Chapter 6 — Modifications
Chapter 6 — Modifications
6.1 Accounting for the Effects of Modifications
ASC 718-10 — Glossary
Modification
A change in the terms or conditions of a
share-based payment award.
ASC
718-20
Modification of an Award
35-2A An entity shall account for
the effects of a modification as described in paragraphs
718-20-35-3 through 35-9, unless all the following are
met:
- The fair value (or calculated value or intrinsic value, if such an alternative measurement method is used) of the modified award is the same as the fair value (or calculated value or intrinsic value, if such an alternative measurement method is used) of the original award immediately before the original award is modified. If the modification does not affect any of the inputs to the valuation technique that the entity uses to value the award, the entity is not required to estimate the value immediately before and after the modification.
- The vesting conditions of the modified award are the same as the vesting conditions of the original award immediately before the original award is modified.
- The classification of the modified award as an equity instrument or a liability instrument is the same as the classification of the original award immediately before the original award is modified.
The disclosure requirements in
paragraphs 718-10-50-1 through 50-2A and 718-10-50-4 apply
regardless of whether an entity is required to apply
modification accounting.
35-3 Except
as described in paragraph 718-20-35-2A, a modification of
the terms or conditions of an equity award shall be treated
as an exchange of the original award for a new award. In
substance, the entity repurchases the original instrument by
issuing a new instrument of equal or greater value,
incurring additional compensation cost for any incremental
value. The effects of a modification shall be measured as
follows:
- Incremental compensation cost shall be measured as the excess, if any, of the fair value of the modified award determined in accordance with the provisions of this Topic over the fair value of the original award immediately before its terms are modified, measured based on the share price and other pertinent factors at that date. As indicated in paragraph 718-10-30-20, references to fair value throughout this Topic shall be read also to encompass calculated value. The effect of the modification on the number of instruments expected to vest also shall be reflected in determining incremental compensation cost. The estimate at the modification date of the portion of the award expected to vest shall be subsequently adjusted, if necessary, in accordance with paragraph 718-10-35-1D or 718-10-35-3 and other guidance in Examples 14 through 15 (see paragraphs 718-20-55-107 through 55-121).
- Total recognized compensation cost
for an equity award 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. Thus, the total compensation cost
measured at the date of a modification shall be the
sum of the following:
-
The portion of the grant-date fair value of the original award for which the promised good is expected to be delivered (or has already been delivered) or the service is expected to be rendered (or has already been rendered) at that date
-
The incremental cost resulting from the modification.
Compensation cost shall be subsequently adjusted, if necessary, in accordance with paragraph 718-10-35-1D or 718-10-35-3 and other guidance in Examples 14 through 15 (see paragraphs 718-20-55-107 through 55-121). -
- A change in compensation cost for an equity award measured at intrinsic value in accordance with paragraph 718-20-35-1 shall be measured by comparing the intrinsic value of the modified award, if any, with the intrinsic value of the original award, if any, immediately before the modification.
35-3A An
entity that has an accounting policy to account for
forfeitures when they occur in accordance with paragraph
718-10-35-1D or 718-10-35-3 shall assess at the date of the
modification whether the performance or service conditions
of the original award are expected to be satisfied when
measuring the effects of the modification in accordance with
paragraph 718-20-35-3. However, the entity shall apply its
accounting policy to account for forfeitures when they occur
when subsequently accounting for the modified
award.
35-4
Examples 12 through 16 (see paragraphs 718-20-55-93 through
55-144) provide additional guidance on, and illustrate the
accounting for, modifications of both vested and nonvested
awards, including a modification that changes the
classification of the related financial instruments from
equity to liability or vice versa, and modifications of
vesting conditions. Paragraphs 718-10-35-9 through 35-14
provide additional guidance on accounting for modifications
of certain freestanding financial instruments that initially
were subject to this Topic but subsequently became subject
to other applicable generally accepted accounting principles
(GAAP).
Cancellation and
Replacement
35-8 Except as described in
paragraph 718-20-35-2A, cancellation of an award accompanied
by the concurrent grant of (or offer to grant) a replacement
award or other valuable consideration shall be accounted for
as a modification of the terms of the cancelled award. (The
phrase offer to grant is intended to cover situations
in which the service inception date precedes the grant
date.) Therefore, incremental compensation cost shall be
measured as the excess of the fair value of the replacement
award or other valuable consideration over the fair value of
the cancelled award at the cancellation date in accordance
with paragraph 718-20-35-3. Thus, the total compensation
cost measured at the date of a cancellation and replacement
shall be the portion of the grant-date fair value of the
original award for which the promised good is expected to be
delivered (or has already been delivered) or the service is
expected to be rendered (or has already been rendered) at
that date plus the incremental cost resulting from the
cancellation and replacement.
The guidance in this chapter primarily applies to modifications of
equity-classified share-based payment awards. Since liability awards are remeasured
at their fair value at the end of each reporting period, an entity does not need to
apply special guidance when accounting for modifications of such awards if their
classification does not change. See Section 6.8 for a discussion of modifications
that result in a change in classification, and see Section 7.4 for a discussion of modifications
of liability-classified awards.
ASC 718-10-20 defines a modification as “[a] change in the terms or
conditions of a share-based payment award.” However, an entity is not required to
apply modification accounting if certain factors are the same immediately before and
after the modification. As shown below, the three criteria in ASC 718-20-35-2A must
be met for a change in the terms or conditions of a share-based payment award not to
be accounted for as a modification under ASC 718-20-35-3.
1
Compare calculated value or intrinsic value, rather than
fair value, if such an alternative measurement method is used. See
Section
6.1.1 for additional discussion of the determination of
whether the fair value (or calculated or intrinsic value) of the
modified award equals that of the original award immediately before the
change occurs in the terms and conditions of the agreement.
A modification under ASC 718 is viewed as an exchange of the
original award for a new award, typically one with equal or greater value because
(1) share-based payment awards are meant to incentivize (rather than disincentivize)
employees and (2) the legal form of such an award may prevent the grantor from
modifying it without the consent of the grantee, and a grantee is not likely to
agree to a modification that results in an award of lesser value. However, if the
award is for stock options, 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.
Any incremental value of the new (or modified) award generally is recorded as
additional compensation cost on the modification date (for vested awards) or over
the remaining vesting period (for unvested awards). The incremental value (i.e.,
incremental compensation cost) is computed as the excess of the fair-value-based
measure of the modified award on the modification date over the fair-value-based
measure of the original award immediately before the modification.
In addition to considering whether a modification results in
incremental compensation cost that must be recognized, an entity must determine
whether it should recognize the award’s original grant-date fair-value-based measure
for equity-classified awards. Total recognized compensation cost attributable to an
equity award that has been modified 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 achieved). (See Sections 6.3.3 and 6.3.4 for illustrations of awards that have
been modified and are not expected to vest under the original vesting conditions.)
Therefore, total recognized compensation cost attributable to an award that has been
modified is generally the sum of (1) the grant-date fair-value-based measure of the
original award for which vesting has occurred or is expected to occur and (2) the
incremental compensation cost conveyed to the holder of the award as a result of the
modification, if any. However, if the original award is not expected to vest under
its original terms, any compensation cost recognized is based on the
modification-date fair-value-based measure of the modified award (i.e., the
grant-date fair-value-based measure of the original award is disregarded).
The examples below illustrate the application of modification
accounting to equity-classified awards and are based on Example 1 in ASC 718-20-55-4
through 55-9.
ASC
718-20
Example 1: Accounting for Share
Options With Service Conditions
55-4 The following Cases illustrate
the guidance in paragraphs 718-10-35-1D through 35-1E for
nonemployee awards, paragraphs 718-10-35-2 through 35-7 for
employee awards, and paragraphs 718-740-25-2 through 25-3
for both nonemployee and employee awards, except for the
vesting provisions:
- Share options with cliff vesting and forfeitures estimated in initial accruals of compensation cost (Case A)
- Share options with graded vesting and forfeitures estimated in initial accruals of compensation cost (Case B)
- Share options with cliff vesting and forfeitures recognized when they occur (Case C).
55-4A
Cases A through C (see paragraphs 718-20-55-10 through
55-34G) describe employee awards. However, the principles on
accounting for employee awards, except for the compensation
cost attribution, are the same for nonemployee awards.
Consequently, all of the following in Case A are equally
applicable to nonemployee awards with the same features as
the awards in Cases A through C (that is, awards with a
specified time period for vesting):
- The assumptions in paragraphs 718-20-55-6 through 55-9
- Total compensation cost considerations (including estimates of forfeitures) in paragraphs 718-20-55-10 through 55-12
- Changes in the estimation of forfeitures in paragraphs 718-20-55-14 through 55-15
- Exercise or expiration considerations in paragraphs 718-20-55-18 through 55-21 and 718-20-55-23.
Therefore, the guidance in
those paragraphs may serve as implementation guidance for
nonemployee awards. Similarly, an entity also may elect to
account for nonemployee award forfeitures as they occur as
illustrated in Case C (see paragraph
718-20-55-34A).
55-4B
Nonemployee awards may be similar to employee awards (that
is, cliff vesting or graded vesting). However, the
compensation cost attribution for awards to nonemployees may
be the same as or different from employee awards. That is
because an entity is required to recognize compensation cost
for nonemployee awards in the same manner as if the entity
had paid cash in accordance with paragraph 718-10-25-2C.
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.
