6.5 Equity Restructuring
ASC 718-10 — Glossary
Equity
Restructuring
A
nonreciprocal transaction between an entity and
its shareholders that causes the per-share fair
value of the shares underlying an option or
similar award to change, such as a stock dividend,
stock split, spinoff, rights offering, or
recapitalization through a large, nonrecurring
cash dividend.
ASC 718-20
Equity
Restructuring or Business
Combination
35-6 Exchanges of share
options or other equity instruments or changes to
their terms in conjunction with an equity
restructuring or a business combination are
modifications for purposes of this Subtopic. An
entity shall apply the guidance in paragraph
718-20-35-2A to those exchanges or changes to
determine whether it shall account for the effects
of those modifications. Example 13 (see paragraph
718-20-55-103) provides further guidance on
applying the provisions of this paragraph. See
paragraph 718-10-35-10 for an
exception.
Equity
Restructuring
55-2 In accordance with
paragraph 718-20-35-6, an entity shall apply the
guidance in paragraph 718-20-35-2A to exchanges of
share options or other equity instruments or
changes to their terms in conjunction with an
equity restructuring to determine whether it shall
account for the effects of those modifications as
described in paragraphs 718-20-35-3 through 35-9.
Example 13 (see paragraph 718-20-55-103) provides
additional guidance on accounting for
modifications of awards in the context of equity
restructurings.
6.5.1 Antidilution Provisions
An equity restructuring is a
nonreciprocal transaction between an entity and
its shareholders that causes a change in the
per-share fair value of the shares underlying an
award (e.g., stock dividend, stock split,
spin-off). Exchanges of stock options or other
equity instruments or changes to their terms in
conjunction with an equity restructuring are
modifications. However, the effect of such
modifications depends on whether an adjustment is
made in accordance with an existing
nondiscretionary antidilution provision. A
nondiscretionary provision is clear and measurable
and requires the entity to take action. By
contrast, a discretionary provision may be broad
or subjective, and it allows but does not require
the entity to take action.
If the terms of the original
award do not include an antidilution provision and
an entity subsequently adds an antidilution
provision but does not contemplate an equity
restructuring, the fair-value-based measure of the
award would generally remain the same.
Accordingly, as long as there are no other changes
to the award that would affect vesting or
classification, the entity does not apply
modification accounting. If the entity
contemplates an equity restructuring, however, it
applies modification accounting and may need to
recognize significant incremental compensation
cost.
In addition, upon an equity
restructuring, it is not uncommon for an entity to
make grantees “whole” (in accordance with a
preexisting nondiscretionary antidilution
provision) on an intrinsic-value basis when the
awards are stock options. In certain
circumstances, the fair-value-based measure of
modified stock options could change as a result of
the equity restructuring even if the intrinsic
value remains the same. Under ASC 718-20-35-2A, an
entity compares the intrinsic value before and
after a modification in determining whether to
apply modification accounting only “if such an
alternative measurement method is used”; thus, if
an entity uses a fair-value-based measure to
calculate and recognize compensation cost for its
share-based payment awards, it would still be
required to apply modification accounting when the
fair-value-based measure has changed, even if the
intrinsic value is the same immediately before and
after the modification.
An entity may adjust an award
by making a cash payment to the holder,
particularly in circumstances in which the equity
restructuring is in the form of a large,
nonrecurring cash dividend. Although the
authoritative guidance does not explicitly address
cash payments made in conjunction with an equity
restructuring, transactions such as these are
treated as a modification or a partial settlement
(or a combination of both). See Section
6.10.2.
