6.9 Modifications Under ASR 268

On January 1, 20X1, Entity A, an SEC registrant, granted 1,000 at-the-money employee stock options, each with a grant-date fair-value-based measure of $12 and an exercise price of $25. The options vest at the end of the fifth year of service (cliff vesting) and contain a redemption feature permitting the employee to require A to net cash settle the options upon a change in control (the occurrence of which is not probable as of the grant date).

Since the options were granted at-the-money and are not fully vested (i.e., the intrinsic value on the grant date is zero), no amount is initially reclassified as temporary equity. However, because the options contain a redemption feature that is not solely within the control of A, A is required to remeasure the options to their redemption value (i.e., their intrinsic value) in temporary equity once it is considered probable that the change-in-control event (i.e., the contingent redemption feature) will occur (generally when the change-in-control event occurs). Accordingly, for the year ended December 31, 20X1, A (1) recognizes compensation cost on the basis of the grant-date fair-value-based measure of the options and (2) reclassifies no amount as temporary equity. See the journal entry below.

On January 1, 20X2, A modifies the options to reduce the requisite service period from five years to four years. Because the modification affects only the options’ service period, which is now 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; therefore, no incremental compensation cost has to be recorded in connection with this modification. Entity A will recognize the remaining unrecognized compensation cost (1,000 options × $12 grant-date fair-value-based measure – $2,400 amount previously recognized = $9,600) over the remainder of the modified requisite service period (three years).

However, on the modification date, the market price of A’s shares is $27, while the exercise price of the options remained at $25. Because the modification of an award is viewed as the exchange of a new award for an old award, A must again consider the application of the measurement guidance in ASR 268 and ASC 480-10-S99-3A as of the modification date. Therefore, in accordance with ASC 480-10-S99-3A, A will reclassify the redemption amount (i.e., the intrinsic value of the options on the modification date) as temporary equity. Accordingly, in 20X2, A (1) recognizes compensation cost on the basis of the options’ grant-date fair-value-based measure and (2) reclassifies as temporary equity an amount based on the options’ intrinsic value ($2) and the portion of the requisite service rendered. See the journal entries below.

On January 1, 20X1, Entity A, an SEC registrant, granted 1,000 at-the-money employee stock options, each with a grant-date fair-value-based measure of $6 and an exercise price of $15. The options vest at the end of the fifth year of service (cliff vesting). In addition, the shares underlying the options contain a redemption feature allowing the employee to require A to repurchase the shares at the then-current fair value six months and one day after exercise of the options.

Since the options were granted at-the-money and are not fully vested (i.e., the intrinsic value on the grant date is zero), no amount is initially reclassified to temporary equity. However, because the options contain a redemption feature, A is required to remeasure the options to their redemption value (i.e., their intrinsic value) in temporary equity in each reporting period until settlement. The amount recorded in temporary equity is based on the options’ redemption amount and the portion of the requisite service rendered as of each reporting period. On December 31, 20X1, the market price of A’s shares is $18. Accordingly, for the year ended December 31, 20X1, A (1) recognizes compensation cost on the basis of the grant-date fair-value-based measure of the options and (2) reclassifies as temporary equity an amount based on the options’ intrinsic value ($3) and the portion of the requisite service rendered. See the journal entries below.

On January 1, 20X2, A modifies the options to reduce the requisite service period from five years to four years. 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; therefore, no incremental compensation cost has to be recorded in connection with this modification. Entity A will recognize the remaining unrecognized compensation cost (1,000 options × $6 grant-date fair-value-based measure – $1,200 amount previously recognized = $4,800) over the remainder of the modified requisite service period (three years).

On the modification date, the market price of A’s shares is $17, while the exercise price of the options remained at $15. The market price of A’s shares increases to $19 as of December 31, 20X2. In accordance with ASR 268 and ASC 480-10-S99-3A, A will reclassify the redemption amount (i.e., the intrinsic value of the options on the modification date) as temporary equity. Accordingly, for the year ended December 31, 20X2, A (1) recognizes compensation cost on the basis of the grant-date fair-value-based measure of the options and (2) reclassifies as temporary equity an amount based on the options’ intrinsic value ($4) and the portion of the requisite service rendered. See the journal entries below.