55-4C
Because of the differences in compensation cost attribution,
the accounting policy election illustrated in Case B (see
paragraph 718-20-55-25) does not apply to nonemployee
awards.
55-5 Cases
A, B, and C share all of the assumptions in paragraphs
718-20-55-6 through 55-34G, with the following
exceptions:
- In Case C, Entity T has an accounting policy to account for forfeitures when they occur in accordance with paragraph 718-10-35-3.
- In Cases A and B, Entity T has an accounting policy to estimate the number of forfeitures expected to occur, also in accordance with paragraph 718-10-35-3.
- In Case B, the share options have graded vesting.
- In Cases A and C, the share options have cliff vesting.
55-6 Entity
T, a public entity, grants at-the-money employee share
options with a contractual term of 10 years. All share
options vest at the end of three years (cliff vesting),
which is an explicit service (and requisite service) period
of three years. The share options do not qualify as
incentive stock options for U.S. tax purposes. The enacted
tax rate is 35 percent. In each Case, Entity T concludes
that it will have sufficient future taxable income to
realize the deferred tax benefits from its share-based
payment transactions.
55-7 The
following table shows assumptions and information about the
share options granted on January 1, 20X5 applicable to all
Cases, except for expected forfeitures per year, which does
not apply in Case C.
55-8 A
suboptimal exercise factor of two means that exercise is
generally expected to occur when the share price reaches two
times the share option’s exercise price. Option-pricing
theory generally holds that the optimal (or
profit-maximizing) time to exercise an option is at the end
of the option’s term; therefore, if an option is exercised
before the end of its term, that exercise is referred to as
suboptimal. Suboptimal exercise also is referred to as early
exercise. Suboptimal or early exercise affects the expected
term of an option. Early exercise can be incorporated into
option-pricing models through various means. In this Case,
Entity T has sufficient information to reasonably estimate
early exercise and has incorporated it as a function of
Entity T’s future stock price changes (or the option’s
intrinsic value). In this Case, the factor of 2 indicates
that early exercise would be expected to occur, on average,
if the stock price reaches $60 per share ($30 × 2). Rather
than use its weighted average suboptimal exercise factor,
Entity T also may use multiple factors based on a
distribution of early exercise data in relation to its stock
price.
55-9 This
Case assumes that each employee receives an equal grant of
300 options. Using as inputs the last 7 items from the table
in paragraph 718-20-55-7, Entity T’s lattice-based valuation
model produces a fair value of $14.69 per option. A lattice
model uses a suboptimal exercise factor to calculate the
expected term (that is, the expected term is an output)
rather than the expected term being a separate input. If an
entity uses a Black-Scholes-Merton option-pricing formula,
the expected term would be used as an input instead of a
suboptimal exercise factor.
Example 12: Modifications and
Settlements
55-93 The
following Cases illustrate the accounting for modifications
of the terms of an award (see paragraphs 718-20-35-3 through
35-4) and are based on Example 1, Case A (see paragraph
718-20-55-10), in which Entity T granted its employees
900,000 share options with an exercise price of $30 on
January 1, 20X5:
- Modification of vested share options (Case A)
- Share settlement of vested share options (Case B)
- Modification of nonvested share options (Case C)
- Cash settlement of nonvested share options (Case D).
55-93A
Cases A through D (see paragraphs 718-20-55-94 through
55-102) describe employee awards. Specifically, each case is
an extension of Case A in Example 1. However, the principles
on how to account for the various aspects of employee
awards, except for the compensation cost attribution and
certain inputs to valuation, are the same for nonemployee
awards. Consequently, the methodology for determining the
additional compensation cost that an entity should recognize
upon modification or settlement in paragraphs 718-20-55-94
through 55-102 is equally applicable to nonemployee awards
with the same features as the awards in Cases A through D
(that is, awards with a specified period of time for
vesting). Therefore, the guidance in those paragraphs may
serve as implementation guidance for similar nonemployee
awards.
55-93B
All aspects of Case A (see paragraph 718-20-55-94) and Case
B (see paragraph 718-20-55-97) that illustrate a
modification and share settlement of vested share options,
respectively, including the immediate recognition of any
additional compensation cost, should be the same for both
employee awards and nonemployee awards.
55-93C
The compensation cost attribution for awards to nonemployees
may be the same or different for employee awards in Case C
(see paragraph 718-20-55-98), which illustrates the
modification of a nonvested share option. That is because an
entity is required to recognize compensation cost for
nonemployee awards in the same manner as if the entity had
paid cash in accordance with paragraph 718-10-25-2C.
55-93D
All aspects of Case D (see paragraph 718-20-55-102), which
illustrates a cash settlement of a nonvested share option,
including the immediate recognition of any additional
compensation cost, should be the same for both employee
awards and nonemployee awards. That is because the cash
settlement of a nonvested share option effectively vests the
share option.
Case A: Modification of Vested Share Options
55-94 On
January 1, 20X9, after the share options have vested, the
market price of Entity T stock has declined to $20 per
share, and Entity T decides to reduce the exercise price of
the outstanding share options to $20. In effect, Entity T
issues new share options with an exercise price of $20 and a
contractual term equal to the remaining contractual term of
the original January 1, 20X5, share options, which is 6
years, in exchange for the original vested share options.
Entity T incurs additional compensation cost for the excess
of the fair value of the modified share options issued over
the fair value of the original share options at the date of
the exchange, measured as shown in the following paragraph.
A nonpublic entity using the calculated value would compare
the calculated value of the original award immediately
before the modification with the calculated value of the
modified award unless an entity has ceased to use the
calculated value, in which case it would follow the guidance
in paragraph 718-20-35-3(a) through (b) (calculating the
effect of the modification based on the fair value). The
modified share options are immediately vested, and the
additional compensation cost is recognized in the period the
modification occurs.
55-95 The
January 1, 20X9, fair value of the modified award is $7.14.
To determine the amount of additional compensation cost
arising from the modification, the fair value of the
original vested share options assumed to be repurchased is
computed immediately before the modification. The resulting
fair value at January 1, 20X9, of the original share options
is $3.67 per share option, based on their remaining
contractual term of 6 years, suboptimal exercise factor of
2, $20 current share price, $30 exercise price, risk-free
interest rates of 1.5 percent to 3.4 percent, expected
volatility of 35 percent to 50 percent and a 1.0 percent
expected dividend yield. The additional compensation cost
stemming from the modification is $3.47 per share option,
determined as follows.
55-96
Compensation cost already recognized during the vesting
period of the original award is $10,981,157 for 747,526
vested share options (see paragraphs 718-20-55-14 through
55-17). For simplicity, it is assumed that no share options
were exercised before the modification. Previously
recognized compensation cost is not adjusted. Additional
compensation cost of $2,593,915 (747,526 vested share
options × $3.47) is recognized on January 1, 20X9, because
the modified share options are fully vested; any income tax
effects from the additional compensation cost are recognized
accordingly.
Case B: Share Settlement of Vested Share
Options
55-97 Rather
than modify the option terms, Entity T offers to settle the
original January 1, 20X5, share options for fully vested
equity shares at January 1, 20X9. The fair value of each
share option is estimated the same way as shown in Case A,
resulting in a fair value of $3.67 per share option. Entity
T recognizes the settlement as the repurchase of an
outstanding equity instrument, and no additional
compensation cost is recognized at the date of settlement
unless the payment in fully vested equity shares exceeds
$3.67 per share option. Previously recognized compensation
cost for the fair value of the original share options is not
adjusted.
Case C: Modification of Nonvested Share Options
55-98 On January 1, 20X6, 1 year
into the 3-year vesting period, the market price of Entity T
stock has declined to $20 per share, and Entity T decides to
reduce the exercise price of the share options to $20. The
three-year cliff-vesting requirement is not changed. In
effect, in exchange for the original nonvested share
options, Entity T grants new share options with an exercise
price of $20 and a contractual term equal to the 9-year
remaining contractual term of the original share options
granted on January 1, 20X5. Entity T incurs additional
compensation cost for the excess of the fair value of the
modified share options issued over the fair value of the
original share options at the date of the exchange
determined in the manner described in paragraphs
718-20-55-95 through 55-96. Entity T adds that additional
compensation cost to the remaining unrecognized compensation
cost for the original share options at the date of
modification and recognizes the total amount ratably over
the remaining two years of the three-year vesting period.
Because the original vesting provision is not changed, the
modification has an explicit service period of two years,
which represents the requisite service period as well. Thus,
incremental compensation cost resulting from the
modification would be recognized ratably over the remaining
two years rather than in some other pattern.
55-99 The
January 1, 20X6, fair value of the modified award is $8.59
per share option, based on its contractual term of 9 years,
suboptimal exercise factor of 2, $20 current share price,
$20 exercise price, risk-free interest rates of 1.5 percent
to 4.0 percent, expected volatilities of 35 percent to 55
percent, and a 1.0 percent expected dividend yield. The fair
value of the original award immediately before the
modification is $5.36 per share option, based on its
remaining contractual term of 9 years, suboptimal exercise
factor of 2, $20 current share price, $30 exercise price,
risk-free interest rates of 1.5 percent to 4.0 percent,
expected volatilities of 35 percent to 55 percent, and a 1.0
percent expected dividend yield. Thus, the additional
compensation cost stemming from the modification is $3.23
per share option, determined as follows.