6.5.1.1 Original Award Contains a Nondiscretionary Antidilution Provision
To determine whether
incremental compensation cost should be recognized, an entity should compare the
fair-value-based measure of the modified award with the fair-value-based measure of the
original award (on the basis of the stated antidilution terms in the award) immediately
before the modification. See below for illustrations of original awards that contain
either a nondiscretionary (Example
6-19) or a discretionary (Example 6-21) antidilution provision. If the award is modified in
accordance with a preexisting nondiscretionary antidilution provision, modification
accounting is not required if the fair-value-based measure, vesting conditions, and
classification are the same immediately before and after the modification. When an
antidilution feature is designed to equalize the fair value of the award as a result of
an equity restructuring, the actual adjustment typically would not affect the award’s
fair-value-based measure immediately before or immediately after the modification
because the change is already contemplated in the award’s fair-value-based measure. The
accounting for a modification of an award with a preexisting nondiscretionary
antidilution provision may result in both (1) a settlement and (2) a modification that
changes the award’s classification to a liability (see Example 6-34).
An entity should carefully
review the terms of its awards to determine
whether an adjustment is required if an equity
restructuring occurs. In certain circumstances
when such an adjustment is required, the entity
may be permitted to choose how to make it (e.g.,
the entity may be allowed to determine how it
adjusts the exercise price or quantity of stock
options). As long as an equitable adjustment is
required by the award, an entity may conclude that
the antidilution provision is nondiscretionary,
even if the entity has some discretion in
determining how to make the adjustment. When it is
not clear that an equitable adjustment is
required, an entity should consider whether the
holder of the award could enforce an antidilution
adjustment. The entity may need to obtain the
opinion of legal counsel to make that
determination.
ASC 718-20
Example
13: Modifications Due to an Equity
Restructuring
55-103 As a reminder,
exchanges of share options or other equity
instruments or changes to their terms in
conjunction with an equity restructuring are
considered modifications for purposes of this
Topic. The following Cases illustrate the guidance
in paragraph 718-20-35-6:
- Original award contains antidilution provisions (Case A).
- Original award does not contain antidilution provisions (Case B).
- Original award does not contain an antidilution provision but is modified on the date of equity restructuring (Case C).
Case A: Original Award Contains
Antidilution Provisions
55-104 In this Case, assume
an award contains antidilution provisions. On May
1 there is an announcement of a future equity
restructuring. On October 12 the equity
restructuring occurs and the terms of the award
are modified in accordance with the antidilution
provisions. In this Case, the modification occurs
on October 12 when the terms of the award are
changed. The fair value of the award is compared
pre- and postmodification on October 12. The
calculation of fair value is necessary to
determine whether there is any incremental value
transferred as a result of the modification, and
if so, that incremental value would be recognized
as additional compensation cost. If there is no
change in fair value, vesting conditions, or the
classification of the award, the entity would not
account for the effect of the modification (see
paragraph 718-20-35-2A).
Example 6-19
Stock Split
When the Original Award Contains a
Nondiscretionary Antidilution Provision
On January 1, 20X1, Entity A
grants 1,000 at-the-money employee stock options
with a grant-date fair-value-based measure of $6
and an exercise price of $10. The options vest at
the end of the third year of service (cliff
vesting) and contain a nondiscretionary
antidilution provision. On July 1, 20X2, A
announces a two-for-one stock split and that a
nondiscretionary antidilution provision will apply
to each of the options. The nondiscretionary
antidilution provision that existed in the
original terms of the options requires an
adjustment to preserve the value of the options
after the stock split. Because the antidilution
provision is not discretionary and already
existed, A is not likely to apply modification
accounting on July 1, 20X2, when A announces the
two-for-one stock split, because modification
accounting is not applied if the fair-value-based
measure of the options immediately before and
after the stock split is the same, and there are
no changes to the vesting conditions or
classification of the options. Accordingly, A
records no incremental compensation
cost.
6.5.1.2 Modification to Add a Nondiscretionary Antidilution Provision in Contemplation of an Equity Restructuring
An adjustment to the terms of
an award to maintain the holder’s value in
response to an equity restructuring may trigger
the recognition of significant compensation cost
if (1) the adjustment is not required under the
existing terms of the award and (2) the provision
that requires an adjustment is added in
contemplation of an equity restructuring. Note
that the addition of a nondiscretionary
antidilution provision to a stock option plan
could result in unintended tax consequences and
could be considered a disqualifying event of an
ISO. An entity should consult with its tax
professional regarding the tax implications of
making changes to its stock option plans.
