
the time of the modification, compensation cost is not recognized because the
IPO has not yet occurred (i.e., it is still not probable that the award will
vest). However, the effects of the modification are measured on the modification
date. Since it is not probable that the original award and the modified award
will vest, the modification is considered a Type IV improbable-to-improbable
modification. As discussed above, when it is not probable as of the modification
date that an award will vest on the basis of its original terms, the original
grant-date fair-value-based measure of compensation cost is disregarded once the
modification is made. Instead, in accordance with ASC 718-20-55-108, any
compensation cost recognized once the IPO occurs will be based on the
modification-date fair-value-based measure.
Many modifications are made before an IPO but are not effective unless the IPO occurs. While the date on which a contingent modification is made is generally the modification date for compensation cost measurement purposes, the accounting consequence may not be recognized until the IPO’s effective date if the modification is contingent on the IPO’s occurrence. For example, an award could be modified to increase the quantity of underlying shares upon a successful IPO. In this circumstance, any additional compensation cost (as determined on the modification date) would not be recognized until the IPO is effective.
In addition, there could be circumstances in which changes associated with an award that are not modifications result in accounting consequences. For example, an entity could grant an equity-classified award with a repurchase feature that causes the award to be liability-classified. If the original terms contain a provision that the repurchase feature will expire upon an IPO, however, the award would be reclassified from liability to equity upon the IPO. See Section 5.9 for further discussion of changes in classification as a result of changes in probable settlement outcomes.
Example 6-13
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 only if A’s cumulative net
income over the succeeding four years is greater than $5
million and A completes an IPO. Entity A believes that
it is probable that the net income performance condition
will be met. However, because an IPO is generally not
considered probable until it occurs (see Section
3.4.2.1), A does not recognize any
compensation cost.
On January 1, 20X4, because its
financial performance has deteriorated, A modifies the
net income performance condition to decrease the
cumulative net income target to $4 million. The
modification does not affect any of the options’ other
terms or conditions. The fair-value-based measure of the
modified options as of the modification date is $12.
Even though A expects the revised net
income target to be met, an IPO has not yet occurred and
is therefore still not considered probable (i.e., the
options are not expected to vest). Accordingly, total
recognized compensation cost for the modified award is
zero (0 options expected to vest × $12 modification-date
fair-value-based measure). As demonstrated in Case D of
Example 14 in ASC 718-20-55-118 and 55-119, since it is
improbable that the options will vest before the
modification, compensation cost is based on the
modification-date fair-value-based measure of the
modified award.
Subsequently, if the modified net income
performance condition ($4 million net income) is met and
an IPO occurs, the options will vest. Accordingly, A
should recognize compensation cost of $12,000 on the
basis of the number of options vested (1,000 options if
there are no forfeitures) and the fair-value-based
measure of the modified options on the date of
modification ($12). See the journal entry below.
Example 6-14
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 only if
(1) A completes an IPO (performance condition) and (2) a
specified target IRR to shareholders is achieved (market
condition). Both conditions must be met for the
employees to earn the awards. Compensation cost should
not be recognized unless it is probable that the
performance condition will be met. Because an IPO
generally is not considered probable until it occurs, A
does not recognize any compensation cost.
On January 1, 20X2, A modifies the market condition by lowering the IRR target. On the modification date, the fair-value-based measure of each of the original options is $10, and the fair-value-based measure of each of the modified options is $13. The fair-value-based measure will incorporate the IRR target because a market condition is not a vesting condition. When an award contains a performance condition and it is not probable that the performance condition will be met before a modification, the original grant-date fair-value-based measure of compensation cost is disregarded, and only the modification-date fair-value-based measure is considered. Because an IPO has not yet occurred and is therefore still not considered probable (i.e., the options are not expected to vest), total recognized compensation cost for the modified award is zero (0 options expected to vest × $13 modification-date fair-value-based measure).
Entity A would ultimately recognize compensation cost on the basis of the modification-date fair-value-based measure of the modified award only when it becomes probable that the performance condition will be met (i.e., upon the occurrence of an IPO). On April 13, 20X4, A completes an IPO. Because the performance condition has now been met, A should recognize compensation cost of $13,000 on the basis of the number of options vested (1,000 options if there are no forfeitures) and the fair-value-based measure of the modified options on the date of modification ($13) irrespective of whether the IRR target is achieved. See the journal entry below.