55-100 On
January 1, 20X6, the remaining balance of unrecognized
compensation cost for the original share options is $9.79
per share option. Using a value of $14.69 for the original
option as noted in paragraph 718-20-55-9 results in
recognition of $4.90 ($14.69 ÷ 3) per year. The unrecognized
balance at January 1, 20X6, is $9.79 ($14.69 – $4.90) per
option. The total compensation cost for each modified share
option that is expected to vest is $13.02, determined as
follows.
55-101 That
amount is recognized during 20X6 and 20X7, the two remaining
years of the requisite service period.
Example 16: Modifications Regarding
an Award’s Classification
Case B: Equity to Equity Modification
(Share Options to Shares)
55-134
Equity to equity modifications also are addressed in
Examples 12 (see paragraph 718-20-55-93) and 14 (see
paragraph 718-20-55-107). This Case is based on Example 1,
Case A (see paragraph 718-20-55-10), in which Entity T
granted its employees 900,000 options with an exercise price
of $30 on January 1, 20X5. At January 1, 20X9, after 747,526
share options have vested, the market price of Entity T
stock has declined to $8 per share, and Entity T offers to
exchange 4 options with an assumed per-share-option fair
value of $2 at the date of exchange for 1 share of nonvested
stock, with a market price of $8 per share. The nonvested
stock will cliff vest after two years of service. All option
holders elect to participate, and at the date of exchange,
Entity T grants 186,881 (747,526 ÷ 4) nonvested shares of
stock. Entity T considers the guidance in paragraph
718-20-35-2A. Because the change in the terms or conditions
of the award changes the vesting conditions of the award,
Entity T applies modification accounting. However, because
the fair value of the nonvested stock is equal to the fair
value of the options, there is no incremental compensation
cost. Entity T will not make any additional accounting
entries for the shares regardless of whether they vest,
other than possibly reclassifying amounts in equity;
however, Entity T will need to account for the ultimate
income tax effects related to the share-based compensation
arrangement.
Example
6-1
On
January 1, 20X1, Entity A grants 1,000 at-the-money employee
stock options, each with a grant-date fair-value-based
measure of $9. The options vest at the end of the fourth
year of service (cliff vesting). On January 1, 20X4, A
modifies the options, which does not affect their remaining
requisite service period. The fair-value-based measure of
the original options immediately before modification is $4,
and the fair-value-based measure of the modified options is
$6.
Over the first three years of service, A records $6,750 (1,000 options × $9
grant-date fair-value-based measure × 75% for three of four
years of services rendered) of cumulative compensation cost.
On the modification date, A computes the incremental
compensation cost as $2,000, or ($6 fair-value-based measure
of modified options – $4 fair-value-based measure of
original options immediately before the modification) ×
1,000 options. The $2,000 incremental compensation cost is
recorded over the remaining year of service. In addition, A
records the remaining $2,250 of compensation cost over the
remaining year of service attributable to the original
options. Therefore, total compensation cost associated with
these options is $11,000 ($9,000 grant-date fair-value-based
measure + $2,000 incremental fair-value-based measure)
recorded over four years of required service for both the
original and modified options.
Example
6-2
Assume all the same facts as in the example above, except that the options
contain a graded vesting schedule (i.e., 25 percent of the
options vest at the end of each year of service). In
accordance with the accounting policy it has elected under
ASC 718-10-35-8, A records compensation cost on a
straight-line basis over the total requisite service period
for the entire award.
For the first three years of service, Entity A records $6,750 (1,000 options ×
$9 grant-date fair-value-based measure × 75% for three of
four years of services rendered) of cumulative compensation
cost. On the date of modification, A computes the
incremental compensation cost as $2,000, or ($6
fair-value-based measure of modified options – $4
fair-value-based measure of original options immediately
before the modification) × 1,000 options. Entity A records
$1,500 of incremental compensation cost immediately because
75 percent of the options have vested.
The remaining
$500 of incremental compensation cost is recorded over the
remaining year of service. In addition, A records the
remaining $2,250 of compensation cost over the remaining
year of service attributable to the original options.
Therefore, total compensation cost associated with these
options is $11,000 ($9,000 grant-date fair-value-based
measure + $2,000 incremental fair-value-based
measure).
Example
6-3
Entity B grants to its employees RSUs that are classified as equity and have a
fair-value-based measure of $1 million on the grant date.
Before the awards vest, B subsequently modifies them to add
a contingent fair-value repurchase feature on the underlying
shares. Assume that the addition of the repurchase feature
does not change the
fair-value-based measure of the awards or their
classification and that the fair-value-based measure on the
modification date is $1.5 million (both immediately before
and after the modification). In addition, there are no other
changes to the awards (including their vesting conditions).
In accordance with ASC 718-20-35-2A, B would not apply
modification accounting because the fair-value-based
measure, vesting conditions, and classification of the
awards are the same immediately before and after the
modification. Accordingly, irrespective of whether the
awards are expected to vest on the modification date, any
compensation cost recognized will continue to be based on
the grant-date fair-value-based measure of $1 million.
Changing Lanes
In May 2021, the FASB issued ASU
2021-04, which clarifies the accounting for
modifications of freestanding equity-classified written call options that
are within the scope of ASC 815-40 and remain equity classified after the
modification. The ASU specifies that when freestanding equity-classified
written call options that are within the scope of ASC 815-40 are modified or
exchanged to compensate grantees in a share-based payment arrangement, an
entity should recognize the effects of such modification by applying the
guidance in ASC 718; however, classification of the options would still be
subject to the requirements of ASC 815-40.
6.1.1 The Fair Value Assessment
Modification accounting is not required if certain conditions
are met, one of which is that the fair-value-based measure (or calculated value
or intrinsic value if such an alternative measurement method is used) must be
the same immediately before and after the modification.
6.1.1.1 Determining Whether a Fair Value Calculation Is Required
An entity will not always need to estimate the
fair-value-based measure of a modified award. An entity might instead be
able to determine whether the modification affects any of the inputs used in
the valuation technique performed for the award. For example, if an entity
changes the net-settlement terms of its share-based payment arrangements
related to statutory tax withholding requirements, that change is not likely
to affect any inputs used to value the awards. If none of the inputs are
affected, the entity would not be required to estimate the fair-value-based
measure immediately before and after the modification (i.e., the entity
could conclude that the fair-value-based measure is the same).
6.1.1.2 Considering Whether Compensation Cost Recognized Has Changed
The evaluation of whether the fair-value-based measure has
changed should not be based on whether the compensation cost recognized has
changed. If an entity makes a modification that changes the fair-value-based
measure of an award, modification accounting would be applied. An entity’s
assessment of whether to apply modification accounting does not take into
account a change in recognized compensation cost. For example, if a
modification changes the fair-value-based measure of an award but it is not
probable that the award will vest both immediately before and after the
modification (a “Type IV improbable-to-improbable” modification), there may
be no change in compensation cost recognized on the modification date
because there is no compensation cost before and after the modification
(compensation cost is recognized only if it is probable that the award will
vest). However, modification accounting would be required (and a new
measurement determined as of the modification date) because the
fair-value-based measure has changed; the new measurement should be used if
it becomes probable that the modified award will subsequently vest.
6.1.1.3 Determining the Unit of Account
In paragraphs BC19 and BC20 of ASU 2017-09, the
FASB discusses the unit of account an entity would apply in determining
whether an award’s fair-value-based measure is the same immediately before
and after a modification. The discussion addresses questions from
stakeholders about whether an entity should compare the value of an award
immediately before and after a modification on the basis of (1) “the total
instruments in an award to [a grantee] that are modified” or (2) “each
individual instrument awarded to [a grantee] that is modified.” The Board
indicates that the unit of account should be consistent with that applied
under other guidance in ASC 718 and with the definition of an award in the
ASC master glossary. That is, an entity should use as the unit of account
the total of all modified instruments in the award rather than each
individual modified instrument awarded to the grantee.
Example 6-4
Entity C grants 10,000 stock options that become
significantly out-of-the-money after the grant date.
To retain the award’s original fair value, C
modifies it by lowering the options’ exercise price
and reducing their quantity to 5,000. If C were to
compare the fair-value-based measure of a single
stock option in the original award immediately
before the modification with the fair-value-based
measure of a single stock option in the modified
award immediately after the modification, the
measure immediately before would be less than the
measure immediately after the modification. If a
single stock option were the unit of account, C
would be required to apply modification accounting.
However, C must base its assessment on the ASC
master glossary’s definition of an award. Although
this award contains multiple instruments, the unit
of account on which C performs the fair value
assessment is the total of all modified instruments
awarded to the employee. Accordingly, C compares the
fair-value-based measure of the original 10,000
stock options with the fair-value-based measure of
the modified 5,000 stock options. In accordance with
ASC 718-20-35-2A, C would not apply modification
accounting if the fair-value-based measure, vesting
conditions, and classification of the awards are the
same immediately before and after the
modification.
Example 6-5
Entity D grants 1,000 equity-classified stock
options to an employee. All 1,000 options are
granted at the same time and contain the same terms
and conditions. In accordance with the definition of
“award” in the ASC master glossary, the employee’s
award consists of 1,000 options. After the grant
date, the options become significantly
out-of-the-money, so D decides to reprice 500 of
them by reducing their exercise price. However, D
retains the original exercise price for the other
500 options. Accordingly, the 500 modified options
are now the award as well as the unit of account in
D’s assessment of whether it must apply modification
accounting. Because the fair-value-based measure of
the 500 modified options has increased, D applies
modification accounting. However, because the other
500 stock options were not modified, that award is
not subject to modification accounting and continues
to be recognized on the basis of its grant-date
fair-value-based measure. While all 1,000 stock
options were the award and the unit of account when
granted, only the 500 modified stock options are the
award and the unit of account for modification
accounting purposes because they were the only
instruments modified. In accordance with the
definition of “award” in the ASC master glossary,
“[r]eferences to an award also apply to a portion of
an award.”