ASC 718-20
Example
13: Modifications Due to an Equity
Restructuring
Case
B: Original Award Does Not Contain Antidilution
Provisions
55-105 In
this Case, the original award does not contain
antidilution provisions. On May 1 there is an
announcement of a future equity restructuring. On
July 26 the terms of an award are modified to add
antidilution provisions in contemplation of an
equity restructuring. On September 30 the equity
restructuring occurs. In this Case, there are two
modifications to account for. The first
modification occurs on July 26, when the terms of
the award are changed to add antidilution
provisions. There must be a comparison of the fair
value of the award pre- and postmodification on
July 26 in accordance with paragraph 718-20-35-2A
to determine whether the entity should account for
the effects of the modifications as described in
paragraphs 718-20-35-3 through 35-9. The
premodification fair value on July 26 is based on
the award without antidilution provisions taking
into account the effect of the contemplated
restructuring on its value. The postmodification
fair value is based on an award with antidilution
provisions, taking into account the effect of the
contemplated restructuring on its value. Any
incremental value transferred would be recognized
as additional compensation cost. Once the equity
restructuring occurs, there is a second
modification event on September 30 when the terms
of the award are changed in accordance with the
antidilution provisions. A second comparison of
pre- and postmodification fair values is then
required to determine whether the fair value of
the award has changed as a result of the
modification. If there is no change in fair value,
vesting conditions, or the classification of the
award, the entity would not account for the effect
of the modification on September 30 (see paragraph
718-20-35-2A). Changes to the terms of an award in
accordance with its antidilution provisions
typically would not result in additional
compensation cost if the antidilution provisions
were properly structured. If there is a change in
fair value, vesting conditions, or the
classification of the award, the incremental value
transferred, if any, would be recognized as
additional compensation cost.
Case C: Original Award Does Not
Contain an Antidilution Provision but Is Modified
on the Date of Equity Restructuring
55-106 Assume the same facts
as in Case B except the terms of the awards are
modified on the date of the equity restructuring,
September 30. In contrast to Case B in which there
are two separate modifications, there is one
modification that occurs on September 30 and the
fair value is compared pre- and postmodification
to determine whether any incremental value is
transferred as a result of the modification. Any
incremental value transferred would be recognized
as additional compensation cost.
Example 6-20
Stock Split
When a Nondiscretionary Antidilution Provision Is
Added
On January 1,
20X1, Entity A grants 1,000 at-the-money employee
stock options with a grant-date fair-value-based
measure of $6 and an exercise price of $10. The
options vest at the end of the third year of
service (cliff vesting) and do not contain an
antidilution provision. On July 1, 20X2, A
announces a two-for-one stock split and the
addition of a nondiscretionary antidilution
provision to each of the options. The
fair-value-based measure of the options
immediately before the addition of the
antidilution provision is $4, and the
fair-value-based measure immediately afterwards is
$7. On December 31, 20X2, the stock split occurs
and A (1) modifies the exercise price of the
options and (2) issues additional options to the
employee to reflect the effects of the stock
split. The fair-value-based measure of the options
before and after the stock split is the
same.
The addition of the antidilution provision on July 1, 20X2, should be accounted
for as a modification. The $3,000 incremental value, or ($7 – $4) × 1,000
options, conveyed to the holder as a result of adding the nondiscretionary
antidilution provision should be recorded as incremental compensation cost
over the remaining 18-month service period. The premodification
fair-value-based measure is based on the original options without a
nondiscretionary antidilution provision and takes into account the effect of
the contemplated equity restructuring (i.e., the stock split) on its value.