6.3.5 Modifications to Accelerate Vesting of Deep Out-of-the-Money Stock Options
At-the-money stock option awards may become out-of-the-money awards because of declines in the value of the underlying shares. If the underlying shares’ value is severely depressed relative to the exercise price, the awards are considered “deep out-of-the-money.” If deep out-of-the-money stock option awards no longer offer sufficient retention motivation to grantees, entities may contemplate accelerating their vesting.
As indicated in ASC 718-10-55-67, the acceleration of the vesting of a deep out-of-the-money award granted to an employee is not substantive because the explicit service period is replaced with a derived service period (see Section 3.6.3 for a discussion of derived service periods). Accordingly, any remaining unrecognized compensation cost should not be recognized immediately, and an entity should generally continue to recognize such cost over the remaining original requisite service period.
To be an in-the-money award, the stock price of the award must, during the derived service period, increase to a level above the stock price on the grant date. Accordingly, the employee must continue to
work for the entity during the derived service period to receive any benefit from the stock option award because it is customary for awards to have features that limit exercisability upon termination (i.e., the term of the option typically truncates, such as 90 days after termination).
ASC 718 does not provide guidance on determining whether an accelerated stock
option award is deep out-of-the-money. An entity will therefore need to use
judgment and may consider, among other factors, those that affect the value of
the award (e.g., volatility of the underlying stock, exercise price, risk-free
rate) and time it will take for the award to become at-the-money. In addition,
an entity may calculate the derived service period of the modified award and
compare it with the original remaining service period to determine whether the
modification is substantive. If the derived service period approximates or is
longer than the original remaining service period, the modification would most
likely not be substantive. In certain situations, it may be clear that the award
is deep out-of-the-money.
While the guidance in ASC 718-10-55-67 addresses employee awards, it should be
applied by analogy to similar types of nonemployee awards.
Example 6-15
On January 1, 20X1, Entity A granted 100 equity-classified at-the-money stock
options to its employees, each with a grant-date
fair-value-based measure of $10. The awards vest at the
end of the fourth year of service (cliff vesting) and
have an exercise price of $20. Accordingly, A recognizes
compensation cost ratably over the four-year service
period. On January 1, 20X3, when the stock options are
deemed to be deep out-of-the-money, A modifies the
awards to accelerate their remaining service period.
Because the awards are considered deep out-of-the-money,
the acceleration of their remaining service period is
not substantive. Accordingly, A should not recognize the
remaining unrecognized compensation cost immediately on
January 1, 20X3. Rather, A should continue to recognize
the remaining unrecognized compensation cost over the
original requisite service period. That is, A should
continue recognizing compensation cost as if the
modification never occurred and recognize the remaining
$500 ($10 grant-date fair-value-based measure × 100
awards × half of the original requisite service period)
in compensation cost over the remaining two years of the
original requisite service period (i.e., recognizing
$250 in each of 20X3 and 20X4).
6.3.6 Modification of the Employee’s Requisite Service Period
The accounting for the modification of a share-based payment award’s requisite service period is based on whether the modified requisite service period is shorter or longer than the original requisite service period.
6.3.6.1 Modification to Reduce the Employee’s Requisite Service Period of an Award
If an entity modifies the requisite service period of a share-based payment
award and the modified award’s requisite service period is shorter than the original award’s requisite service
period, the entity should recognize compensation cost over the remaining
portion of the modified award’s requisite service period. The
fair-value-based measure of the modified award would most likely be the same
or less than the fair-value-based measure of the original award immediately
before modification because the modification only affects the service period
of the award. Vesting conditions are not directly factored into the
fair-value-based measure of an award. In addition, if the award is a stock
option award, 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, as discussed in Section 6.1. Accordingly, there is no
incremental value conveyed to the holder of the award, and no incremental
compensation cost is recognized in connection with the modification.
However, the entity may consider whether the reduction in the requisite service
period affects the number of awards that are expected to vest. If, as a
result of the modification, the entity expects additional awards to vest,
those awards may be accounted for as an improbable-to-probable
modification.3 For the awards that were originally expected to vest, no incremental
compensation cost is recognized in connection with the modification, as
discussed above. For the additional awards expected to vest as a result of
the modification, the entity will record compensation cost on the basis of
(1) the incremental number of awards that are now expected to vest and (2)
the modification-date fair-value-based measure of the awards over the
remaining portion of the requisite service period of the modified awards.
See Section
6.3.3 for a discussion of improbable-to-probable
modifications.
Example 6-16
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 $20. The options vest at
the end of the fourth year of service (cliff
vesting). In addition, A has a policy of estimating
forfeitures and estimates that 10 percent of the
options will be forfeited.