6.1.1.4 Determining Whether the Fair Value Is the Same Before and After Modification
In determining whether modification accounting is
appropriate, some practitioners have expressed uncertainty about whether the
fair-value-based measure of an award must be exactly the same
immediately before and after the modification (i.e., a binary assessment) or
whether they can apply judgment on the basis of the significance of the
change in the fair-value-based measure. The FASB explained in ASU 2017-09
that it decided not to establish specific requirements regarding the use of
judgment in this assessment, observing that entities must use judgment to
apply other aspects of ASC 718 and do so without relying on specific
guidance. Accordingly, an entity may need to use judgment in certain
circumstances to determine whether the fair-value-based measure of an award
is the same immediately before and after a modification. For example, as a
result of using judgment, an entity may reasonably conclude that the
fair-value-based measure is the same when a difference is de minimis and the
facts and circumstances indicate that the intent of the modification was to
retain the award’s original fair value.
Example 6-6
Entity E grants to an employee 1,000
equity-classified stock options that become
significantly out-of-the-money after the grant date.
To retain the award’s original fair value, E decides
to replace the 1,000 stock options with 423 RSUs.
The fair-value-based measure of the 1,000 stock
options immediately before the modification is
$100,000, and the fair-value-based measure of the
423 RSUs is $100,010. The difference is de minimis
and solely attributable to E’s having rounded up the
423 RSUs, which it does because it is precluded from
issuing fractional shares. Accordingly, E concludes
that the fair-value-based measure of the award is
the same immediately before and after the
modification.
6.1.2 Examples of Changes for Which Modification Accounting Would or Would Not Be Required
The Background Information and Basis for Conclusions of ASU
2017-09 provides examples (that “are educational in nature, are not
all-inclusive, and should not be used to override the guidance in paragraph
718-20-35-2A”) of changes to awards for which modification accounting generally
would or would not be required. The table below summarizes those examples.
Share-based payment plans commonly contain clawback provisions
that allow an entity to recoup awards upon certain contingent events (e.g.,
termination for cause, violation of a noncompete provision, material financial
statement restatement), as discussed in Section 3.9. Under ASC 718-10-30-24, such clawback provisions
generally are not reflected in estimates of the fair-value-based measure of
awards. Accordingly, the addition of a clawback provision to an award would
typically not result in the application of modification accounting because such
clawbacks generally do not change the award’s fair-value-based measure, vesting
conditions, or classification.
Example 6-7
Entity F grants 100,000 equity-classified stock options
to its CEO. A year after the grant date, F modifies the
award to add a well-defined, objective, and
nondiscretionary clawback provision related to a
material restatement of F’s financial statements. Entity
F concludes that the modification does not change the
award’s fair-value-based measure, vesting conditions, or
classification. In assessing whether the award’s
fair-value-based measure changes as a result of the
modification, F determines that the addition of the
clawback provision does not affect any of the inputs
used in the valuation technique since clawback
provisions generally are not reflected in estimates of
the fair-value-based measure of awards. As a result, F
concludes that it is not required to apply modification
accounting.
6.1.3 Tax Effects of Award Modifications
Modification of share-based payment agreements may have unintended tax consequences.
For example, a modification may affect the U.S. federal tax treatment of a
nonstatutory option (i.e., an NQSO) under IRC Section 409A, which could have
significant tax consequences for the grantee of the share-based payment award (see
Section 4.12.2 for additional information on nonstatutory options
and IRC Section 409A) or result in a disqualifying event of an ISO (see Section 6.5.1.2).
In addition, modification of a share-based payment plan may change
the deductibility of awards issued to a “covered employee” under IRC Section 162(m)
and how the limitations are applied for income tax purposes. IRC Section 162(m)
applies differently to (1) compensation arrangements entered into before November 2,
2017 (that have not been materially modified on or after that date), and (2)
compensation arrangements entered into on or after November 2, 2017. Compensation
arrangements that were in place before this date are effectively “grandfathered”
(i.e., legacy requirements apply). However, if a modification occurs on or after
this date, the award may no longer qualify for this exception. See Section 10.2.3 of Deloitte’s Roadmap Income Taxes for
additional information.
Given the potential for unintended tax consequences associated with modifications to
share-based compensation plans, entities are urged to consult with their tax
advisers.
Footnotes
1
Compare calculated value or intrinsic value, rather than
fair value, if such an alternative measurement method is used. See
Section
6.1.1 for additional discussion of the determination of
whether the fair value (or calculated or intrinsic value) of the
modified award equals that of the original award immediately before the
change occurs in the terms and conditions of the agreement.
6.2 Modification Date
To determine the accounting period in which to record any incremental compensation cost resulting from an award’s modification as well as to measure the modification’s effect, an entity must establish a modification date. For example, if the award is fully vested, the entity recognizes any incremental cost entirely on the modification date. When establishing the modification date, the entity considers the same conditions it does when establishing the grant date for the original share-based payment award.
As discussed in Section 3.2, a grant date is generally considered to be the date on which all of the following conditions have been met:
- The entity and grantee have reached a mutual understanding of the key terms and conditions of the share-based payment award (see Sections 3.2.2, 3.2.3, and 3.2.5).
- The grantee begins to benefit from, or be adversely affected by, subsequent changes in the price of the entity’s equity shares for equity instruments (see Section 3.2.4).
- All necessary approvals have been obtained. Awards made under an arrangement that is subject to shareholder approval are not deemed to be granted until that approval is obtained unless approval is essentially a formality (or perfunctory). For example, if shareholder approval is required but management and the members of the board of directors control enough votes to approve the arrangement, shareholder approval is essentially a formality or perfunctory. Similarly, individual awards that are subject to approval by the board of directors, management, or both are not deemed to be granted until all such approvals are obtained (see Section 3.2.1).
- For awards to employees, the recipient meets the definition of an employee (see Section 2.2 for guidance on the definition of an employee).
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. For
modifications of an award whose vesting was probable under the original vesting
conditions, when determining the ultimate compensation to recognize, an entity 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.
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 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 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.
|
The various types of modifications, their accounting results, and the bases 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 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 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 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 6-10
On January 1, 20X1, Entity A grants 1,000 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.
6.3.3.2 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 6-11
Assume the same facts as in Example 6-10,
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
6-10.
If it applies View 2, it would recognize compensation cost on a straight-line
basis over the five-year service period (as it did
in Example
6-10) 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 will be based on a new fair-value-based measure determined on
the modification date on the basis of the terms of the compensation cost. Once an IPO occurs, the
compensation cost will be recognized on the basis of 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 6-12
On January 1, 20X1, Entity A grants
1,000 at-the-money employee stock options, each with a
grant-date fair-value-based measure of $9. The options
vest 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 6-13
On January 1, 20X1, Entity A grants 1,000 at-the-money employee stock options,
each with a grant-date fair-value-based measure of $9.
The options vest 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 6-14
On January 1, 20X1, Entity A granted 100 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 (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 6-15
On January 1, 20X1, Entity A grants 1,000 at-the-money employee stock options, each with a grant-date fair-value-based measure of $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 6-16 below.
- 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 6-16. (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 6-16
Assume the same facts as in Example 6-15, 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 6-17
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
|
Options
|
---|---|---|
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
|
Options
|
---|---|---|
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].
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 6-18
On January 1, 20X1, Entity A granted 1,000 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. An entity may wish to seek the opinion of legal counsel in determining whether it is obligated to settle in cash or other assets. 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.
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.
6.6 Business Combination
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.
An acquiring entity may issue share-based payment awards (referred to in ASC 805
as “replacement awards”) to the acquiree’s employees or vendors to replace their
existing share-based payment awards. Exchanges of share-based payment awards in a
business combination are considered modifications under ASC 718-20-35-6. An acquirer
often issues replacement awards to ensure that the acquiree’s employees or vendors
are in a similar economic position immediately before and after the consummation of
the business combination. The replacement awards may represent consideration
transferred in the business combination (i.e., they may be related to past goods or
services that the grantees provided to the acquiree before the acquisition date),
compensation for future goods or services (i.e., postcombination goods or services)
by the grantees, or both. See Chapter 10 for
further discussion of the accounting treatment of awards that are exchanged in a
business combination.
6.7 Short-Term Inducements
ASC 718-20 — Glossary
Short-Term Inducement
An offer by the entity that would result in modification of an award to which an award holder may subscribe for a limited period of time.
ASC 718-20
Short-Term Inducements
35-5 Except as described in paragraph 718-20-35-2A, a short-term inducement shall be accounted for as a modification of the terms of only the awards of grantees who accept the inducement, and other inducements shall be accounted for as modifications of the terms of all awards subject to them.
The ASC master glossary defines a short-term inducement as an “offer by the
entity that would result in modification of an award to which an award holder may
subscribe for a limited period of time.” Modification accounting applies only to the
awards for which holders accept the offer. While entities must use judgment in
determining what constitutes a limited period, we would generally expect it to be
less than a few months. If an inducement is not “for a limited period of time,” it
is considered a long-term inducement and is accounted for as a modification of all
awards subject to the inducement, even if the inducement is not accepted by the
holder.