The postmodification fair-value-based measure is based on the modified
options with a nondiscretionary antidilution provision and takes into
account the effect of the contemplated equity restructuring on its
value.
On December 31,
20X2, the reduction in the exercise price of the
options and the issuance of the additional options
as a result of the stock split would not be
subject to modification accounting. Provided that
there are no changes to vesting conditions or the
classification of the options, A does not apply
modification accounting since the fair-value-based
measure of the options before and after the
modification is the same. Changes to the terms of
an award in accordance with its nondiscretionary
antidilution provisions often do not result in
incremental compensation cost if the antidilution
provisions are structured to retain the same
fair-value-based measure of the award.
Example 6-21
Stock Split
When the Original Award Contains Discretionary
Antidilution Provisions
Assume the same facts as in the example above, except that the original terms of
the options contain a discretionary antidilution provision. Under the
provision, A may — but is not required to — adjust the terms of the options
in response to an equity restructuring (e.g., stock split). Because the
antidilution provision is discretionary, the options are treated as though
the provision does not exist. That is, if A were to reduce the exercise
price of the options and issue additional options on December 31, 20X2, it
has in substance “added” a nondiscretionary antidilution provision to the
original terms of the options. As a result of the modification to add a
nondiscretionary antidilution provision to the terms of the options, and to
reduce the exercise price of the options and issue additional options,
incremental value would be conveyed to the holder (as it was in the example
above). Accordingly, A should record incremental compensation cost for the
incremental value conveyed to the holder on December 31, 20X2, over the
remaining 12-month service period.
Alternatively, if A announces on July 1, 20X2, that it will adjust the terms of
the options in response to the stock split, a modification occurs on July 1,
20X2, to effectively add a nondiscretionary antidilution provision to the
options’ terms. The addition of the nondiscretionary antidilution provision
results in incremental value conveyed to the holder. Accordingly, A should
record incremental compensation cost of $3,000 (as determined in the example
above) over the remaining 18-month service period.
6.5.1.3 Modification to Add a Nondiscretionary Antidilution Provision That Is Not in Contemplation of an Equity Restructuring
While adding a
nondiscretionary antidilution provision generally
increases the value of an award, a market
participant would typically not place significant
value on such a provision if an equity
restructuring is not anticipated since it would be
difficult to determine the provision’s effect on
the valuation of the award.
Because a modification to add
a nondiscretionary antidilution provision that is
not made in contemplation of an equity
restructuring would generally result in the same
fair-value-based measure before and after the
modification, modification accounting would not be
applied as long as there are no other changes to
the award.
6.5.2 Spin-Offs
As discussed in Section
6.5.1, a spin-off is considered an
equity restructuring. Accordingly, under ASC
718-20-35-6, “[e]xchanges of share options or
other equity instruments or changes to their terms
in conjunction with an equity restructuring” are
treated as modifications.
In a spin-off, individuals who
were originally employees or vendors of an entity
(the former parent or spinnor) that is spinning
off a consolidated entity (the former subsidiary
or spinnee) may become employees or vendors of the
former subsidiary or remain employees or vendors
of the former parent. Those individuals may
exchange their share-based payment awards for
awards in the former parent, the former
subsidiary, or both. The former parent’s
(spinnor’s) and former subsidiary’s (spinnee’s)
accounting for these share-based payment awards
will ultimately be based on whose employees or
vendors are providing the goods or services to
earn any remaining portions of the awards after
the spin-off.
