6.4 Modification of Factors Other Than Vesting Conditions
Modifications may be made to an award that do not affect its vesting conditions (i.e., its service or performance conditions). If modification accounting is required for such changes (see Section 6.1 for circumstances in which modification accounting is not required), the same principles apply as those discussed in Section 6.3.
6.4.1 Modification of a Market Condition
The modification of an award’s market condition does not directly affect the probability that the award
will be earned. Unlike a service or a performance condition, a market condition is not a vesting condition
but rather is factored into the award’s fair-value-based measure (see Section 3.5). However, the
modification could indirectly affect the probability that the award will be earned if there is a change in a
derived service period.
The determination of whether an award will vest depends on whether the grantee meets any service
or performance conditions. Accordingly, if the original award is expected to vest at the time of the
modification, incremental compensation cost is computed as the excess of the fair-value-based measure
of the modified award on the date of modification over the fair-value-based measure of the original
award immediately before the modification.
Example 6-19
On January 1, 20X1, Entity A granted 1,000 equity-classified at-the-money
employee stock options, each with a grant-date
fair-value-based measure of $5 and a derived service
period of five years. The options have an exercise price
of $12 and become exercisable only if the market price
of A’s shares reaches $20. In addition, A has a policy
of estimating forfeitures, and it estimates that 15
percent of the options will be forfeited because the
employees will terminate employment before the end of
the derived service period.
Over the first year of service, A records $850 of cumulative compensation cost,
or (1,000 options × 85 percent of options expected to
vest) × $5 grant-date fair-value-based measure × 20
percent for one of five years of services rendered. On
January 1, 20X2, because of a significant decline in the
market price of A’s shares, A modifies the options to be
exercisable when the market price of A’s shares reaches
$15. The fair-value-based measure of the original
options immediately before modification is $3, and the
fair-value-based measure of the modified options is $4.
In addition, the derived service period of the modified
options is three years. As a result of the reduction in
the derived service period, A expects additional options
to vest. Accordingly, A revises its forfeiture estimate
from 15 percent to 10 percent and computes the
incremental compensation cost as a result of modifying
the options’ market condition as follows:
The total compensation cost to be recognized over the remaining derived service
period of the modified options (three years) of
$4,450 is the unrecognized compensation cost from
the original options of $3,400 — [(1,000 options ×
85 percent of options expected to vest) × $5
grant-date fair-value-based measure – $850
previously recognized — plus the incremental
compensation cost resulting from the modification
of the options’ market condition of $1,050
(determined above)].
6.4.2 Modification of Stock Options During Blackout Periods
In certain instances, grantees (including grantees who are no longer employed or are no longer providing goods or services) may not be able to exercise their stock options because of blackout periods imposed by the entity or others. Blackout periods may be imposed because (among other reasons):
- The terms of an award require such periods (e.g., to restrict the selling of an entity’s securities close to its earnings releases).
- The entity’s registration statements on Form S-8 are temporarily suspended because its filing requirements under the Securities Exchange Act of 1934 are not current.
- An entity’s stock has been delisted.
If grantees have vested options that will expire during a blackout period,
sometimes entities will (even though they have no
obligation to do so) extend the options’ term to
give such grantees the ability to exercise the
options after the blackout period is over (or
provide other assets in lieu of the options). The
extension of the options’ contractual term should
be accounted for as a modification. If, at the
time of the modification, the original options are
not exercisable because of a blackout period and
the entity is not obligated to settle the option
in cash or other assets, the options have no value
to the holders. In accordance with ASC
718-20-35-3, the incremental compensation cost is
the excess of the fair-value-based measure of the
modified award on the date of modification over
the fair-value-based measure of the original award
immediately before the modification. Since the
original options’ value is zero, the incremental
value would be the fair-value-based measure of the
modified options because the entity has, in
substance, replaced worthless options with options
that the grantees can exercise in the future.
Further, because the award is fully vested, the
compensation cost would be recognized in full on
the date of the modification. An entity may wish
to seek the opinion of legal counsel in
determining whether it is obligated to settle in
cash or other assets. If the entity determines on
the basis of the opinion of legal counsel that it
is obligated to cash settle the vested options, it
would classify the vested options as liabilities
during the blackout period.