The modification date for a short-term inducement is typically the date on which an
award holder accepts the offer (i.e., “opts in”). If award holders opt in on
different dates, the entity would have multiple modification dates. However, if
award holders have the ability to withdraw their acceptance (i.e., “opt out”) before
the end of the offer period, the modification date would be the date on which the
withdrawal right expires. By contrast, the modification date of a long-term
inducement is the date on which the inducement is offered, regardless of how many
award holders accept the offer or when they accept it.
See Section 6.10.2 for a
discussion of short-term offers to settle an equity award for cash or other assets.
Example 6-23
On January 1, 20X1, Entity A grants 1,000 at-the-money employee stock options to each of its 100 employees. The options have a grant-date fair-value-based measure of $3 and an exercise price of $10, and they vest at the end of the third year of service (cliff vesting).
On December 31, 20X1, A offers to all 100 employees the ability to reduce the
exercise price of the stock options to $8 if the employees
are willing to extend the vesting period for an additional
year. The offer is valid for the remaining original service
period of two years. Because the inducement is not
short-term (i.e., it is not offered for a limited period), A
should account for the inducement as a modification of all
100,000 stock options on December 31, 20X1 (i.e., the
modification date), regardless of how many employees accept
the offer.
Example 6-24
Assume the same facts as in the example above, except that the employees have
only one month to accept the offer, and those who opt in do
not have the ability to opt out once they have accepted the
offer. During that one-month period, 60 employees accept the
offer. Entity A would apply modification accounting to only
the 60,000 stock options awarded to employees who accepted
the offer because it has determined that the offer is a
short-term inducement. In addition, the modification date
for each opt-in is the date on which each employee accepts
the offer.
6.8 Modifications That Result in a Change in Classification
A modification can result in a change in an award’s classification from equity to liability or vice versa. The accounting for the modification will depend on the classification of the award before and after the modification.
6.8.1 Modification From an Equity Award to a Liability Award
To account for the modification of an award that results in reclassification
from equity to liability, an entity would, on the modification date,
recognize a share-based liability for the portion of the award for
which the goods or services have already been provided and multiply
that amount by the modified award’s fair-value-based measure. If the
fair-value-based measure of the modified award is less than or equal
to the fair-value-based measure of the original award, the offsetting
amount would be recorded in APIC. If, on the other hand, the
fair-value-based measure of the modified award is greater than the
fair-value-based measure of the original award, the excess value would
be recognized as additional compensation cost either immediately (for
vested awards) or over the remaining employee requisite service period
or nonemployee’s vesting period (for unvested awards). Because the
award has been reclassified as a liability, it is remeasured at a
fair-value-based amount in each reporting period until settlement.
However, total compensation cost cannot be less than the grant-date
fair-value-based measure of the original award if the original award
was expected to vest.
The accounting for such a modification differs from that of a settlement of an award. For example, if an
entity cash settles a fully vested equity award rather than modifying its terms to reclassify it as a liability,
the entity does not apply modification accounting. As long as the cash settlement amount is less than
or equal to the award’s then-current fair-value-based measure, no additional compensation cost results
under ASC 718-20-35-7 and the settlement is accounted for as a treasury stock transaction. See Section 6.10.1 for a discussion of a cash settlement that is different from the current fair-value-based measure, and see Section 6.10.2 for a discussion of how to differentiate between a modification and a settlement.
Example 16 in ASC 718-20-55-123 below describes employee awards; however,
the FASB indicates that the same principles apply to nonemployee
awards with similar features as the awards described in Cases A
through E in the determination of total compensation cost to be
recognized as a result of a modification. The cost associated with
nonemployee awards should be recognized in the same period(s) and in
the same manner as though the grantor had paid cash.
ASC 718-20
Example 16: Modifications That Change an Award’s Classification
Case A: Equity to Liability Modification (Share-Settled Share Options to Cash-Settled Share Options)
55-123 Entity T grants the
same share options described in Example 1, Case A
(see paragraph 718-20-55-10). As in Example 1,
Case A, Entity T has an accounting policy to
estimate the number of forfeitures expected to
occur in accordance with paragraph 718-10-35-3.
The number of options for which the requisite
service is expected to be rendered is estimated at
the grant date to be 821,406 (900,000 ×
.973). For simplicity, this Case
assumes that estimated forfeitures equal actual
forfeitures. Thus, as shown in the table in
paragraph 718-20-55-130, the fair value of the
award at January 1, 20X5, is $12,066,454 (821,406
× $14.69), and the compensation cost to be
recognized during each year of the 3-year vesting
period is $4,022,151 ($12,066,454 ÷ 3). The
journal entries for 20X5 are the same as those in
paragraph 718-20-55-12.
55-124 On January 1, 20X6, Entity T modifies the share options granted to allow the employee the choice of share settlement or net cash settlement; the options no longer qualify as equity because the holder can require Entity T to settle the options by delivering cash. Because the modification affects no other terms or conditions of the options, the fair value (assumed to be $7 per share option) of the modified award equals the fair value of the original award immediately before its terms are modified on the date of modification; the modification also does not change the number of share options for which the requisite service is expected to be rendered. On the modification date, Entity T recognizes a liability equal to the portion of the award attributed to past service multiplied by the modified award’s fair value. To the extent that the liability equals or is less than the amount recognized in equity for the original award, the offsetting debit is a charge to equity. To the extent that the liability exceeds the amount recognized in equity for the original award, the excess is recognized as compensation cost. In this Case, at the modification date, one-third of the award is attributed to past service (one year of service rendered/three-year requisite service period). The modified award’s fair value is $5,749,842 (821,406 × $7), and the liability to be recognized at the modification date is $1,916,614 ($5,749,842 ÷ 3). The related journal entry follows.
55-125 No entry would be made to the deferred tax accounts at the modification date. The amount of remaining additional paid-in capital attributable to compensation cost recognized in 20X5 is $2,105,537 ($4,022,151 – $1,916,614).
55-126 Paragraph
718-20-35-3(b) specifies that total recognized
compensation cost for an equity award shall at
least equal the fair value of the award at the
grant date unless at the date of the modification
the service or performance conditions of the
original award are not expected to be satisfied.
In accordance with that principle, Entity T would
ultimately recognize cumulative compensation cost
equal to the greater of the following:
-
The grant-date fair value of the original equity award
-
The fair value of the modified liability award when it is settled.
55-127 To the extent that the recognized fair value of the modified liability award is less than the recognized compensation cost associated with the grant-date fair value of the original equity award, changes in that liability award’s fair value through its settlement do not affect the amount of compensation cost recognized. To the extent that the fair value of the modified liability award exceeds the recognized compensation cost associated with the grant-date fair value of the original equity award, changes in the liability award’s fair value are recognized as compensation cost.
55-128 At December 31, 20X6, the fair value of the modified award is assumed to be $25 per share option; hence, the modified award’s fair value is $20,535,150 (821,406 × $25), and the corresponding liability at that date is $13,690,100 ($20,535,150 × 2/3) because two-thirds of the requisite service period has been rendered. The increase in the fair value of the liability award is $11,773,486 ($13,690,100 – $1,916,614). Before any adjustments for 20X6, the amount of remaining additional paid-in capital attributable to compensation cost recognized in 20X5 is $2,105,537 ($4,022,151 – $1,916,614). The cumulative compensation cost at December 31, 20X6, associated with the grant-date fair value of the original equity award is $8,044,302 ($4,022,151 × 2). Entity T would record the following journal entries for 20X6.
55-129 At December 31, 20X7, the fair value is assumed to be $10 per share option; hence, the modified award’s fair value is $8,214,060 (821,406 × $10), and the corresponding liability for the fully vested award at that date is $8,214,060. The decrease in the fair value of the liability award is $5,476,040 ($8,214,060 – $13,690,100). The cumulative compensation cost as of December 31, 20X7, associated with the grant-date fair value of the original equity award is $12,066,454 (see paragraph 718-20-55-123). Entity T would record the following journal entries for 20X7.
55-130 The modified liability award is as follows.
55-131 For simplicity, this Case assumes that all share option holders elected to be paid in cash on the same day, that the liability award’s fair value is $10 per option, and that Entity T has already recognized its income tax expense for the year without regard to the effects of the settlement of the award. In other words, current tax expense and current taxes payable were recognized based on income and deductions before consideration of additional deductions from settlement of the award.
55-132 The $8,214,060 in cash
paid to the employees on the date of settlement is
deductible for tax purposes. In the period of
settlement, tax return deductions that are less than
compensation cost recognized result in a charge to
income tax expense. The tax benefit is $2,874,921
($8,214,060 × .35). Because tax return deductions are
less than compensation cost recognized, the entity must
write off the deferred tax assets recognized in excess
of the tax benefit from the exercise of employee stock
options to income tax expense in the income statement.
The journal entries to reflect settlement of the share
options are as follows.
55-133 If instead of requesting cash, employees had held their share options and those options had expired worthless, the share-based compensation liability account would have been eliminated over time with a corresponding increase to additional paid-in capital. Previously recognized compensation cost would not be reversed. Similar to the adjustment for the actual tax deduction described in paragraph 718-20-55-132, all of the deferred tax asset of $4,223,259 would be charged to income tax expense when the share options expire.