6.5.2.1 Attribution of Compensation Cost in a Spin-Off
In a spin-off, compensation
cost related to share-based payment awards should be recognized by the entity whose
employees or vendors are providing the goods or services to earn any remaining portions
of the award. For those grantees that will continue to provide goods or services to the
former subsidiary, the former parent does not reverse any compensation cost recorded for
the awards before the spin-off date (i.e., the awards are not forfeited). After the
spin-off, the former parent no longer records compensation cost related to the original
or modified awards issued to employees or vendors of the former subsidiary. The
remaining unrecognized fair-value-based measure of the original awards and the
incremental compensation cost associated with the modified awards, if any, are
recognized by the former subsidiary over the remaining employee requisite service period
or nonemployee’s vesting period. For those grantees that will continue to provide goods
or services to the former parent, the former parent continues to recognize the remaining
unrecognized fair-value-based measure of the original awards and the incremental
compensation cost associated with the modified awards, if any, over the remaining
employee requisite service period or nonemployee’s vesting period.
At its September 1, 2004,
meeting, the FASB reached the following conclusion
about spin-off transactions:
In connection with a spinoff transaction and as a
result of the related modification, employees of
the former parent may receive unvested equity
instruments of the former subsidiary, or employees
of the former subsidiary may retain unvested
equity instruments of the former parent. The Board
decided that, based on the current accounting
model for spinoff transactions, the former parent
and former subsidiary should recognize
compensation cost related to the unvested modified
awards for those employees that provide service to
each respective entity. For example, if an employee of the former
subsidiary retains unvested equity instruments of
the former parent, the former subsidiary would
recognize in its financial statements the
remaining unrecognized compensation cost
pertaining to those instruments. In those cases,
the former parent would recognize no compensation
cost related to its unvested equity instruments
held by those former employees that subsequent to
the spinoff provide services solely to the former
subsidiary. [Emphasis added]
We understand that this
guidance was not included in FASB Statement No.
123(R) because the FASB deleted the example of a
spin-off transaction just before issuing the
standard. However, the rationale for the FASB’s
conclusion above remains appropriate.
6.5.2.2 Classification of Awards in a Spin-Off
Under an exception in FASB Interpretation 44, an entity was not required to
change the accounting method of an award when the
award holder’s status changed from employee to
nonemployee as a direct result of a spin-off. If
an employee was granted a share-based payment
award that was outstanding as of the date of the spin-off, and that employee was then considered a nonemployee as a direct result of the spin-off, a change from the intrinsic value method to the fair value method for the award previously granted was not required under Interpretation 44.
While nullified by FASB Statement 123(R), the guidance in Interpretation
44 remains applicable by analogy since it contains
the only guidance on accounting for share-based
payment awards in a spin-off. For example, ASC 718
does not provide guidance on the classification of
awards that are, after a spin-off, (1) indexed to
the spinnor’s equity (i.e., the former parent’s
equity) and held by employees or vendors of the
spinnee (i.e., the former subsidiary) or (2)
indexed to the spinnee’s equity (i.e., the former
subsidiary’s equity) and held by employees or
vendors of the spinnor (i.e., the former parent).
Accordingly, in a manner similar to the exception
under which an entity is not required to change
its accounting method when there is a change in
the award holder’s status, the spinnee should
account for its awards that are indexed to the
spinnor’s equity in the same manner as the spinnor
(i.e., equity versus liability); that is, by using
the guidance for share-based payment awards as
though the spin-off had not occurred and provided
that no other changes to the award have been made.
Likewise, the spinnor should account for its
awards that are indexed to the spinnee’s equity in
the same manner as the spinnee.
6.5.2.3 Determining the Market Price Before and After a Spin-Off
To determine whether
modification accounting is required and, if so, to
account for a modification in a spin-off, an
entity compares the fair-value-based measure of
the original share-based payment award immediately
before the spin-off with the fair-value-based
measure of the modified share-based payment award
immediately after the spin-off. The
fair-value-based measure of the original award
immediately before the spin-off is determined on
the basis of the assumptions (e.g., stock price,
volatility, expected dividends, risk-free interest
rate) before the spin-off. The fair-value-based
measure of the modified award immediately after
the spin-off is determined on the basis of the
assumptions that exist immediately after the
spin-off.
Depending on the structure of
the share-based payment plan and the spin-off, the
market price of the parent’s shares before and
after the spin-off, as well as the market price of
the spinnee’s shares after the transaction, may
also be relevant.