Over the first year of service, A records $4,500 of cumulative compensation
cost, or (1,000 options × 90 percent of options
expected to vest) × $20 grant-date fair-value-based
measure × 25 percent for one of four years of
services rendered. On January 1, 20X2, A modifies
the options to reduce the requisite service period
from four years to three years. The fair-value-based
measure of the modified options as of the
modification date is $12. Because the modification
only affects the service period of the options, and
the service period is shorter, the fair-value-based
measure of the modified options would most likely be
equal to or less than the fair-value-based measure
of the original options immediately before
modification. Accordingly, there is no incremental
value conveyed to the holder of the award.
However, because of the reduced requisite service period, A now expects 95
percent of the options to vest. Accordingly, A will
recognize the remaining unrecognized compensation
cost for the 900 options originally expected to vest
— (1,000 options × 90 percent of options originally
expected to vest) × $20 grant-date fair-value-based
measure – $4,500 amount previously recognized =
$13,500 — over the remainder of the modified
requisite service period (two years). For the 50
options now expected to vest as a result of the
modification, A may recognize $600 of incremental
compensation cost (50 options expected to vest × $12
modification-date fair-value-based measure) over the
remainder of the modified requisite service period
(two years).
6.3.6.2 Modification to Increase the Employee’s Requisite Service Period of an Award
If the requisite service period of a modified award is longer than the requisite service period of the original award and, both before and after the modification, it is probable that the awards will vest (Type I or probable-to-probable modification), an entity may make an accounting policy choice to use either of the following methods (both were discussed by the Statement 123(R) Resource Group at its May 26, 2005, meeting; see Section 6.3.1 for a discussion of probable-to-probable modifications):
- The unrecognized compensation cost remaining from the original award would be recognized over the remaining portion of the requisite service period of the original award. The incremental compensation cost, if any, as a result of the modification would be recognized over the remaining portion of the requisite service period of the modified award. See Method 1 in Example 6-17.
- The unrecognized compensation cost remaining from the original award plus the incremental compensation cost, if any, as a result of the modification would be recognized in its entirety over the remaining portion of the requisite service period of the modified award. See Method 2 in Example 6-17. (Note, however, that if an employee is not expected to render service over the new requisite service period but is expected to render service over the original requisite service period, the unrecognized compensation cost remaining from the original award would be recognized over the remaining portion of the original award’s requisite service period.)
Regardless of the method chosen, it must be applied consistently and disclosed in accordance with ASC 235-10 if it is material to the financial statements.
Under either method, if the employee does not remain employed for the original award’s requisite service period, any previously recognized compensation cost should be reversed. However, if the employee remains employed for the original award’s requisite service period but terminates employment before the modified award’s requisite service period, all compensation cost associated with the original award should be recognized. Under Method 1, all compensation cost associated with the original award would already have been recognized. Under Method 2, all compensation cost associated with the original award should be immediately recognized. However, under either method, any previously recognized incremental compensation cost associated with the modified award should be reversed. As a result of a modification, the total recognized compensation cost attributable to an award is generally required to be at least equal to the grant-date fair-value-based measure of the original award if the original service or performance condition is met or is expected to be met as of the modification date.
Example 6-17
Assume the same facts as in Example 6-16, except that on January
1, 20X2, Entity A modifies the options to (1)
reprice them (i.e., lower the exercise price to
equal the market price of A’s shares) and (2)
lengthen the requisite service period from four
years to five years. The fair-value-based measure of
the original options immediately before the
modification is $12, and the fair-value-based
measure of the modified options is $16. For
simplicity, assume that the extension of the service
period does not affect forfeitures (90 percent
expected to vest).
On the modification date, A computes the incremental compensation cost as
$3,600, or ($16 fair-value-based measure of modified
options – $12 fair-value-based measure of original
options immediately before the modification) × 900
options. Accordingly, A will recognize the total
remaining unrecognized compensation cost of $17,100
($13,500 of unrecognized compensation cost from the
original options plus $3,600 in incremental
compensation cost from the modification) by using
one of two acceptable methods:
-
Method 1 — Entity A will recognize the unrecognized compensation cost remaining from the original award of $13,500 over the remaining portion of the requisite service period of the original award (three years). The incremental compensation cost of $3,600 as a result of the modification will be recognized over the remaining portion of the requisite service period of the modified award (four years).
-
Method 2 — Entity A will recognize $17,100 ratably over the remaining portion of the requisite service period of the modified award (four years).