Case E: Equity to Liability Modification (Share Options to Fixed Cash Payment)
55-144 Entity T grants the
same share options described in Example 1, Case A (see
paragraph 718-20-55-10) and records similar journal
entries for 20X5 (see paragraphs 718-20-55-12 through
55-16). By January 1, 20X6, Entity T’s share price has
fallen, and the fair value per share option is assumed
to be $2 at that date. Entity T provides its employees
with an election to convert each share option into an
award of a fixed amount of cash equal to the fair value
of each share option on the election date ($2) accrued
over the remaining requisite service period, payable
upon vesting. The election does not affect vesting; that
is, employees must satisfy the original service
condition to vest in the award for a fixed amount of
cash. Entity T considers the guidance in paragraph
718-20-35-2A. Because the change in the terms or
conditions of the award changes the classification of
the award from equity to liability, Entity T applies
modification accounting. This transaction is considered
a modification instead of a settlement because Entity T
continues to have an obligation to its employees that is
conditional upon the receipt of future employee
services. There is no incremental compensation cost
because the fair value of the modified award is the same
as that of the original award. At the date of the
modification, a liability of $547,604 [(821,406 × $2) ×
(1 year of requisite service rendered ÷ 3-year requisite
service period)], which is equal to the portion of the
award attributed to past service multiplied by the
modified award’s fair value, is recognized by
reclassifying that amount from additional paid-in
capital. The total liability of $1,642,812 (821,406 ×
$2) should be fully accrued by the end of the requisite
service period. Because the possible tax deduction of
the modified award is capped at $1,642,812, Entity T
also must adjust its deferred tax asset at the date of
the modification to the amount that corresponds to the
recognized liability of $547,604. That amount is
$191,661 ($547,604 × .35), and the write-off of the
deferred tax asset is $1,216,092 ($1,407,753 –
$191,661). That write-off would be recognized as income
tax expense in the income statement. Compensation cost
of $4,022,151 would be recognized in each of 20X6 and
20X7 for a cumulative total of $12,066,454 (as
calculated in Case A); of this, $547,604 would be
recognized as an increase to the liability balance, with
the remaining $3,474,547 recognized as an increase in
additional paid-in capital. A deferred tax benefit would
be recognized in the income statement, and a
corresponding increase to the deferred tax asset would
be recognized for the tax effect of the increased
liability of $191,661 ($547,604 × .35). The compensation
cost recognized in additional paid-in capital in this
situation has no associated income tax effect
(additional deferred tax assets are recognized based
only on subsequent increases in the amount of the
liability).
Example 6-25
On January 1, 20X1, Entity A grants 1,000 at-the-money share-settled SARs, each with a grant-date fair-value-based measure of $3. The SARs vest at the end of the fourth year of service (cliff vesting). On December 31, 20X2, A modifies the awards from share-settled SARs to cash-settled SARs. The fair-value-based measure of the SARs on December 31, 20X2, and December 31, 20X3, is $4 and $5, respectively.
Because the modification only affects the SARs’ settlement feature (i.e., cash settlement vs. share settlement), the fair-value-based measure of the modified SARs presumably equals the fair-value-based measure of the original SARs immediately before modification. Accordingly, there is no incremental value conveyed to the holder of the SARs.
However, because the modification-date fair-value-based measure is greater than
the grant-date fair-value-based measure, A (1)
reclassifies the amount currently residing in
APIC, $1,500 (1,000 SARs × $3 grant-date
fair-value-based measure × 50% for two of four
years of services rendered), as a share-based
liability and (2) records the excess $500 — ($4
modification-date fair-value-based measure – $3
grant-date fair-value-based measure) × 1,000 SARs
× 50% for two of four years of services rendered —
as additional compensation cost to record the new
liability award at its fair-value-based measure,
with a corresponding adjustment to share-based
liability in the period of modification. See the
journal entries below.
Now that the SARs are
classified as a liability, A must remeasure them
at their fair-value-based amount in each reporting
period until settlement in accordance with ASC
718-30-35-2. (Chapter 7 discusses the differences
between the accounting treatment of equity and
liability awards.) See the journal entry
below.
Example 6-26
Assume all the same facts as in the example above, except that the
fair-value-based measure of the SARs on the date
of modification (December 31, 20X2) and December
31, 20X3, is $2.50 and $2, respectively. Entity A
reclassifies the portion of the SARs’
modification-date fair-value-based measure of
$1,250 (1,000 SARs × $2.50 fair-value-based
measure × 50% for two of four years of services
rendered) currently residing in APIC as a
share-based liability. See the journal entries
below.
Now that the SARs are classified as a liability, in accordance with ASC 718-30-35-2, A must remeasure them at their fair-value-based amount in each reporting period until settlement. If the value of the liability award at settlement is less than its grant-date fair-value-based measure, then total compensation cost will equal the grant-date fair-value-based measure, and a portion of that value will remain in equity. On the other hand, if at settlement the value of the liability award is greater than its grant-date fair-value-based measure, total compensation cost will equal the liability award’s value at settlement. This conclusion is consistent with the requirement in ASC 718 that compensation cost for an equity award (i.e., the original award’s treatment before modification) should generally be recorded at least at its grant-date fair-value-based measure. See the journal entries below.
6.8.2 Modification From a Liability Award to an Equity Award
The treatment of a modification that changes an award’s classification from liability to equity is different from the treatment of other modifications, for which total recognized compensation cost attributable to an award that has been modified is, at least, the grant-date fair-value-based measure of the original award unless the original award was not expected to vest. For liability to equity modifications, the aggregate amount of compensation cost recognized is generally the fair-value-based measure of the award on the modification date. To account for the modification, an entity would, on the modification date, record the amounts previously recorded as a share-based compensation liability as a component of equity in the form of a credit to APIC. Because the award is no longer classified as a liability, it no longer has to be remeasured at a fair-value-based amount in each reporting period until settlement.
ASC 718-30
Example 1: Cash-Settled Stock Appreciation Right
55-1 This Example illustrates the guidance in paragraphs 718-30-35-2 through 35-4 and 718-740-25-2 through 25-4.
55-1A
This Example (see paragraphs 718-30-55-2 through
55-11) describes employee awards. However, the
principles on how to account for the various
aspects of employee awards, except for the
compensation cost attribution and certain inputs
to valuation, are the same for nonemployee awards.
Consequently, the concepts about valuation and
forfeiture estimation and remeasurement of awards,
exercise, and expiration in paragraphs 718-30-55-2
through 55-11 are equally applicable to
nonemployee awards with the same features as the
awards in this Example (that is, awards with a
specified period of time for vesting classified as
liabilities). Therefore, the guidance in those
paragraphs may serve as implementation guidance
for similar nonemployee awards.
55-1B
Compensation cost attribution for awards to
nonemployees may be the same or different for
employee awards. That is because an entity is
required to recognize compensation cost for
nonemployee awards in the same manner as if the
entity had paid cash in accordance with paragraph
718-10-25-2C. 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.
55-2 Entity T, a public
entity, grants share appreciation rights with the
same terms and conditions as those described in
Example 1 (see paragraph 718-20-55-4). As in
Example 1, Case A, Entity T makes an accounting
policy election in accordance with paragraph
718-10-35-3 to estimate the number of forfeitures
expected to occur and includes that estimate in
its initial accrual of compensation costs. Each
stock appreciation right entitles the holder to
receive an amount in cash equal to the increase in
value of 1 share of Entity T stock over $30.
Entity T determines the grant-date fair value of
each stock appreciation right in the same manner
as a share option and uses the same assumptions
and option-pricing model used to estimate the fair
value of the share options in that Example;
consequently, the grant-date fair value of each
stock appreciation right is $14.69 (see paragraphs
718-20-55-7 through 55-9). The awards cliff-vest
at the end of three years of service (an explicit
and requisite service period of three years). The
number of stock appreciation rights for which the
requisite service is expected to be rendered is
estimated at the grant date to be 821,406 (900,000
× .973). Thus, the fair value of the
award as of January 1, 20X5, is $12,066,454
(821,406 × $14.69). For simplicity, this Example
assumes that estimated forfeitures equal actual
forfeitures.
ASC 718-20
Example 16: Modifications That Change an Award’s Classification
Case C: Liability to Equity Modification (Cash-Settled to Share-Settled Stock Appreciation Rights)
55-135 This Case is based on the facts given in Example 1 (see paragraph 718-30-55-1). Entity T grants cash-settled stock appreciation rights to its employees. The fair value of the award on January 1, 20X5, is $12,066,454 (821,406 × $14.69) (see paragraph 718-30-55-2).
55-136 On December 31, 20X5, the assumed fair value is $10 per stock appreciation right; hence, the fair value of the award at that date is $8,214,060 (821,406 × $10). The share-based compensation liability at December 31, 20X5, is $2,738,020 ($8,214,060 ÷ 3), which reflects the portion of the award related to the requisite service provided in 20X5 (1 year of the 3-year requisite service period). For convenience, this Case assumes that journal entries to account for the award are performed at year-end. The journal entries for 20X5 are as follows.
55-137 On January 1, 20X6, Entity T modifies the stock appreciation rights by replacing the cash-settlement feature with a net share settlement feature, which converts the award from a liability award to an equity award because Entity T no longer has an obligation to transfer cash to settle the arrangement. Entity T would compare the fair value of the instrument immediately before the modification to the fair value of the modified award and recognize any incremental compensation cost. Because the modification affects no other terms or conditions, the fair value, assumed to be $10 per stock appreciation right, is unchanged by the modification and, therefore, no incremental compensation cost is recognized. The modified award’s total fair value is $8,214,060. The modified award would be accounted for as an equity award from the date of modification with a fair value of $10 per share. Therefore, at the modification date, the entity would reclassify the liability of $2,738,020 recognized on December 31, 20X5, as additional paid-in capital. The related journal entry is as follows.