The market price of the
parent’s shares immediately before the
modification should be based on the closing price
on the date of the spin-off, otherwise known as
the “record date.” Sometimes the parent’s shares
begin trading on an “ex-dividend” basis before the
distribution date, which already excludes the
value of the spinnee’s shares. In these
circumstances, and if the spinnee’s shares are
trading on a “when-issued” basis (e.g., after the
spinnee’s registration statement is declared
effective), to determine the market price of the
parent’s shares immediately before the
modification, an entity would add the
distribution-date (i.e., spin-off date) closing
price of the spinnee’s shares to the
distribution-date closing price of the parent’s
shares, since the parent’s shares incorporate the
reduction in value that is attributable to the
spin-off.
The market price of the
parent’s shares immediately after the modification
is the opening price on the first trading date
after the distribution. However, if the parent’s
shares are traded on an ex-dividend basis and the
spinnee’s shares are traded on a when-issued
basis, the entity uses the price of the parent’s
shares at the time of the spin-off since the
market price will already exclude the closing
price of the spinnee’s shares.
The market price of the
spinnee’s shares immediately after the
modification is the closing price of the spinnee’s
shares on the distribution date as long as the
shares are traded on a when-issued basis.
Otherwise, the entity should use the opening price
of the spinnee’s shares on the first trading date
after the distribution as the market price of the
spinnee’s shares immediately after the
modification.
6.5.3 Accounting for Awards Modified in Conjunction With an Equity Restructuring Held by Individuals No Longer Employed or Providing Goods or Services
Share-based payment awards
that were originally granted to individuals in exchange for goods or services continue to
be accounted for under ASC 718 throughout the awards’ life unless their terms are modified
when a grantee is no longer an employee or a nonemployee has vested in the award and is no
longer providing goods or services. Because changes to an award’s terms in conjunction
with an equity restructuring are treated as a modification, when the individuals are no
longer employed or providing goods or services, the entity would normally be required to
account for (1) the modification in accordance with the guidance in ASC 718 and (2) the
award after the modification under other applicable GAAP. However, if changes to an
award’s terms are made solely to reflect an equity restructuring, ASC 718-10-35-10A does
not require the entity (including the spinnor and spinnee in connection with a spin-off)
to account for the award after the modification under other applicable GAAP if both of the
following conditions are met:
-
There is no increase in fair value of the award (or the ratio of intrinsic value to the exercise price of the award is preserved, that is, the holder is made whole) or the antidilution provision is not added to the terms of the award in contemplation of an equity restructuring.
-
All holders of the same class of equity instruments (for example, stock options) are treated in the same manner.
Example 6-22
Former parent P (spinnor)
modifies awards held by employees of the former
subsidiary (spinnee) as a direct result of a
spin-off. There is no change in the ratio of the
awards’ intrinsic value to their exercise price or
addition of an antidilution provision in
contemplation of the spin-off, and all holders of
the same class of equity instruments are treated
in the same manner. While in accounting for the
awards after their terms have changed P would not
consider changes that reflect the spin-off to be a
modification that causes the awards to be
accounted for under other applicable GAAP, P still
would need to treat the changes to the terms as a
modification in accordance with ASC 718. That is,
P would need to consider whether, as a result of
the changes in the awards’ terms, it would be
required under ASC 718-20-35-2A and 35-3 to apply
modification accounting and recognize any
incremental compensation cost. For example, while
the nonemployees may be made whole if “the ratio
of intrinsic value to the exercise price of the
award[s] is preserved,” the fair-value-based
measure of the modified awards on the date of the
spin-off may be greater than the fair-value-based
measure of the original awards immediately before
the spin-off. If so, for unvested awards, the
former subsidiary would recognize incremental
compensation cost for the excess of the
fair-value-based measure of the modified awards
over the fair-value-based measure of the original
awards over the remaining service
period.