6.3.7 Determining the Unit of Account When Assessing the Type of Modification
A share-based payment award may contain a performance condition
under which a different number of shares vest depending on various outcomes of a
performance target (e.g., an EPS growth percentage). ASC 718-10-25-20 requires
compensation cost to be accrued on the basis of the probable outcome of an award’s
performance conditions; however, ASC 718 prohibits recognition of compensation cost
for a performance condition or conditions whose achievement is not probable. The
interrelationship of the performance targets is a key part of the unit-of-account
assessment. An entity would only accrue compensation cost associated with the number
of awards whose vesting is probable at the end of each reporting period. If a
modification is made to one or more performance targets that results in the vesting
of a different number of awards, an entity should consider whether to apply
modification accounting to the award in tranches (under ASC 718-20-35-2A) on the
basis of each tranche’s probability of vesting immediately before and after the
performance target or targets are modified. The example below illustrates such a
scenario.
Example 6-18
On January 1, 20X1, Entity A grants stock
options to an employee. The stock options (1) include a
performance condition that is based on a three-year
cumulative EBITDA growth target and (2) have a grant-date
fair-value-based measure of $6. The number of
equity-classified stock options that will vest at the end of
the third year of employment (cliff vesting) varies
depending on the EBITDA growth target achieved, as defined
below:
|
Tranche
|
EBITDA Growth Target
|
Total Options to Vest
|
|---|---|---|
|
1
|
100%
|
1,000
|
|
2
|
110%
|
1,100
|
|
3
|
120%
|
1,200
|
During 20X1 and 20X2, A believes that it is
probable that the 100 percent EBITDA growth target will be
met at the end of 20X3 but not probable that the 110 percent
growth target will be met. Accordingly, A recognizes
compensation of $2,0004 in 20X1 and 20X2 on the basis of its conclusion that
Tranche 1 will be the probable outcome.
In early 20X3, A decides to lower the EBITDA growth target
needed for vesting under each tranche to the following:
|
Tranche
|
EBITDA Growth Target
|
Total Options to Vest
|
|---|---|---|
|
1
|
95%
|
1,000
|
|
2
|
105%
|
1,100
|
|
3
|
115%
|
1,200
|
The fair-value-based measure of each option
on the day of modification is $7. On the date of the
modification, A believes that it is (1) probable that the
105 percent EBITDA growth target will be met at the end of
20X3 under the modified terms but (2) not probable that the
110 percent growth target will be met under the original
terms. This represents an improbable-to-probable
modification for the incremental 100 options whose vesting
is now probable on the basis of the modification (1,100
options in total are now expected to vest). During 20X3, A
will accrue compensation cost for the Tranche 1 awards
expected to vest by using the $6 original grant-date
fair-value-based measure because vesting of the Tranche 1
awards was probable before and after the modification and
there is no incremental compensation cost as a result of the
modification (the fair-value-based measure of each option
immediately before and after the modification is $7). For
Tranche 2, A will accrue compensation cost beginning on the
modification date for the 100 incremental options expected
to vest by using the $7 fair value of the options on the day
of the modification ($700 in incremental compensation cost
over the remaining requisite service period).
Vesting of the Tranche 3 awards was
improbable before the modification and continues to be
improbable after it. Since it is not probable that the
original award and the modified award will vest under
Tranche 3, the modification is considered a Type IV
improbable-to-improbable modification. If the 115 percent
EBITDA growth target subsequently become probable, any
compensation cost recognized will be based on the $7
fair-value-based measure for each option determined on the
modification date.
Footnotes
2
ASC 718 requires an entity to
record compensation cost if either the original
performance condition or the modified performance
condition is met. In this case, since the modified
performance target is lower than the original
performance target, the attainment of the modified
target would be sufficient to trigger recognition
of compensation cost.
3
An entity that modifies a group of awards granted to
a number of grantees may instead choose to consider each grantee’s
awards as the unit of account when determining whether the awards
are expected to vest and the type of modification accounting to
apply. When applying this approach, the entity may conclude that
each individual’s awards were expected to vest before the
modification and are accounted for as a probable-to-probable
modification. That is, even if a few grantees were expected to
forfeit the original awards as a result of normal turnover, the
entity may account for the entire modification as a
probable-to-probable modification. However, if an entity’s policy is
to estimate forfeitures when recognizing compensation cost, and the
percentage of all modified awards that are expected to vest
increases (i.e., the entity’s forfeiture rate is reduced),
additional compensation cost will be recognized for those awards on
the basis of their original grant-date fair-value-based measure.
4
Calculated as [($6 × 1,000 options)
÷ by 3 years].