55-138 Entity T will account for the modified awards as equity going forward following the pattern given in Example 1, Case A (see paragraph 718-20-55-1), recognizing $2,738,020 of compensation cost in each of 20X6 and 20X7, for a cumulative total of $8,214,060.
Example 6-27
On January 1, 20X1, Entity A grants 1,000 at-the-money cash-settled SARs, each with a grant-date fair-value-based measure of $3. The SARs vest at the end of the fourth year of service (cliff vesting). On December 31, 20X1, the SARs’ fair-value-based measure is still $3. On December 31, 20X2, A modifies the awards, changing them from cash-settled SARs to share-settled restricted stock awards. The fair-value-based measure of the restricted stock awards on December 31, 20X2, is $7, and the fair-value-based measure of the original SARs immediately before modification is $5.
The modification to replace the original SARs awards with restricted stock
awards and to change the settlement feature of the
awards (i.e., share settlement versus cash
settlement) increases the fair-value-based measure
of the modified restricted stock awards relative
to the fair-value-based measure of the original
SARs immediately before modification. Accordingly,
since there is incremental value conveyed to the
holder of the restricted stock awards in
connection with the modification from liability to
equity, A will record incremental compensation
cost of $2,000, or ($7 – $5) × 1,000 restricted
stock awards, over the remaining two years of
service required.
On December 31, 20X2, the modified restricted stock awards are accounted for as an equity award from
the date of modification, with compensation cost fixed at $7 (which is the fair-value-based measure on the
modification date). As a result, A reclassifies as APIC the amount previously recorded as a share-based liability
($2,500 = 1,000 SARs × $5 modification-date fair-value-based measure × 50% for two of four years of services
rendered). In addition, A records the remaining $4,500 of compensation cost (1,000 restricted stock awards ×
$7 modification-date fair-value-based measure – $2,500 previously recognized compensation cost) over the
remaining service period (two years). See the journal entries below.
When a reduction in an award’s fair-value-based measure occurs in conjunction with a change in its classification from liability to equity, an entity should record the reduction in the fair-value-based measure in equity (as APIC), not in the income statement. Grantees ordinarily would not exchange one award for another that is less valuable. Therefore, their acceptance of the new award is analogous to debt forgiveness by a related party and should be treated as a contribution of capital (see ASC 470-50-40-2).
This situation is also analogous to the example described in paragraph 5 of FASB Interpretation 28, in which employees are granted a combination award (i.e., SARs that are exercisable for the same period as companion stock options, and the exercise of either cancels the other). If circumstances change and the employee will exercise the stock option rather than the SAR, accrued compensation related to the appreciation right is not adjusted. Although Interpretation 28 has been nullified by FASB Statement 123(R), the guidance in paragraph 5 remains
applicable by analogy.
Example 6-28
On January 1, 20X1, Entity A grants 100 cash-settled performance units to each of its 100 employees. The units vest at the end of the third year of service (cliff vesting). On January 1, 20X2, A modifies the units (after obtaining approval from each of the unit holders) to require settlement in shares and further restricts the employees from selling the shares for one year after they become vested. The fair-value-based measure of the units immediately before modification is $12, and the fair-value-based measure of the modified award is $11. The decrease in value is attributable to the addition of the restriction on the ability to sell the vested shares.
On December 31, 20X1, A records the 20X1 compensation cost and a corresponding share-based liability on the basis of the current fair-value-based measure of the units ($12), the number of units to be issued (10,000), and the percent of services rendered (33 percent for one of three years of services rendered). See the journal entry below.
On January 1, 20X2, A accounts for the modification by first reclassifying the accumulated value of the equity award (on the basis of the new fair-value-based measure) as APIC (10,000 units × $11 fair-value-based measure × 33% for one of three years of services rendered = $36,667). Next, A reclassifies the remaining share-based liability (representing the employees’ capital contributions) as equity ($40,000 – $36,667 = $3,333). See the journal entry below.
Using the new fair-value-based measure of the award, A records the entry below to recognize the compensation cost of $36,667 (10,000 units × $11 fair-value-based measure × 33% for one of three years of services rendered) for both 20X2 and 20X3.
6.9 Modifications Under ASR 268
SEC ASR 268 and ASC 480-10-S99-3A require (with limited exceptions) temporary-equity classification for share-based payment awards with redemption features not solely within the control of the entity (as long as the awards would not otherwise be classified as liabilities). See Section 5.10 for a discussion of classification of awards with redemption features not solely within the control of the entity.
The modification guidance in ASC 718-20 also applies to awards that are accounted for in accordance with ASR 268 and ASC 480-10-S99-3A. In other words, SEC registrants are required to record the incremental fair-value-based measure, if any, of the modified award as compensation cost on the date of modification (for vested awards) or over the remaining service period (for unvested awards). In addition, SEC registrants are required to reclassify the redemption amount to temporary equity on the modification date.
Example 6-29
Accounting for the Modification of an Award With a Contingent Cash-Settlement Feature
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.
Journal Entry: December 31, 20X1
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.
Journal Entry: January 1, 20X2
Journal Entries: December 31, 20X2
Example 6-30
Accounting for the Modification of an Award That Is Puttable by the Employee
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.
Journal Entries: December 31, 20X1
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.
Journal Entries: December 31, 20X2
6.10 Repurchases and Settlements
ASC 718-20
Repurchase or Cancellation
35-7 The amount of cash or other assets transferred (or liabilities incurred) to repurchase an equity award
shall be charged to equity, to the extent that the amount paid does not exceed the fair value of the equity
instruments repurchased at the repurchase date. Any excess of the repurchase price over the fair value of
the instruments repurchased shall be recognized as additional compensation cost. An entity that repurchases
an award for which the promised goods have not been delivered or the service has not been rendered has,
in effect, modified the employee’s requisite service period or nonemployee’s vesting period to the period
for which goods have already been delivered or service already has been rendered, and thus the amount of
compensation cost measured at the grant date but not yet recognized shall be recognized at the repurchase
date.
A settlement is a payment (usually in the form of shares or cash) made to fulfill a share-based payment
award. Stock options are typically settled in shares, while many phantom stock unit plans are settled in
cash. In addition, certain share-based payment plans may give the entity the option to repurchase the
underlying shares in cash, may give the grantee the option to sell them for cash, or do both.
An entity must carefully consider whether any cash-settlement features affect an award’s classification.
Even if an award’s terms do not permit cash settlement, an entity’s past practice of settling or
intending to settle awards in cash before the risks and rewards of share ownership are borne by
grantees (generally six months from the date options are exercised or shares are vested) may indicate
that awards are in-substance liabilities. See Chapter 5 for a detailed discussion of determining the classification of an award.
Because cash settlement is often required under the terms of
liability-classified awards, use of the term
“settlement” in this section generally refers to
the payment made to satisfy an award that is
equity-classified and includes the repurchase of
equity instruments. While the next section
discusses the settlement of share-based payment
awards in cash, the guidance also applies to
settlements in other assets or liabilities.
6.10.1 Cash Settlements
The amount of cash paid to settle an equity-classified award is charged directly to equity as long as that amount is equal to or less than the fair-value-based measure of the award on the settlement date. To the extent that the settlement consideration exceeds the fair-value-based measure of the equity-classified award on the settlement date, that difference is recognized as additional compensation cost.
If an entity settles an unvested award (i.e., an award for which the goods or services have not been provided), the entity has effectively modified the award to accelerate the vesting conditions associated with it. Accordingly, any remaining unrecognized compensation cost is generally recognized immediately on the settlement date.
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 12: Modifications and Settlements
Case D: Cash Settlement of Nonvested Share Options
55-102 Rather than modify the share option terms, Entity T offers on January 1, 20X6, to settle the original January 1, 20X5, grant of share options for cash. Because the share price decreased from $30 at the grant date to $20 at the date of settlement, the fair value of each share option is $5.36, the same as in Case C. If Entity T pays $5.36 per share option, it would recognize that cash settlement as the repurchase of an outstanding equity instrument and no incremental compensation cost would be recognized. However, the cash settlement of the share options effectively vests them. Therefore, the remaining unrecognized compensation cost of $9.79 per share option would be recognized at the date of settlement.
Example 6-31
On January 1, 20X1, Entity A grants 1,000 at-the-money employee stock options, each with a grant-date fair-value-based measure of $9. The options vest at the end of the fourth year of service (cliff vesting). On December 31, 20X2, the market price of A’s stock has declined so dramatically that A wishes to settle the options because they provide little future incentive value to its employees. In this case, the employees may be willing to relinquish the options for an amount less than their then-current fair-value-based measure because payment would be immediate, settlement would not require future service, and the options may not become in-the-money during the expected term. The fair-value-based measure of the options on the settlement date is $3.50, and A settles the options for $2 in cash.
Before settlement, A recorded compensation cost of $4,500 on the basis of the number of options expected to vest (1,000 options, assuming no forfeitures), the grant-date fair-value-based measure of the options ($9), and the amount of services rendered (50 percent for two of four years of services rendered). On the settlement date, A would record the amount of cash paid ($2,000 = 1,000 options × $2 cash paid per option), with a corresponding charge to equity. Simultaneously, A would record the remaining unrecognized compensation cost ($4,500) because the options have fully vested as a result of the settlement. See the journal entries below (recorded on the settlement date).
An entity may make a cash payment to a grantee and concurrently cancel that
grantee’s awards. While the transaction would typically be accounted for as a
settlement, the determination of whether such a payment is a modification,
settlement, or other action is based on the facts and circumstances of each
situation. For example, an entity may enter into a separation agreement with an
employee to terminate employment or terminate an arrangement with a nonemployee
in which the entity (1) will make a termination payment in cash and (2)
separately cancel all of the grantee’s outstanding share-based payment awards.
The entity should account for the separation agreement and cancellation of the
awards as a single transaction. That is, the entity should view the termination
arrangement and related termination payment as the repurchase of all outstanding
awards for cash. Accordingly, as long as the settlement consideration does not
exceed the fair-value-based measure of the equity-classified awards as of the
settlement date, the entity records no additional compensation cost and charges
the amount of cash paid to settle the awards directly to equity. If the
settlement consideration exceeds the fair-value-based measure of the
equity-classified awards as of the settlement date, the entity recognizes the
amount in excess of the fair-value-based measure as additional compensation
cost.
In determining the accounting for the awards that are settled, the entity should consider the vested and unvested awards as follows:
- Vested awards — Since the termination payment for the vested awards is a settlement, the entity should recognize as a charge to equity the amount paid to repurchase the vested awards that is less than or equal to the fair-value-based measure of the vested awards on the repurchase date.
- Unvested awards — Since the grantee will not render the services or deliver the goods to earn the awards, the unvested awards are not expected to vest as of the separation date. Therefore, the entity should reverse any previously recognized compensation cost related to the unvested awards. The termination payment is an improbable-to-probable modification of the unvested awards. (See Sections 6.3 and 6.3.3 for a discussion of improbable-to-probable modifications.) That is, as a result of the termination arrangement, the grantee would not have vested in these awards upon termination of employment or the arrangement with a nonemployee (improbable). The termination payment effectively accelerated the awards’ vesting (i.e., made it probable that the awards would vest upon cash settlement). Accordingly, the total fair-value-based measure of the unvested awards is zero immediately before settlement on the separation date (0 awards expected to vest × fair-value-based measure of the unvested awards as of the date of the separation agreement). To determine the incremental compensation cost resulting from the settlement, the entity would subtract this value (zero) from the cash paid for the unvested awards (i.e., any cash paid in excess of the fair-value-based measure of the vested awards). Therefore, the entity would recognize the amount of cash paid for the unvested awards as compensation cost on the date of the termination arrangement. No amount should be recognized as the repurchase of an equity-classified award.
The decision tree below
addresses cash settlement as part of an employee
separation.
Example 6-32
On January 1, 20X3, Entity A enters into a separation agreement with one of its executives, who also terminates employment on that date:
- In connection with the separation agreement, A agrees to pay $1 million in cash to the executive upon termination of employment.
- The executive concurrently agrees to cancel all outstanding employee options to purchase A’s common stock (both vested and unvested).
- The executive has 10,000 vested employee stock options, each with a grant-date fair-value-based measure of $30 and a fair-value-based measure of $40, on January 1, 20X3.
- The executive has 10,000 unvested employee stock options, each with a grant-date fair-value-based measure of $35 and a fair-value-based measure of $42, on January 1, 20X3. The options were granted on January 1, 20X1, and vest at the end of the fourth year of service (cliff vesting).
In determining the fair-value-based measure of the outstanding options that are settled, A should consider the vested and unvested options as follows:
Vested Options
The termination payment is viewed as a settlement of the vested options. Therefore, A should recognize in equity the amount of cash paid to settle the options up to the fair-value-based measure of the options. See the journal entry below.
To record the repurchase of the vested options on the date of the separation agreement (10,000 options × $40 fair-value-based measure as of the date of the separation agreement).
Unvested Options
Since the executive’s unvested options are no longer expected to vest as of the date of the separation agreement, A should reverse any previously recognized compensation cost associated with these options on the date of the separation agreement. The termination payment is then treated as an improbable-to-probable modification of the unvested options. Accordingly, the total fair-value-based measure of the unvested options is zero immediately before the date of the separation agreement (0 options expected to vest × $42 fair-value-based measure of the unvested options as of the date of the separation agreement). The cash paid for the unvested options is $600,000, which is the total amount of cash paid for the vested and unvested options ($1 million) less the fair-value-based measure of the vested options ($400,000). Therefore, A recognizes the $600,000 settlement of the unvested options as compensation cost on the date of the separation agreement. See the journal entries below.
6.10.2 Cash Settlements Versus Modifications
As discussed in Section 6.7, modification accounting
generally applies to short-term inducements (1) to
which the award holder can subscribe for a limited
period and (2) that are accepted by the award
holder. However, the accounting consequences could
be considerably different depending on whether the
repurchase of an equity-classified share-based
payment award for cash or other assets in the
future constitutes (1) a short-term offer that
is, in substance, a settlement of the equity award
or (2) a modification of the equity award that
changes the award’s classification from equity to
liability followed by a settlement of the now
liability-classified award.
If the repurchase of (or offer to repurchase) the equity award is considered a settlement, the requirements of ASC 718-20-35-7 apply. That is, as long as the settlement consideration (cash, other assets, or liabilities incurred) does not exceed the fair-value-based measure of the equity award as of the settlement date, no additional compensation cost is recorded. The amount of cash, other assets, or liabilities incurred to settle an award is charged directly to equity. To the extent that the settlement consideration exceeds the fair-value-based measure of the equity award on the settlement date, that difference is recognized as additional compensation cost.
Alternatively, if the repurchase of (or offer to repurchase) the equity award is considered a modification that changes the award’s classification from equity to liability followed by a subsequent settlement of the now liability-classified award, an entity may need to recognize additional compensation cost as of the modification date on the basis of the fair-value-based measure of the liability award. That is, upon changing the award’s classification from equity to liability, an entity would adjust the carrying value of the equity award to its then-current fair-value-based measure as a share-based liability. Additional compensation cost would be recorded if the fair-value-based measure of the liability award on the modification date is greater than the original grant-date fair-value-based measure of the equity award. (See Section 6.8.1 for a more detailed discussion of the accounting for a modification that changes an award’s classification from equity to liability.) Because the award is now a share-based liability, the entity would remeasure it at its fair-value-based amount in each reporting period until settlement. (See Chapter 7 for a more detailed discussion of the accounting for liability awards.) In addition, the amount of cumulative compensation cost recognized cannot be less than the original grant-date fair-value-based measure. When the cash is paid to settle the liability award at an amount equal to its fair value, the share-based liability is settled with a corresponding credit to cash.
An entity must determine whether to account for a repurchase transaction in
which it offers to settle the equity award for
cash or other assets (or liabilities incurred) on
some future date as a settlement or a modification
of the equity award. The FASB clarified in FSP FAS
123(R)-6 that its intent was not for an award’s
classification to change from equity to liability
as a result of an offer to repurchase the award
for a limited period. Paragraph 11 of FSP FAS
123(R)-6 states, in part:
The
Board did not intend for a short-term inducement
that is deemed to be a settlement to affect the
classification of the award for the period it
remains outstanding (for example, change the award
from an equity instrument to a liability
instrument). Therefore, an offer (for a limited
time period) to repurchase an award should be
excluded from the definition of a short-term
inducement and should not be accounted for as a
modification pursuant to paragraph 52 of Statement
123(R) [codified in ASC 718-20-35-5].
Entities should use judgment to determine whether an offer to repurchase an
equity award is outstanding for more than a
“limited time period”; that is, whether the
repurchase of the equity award should be accounted
for as (1) a short-term offer that is, in
substance, a settlement of the equity award or (2)
a modification of the equity award followed by the
settlement of a liability award.
The following are among the items an entity
should consider in determining whether an offer to
repurchase an award that has been accepted by the
holder is a modification that changes the award’s
classification from equity to liability:
-
The amount that would be paid to settle the awards continues to be indexed to the grantor’s equity (i.e., the settlement amount is not fixed or determinable).
-
Whether substantive future service is required.
Note that if an entity’s practice or intent is to repurchase (or offer to
repurchase) equity awards, it should evaluate the
substantive terms of all outstanding share-based
payment awards in accordance with ASC
718-10-25-15. An entity’s consistent pattern of
cash settling, or its intent to cash settle,
awards may suggest that its outstanding awards’
substantive terms permit cash settlement and
therefore require liability classification. This
concept was emphasized in paragraph 11 of FSP FAS
123(R)-6, which states, in part:
[I]f an entity has a history of
settling its awards for cash, the entity should
consider whether at the inception of the awards it
has a substantive liability pursuant to paragraph
34 of Statement 123(R) [codified in ASC
718-10-25-15].
Example 6-33
On January 1, 20X1, Entity A granted 1,000 at-the-money employee stock options, each with a grant-date fair-value-based measure of $10. Throughout the options’ life, they are classified as equity. After the options are fully vested, A offers to repurchase them for cash equal to their then-current fair-value-based measure ($12 per option). If the offer to repurchase the options is considered a settlement, because, for example, the options will be settled immediately, the entire $12,000 (1,000 options × $12 fair-value-based measure on the settlement date) will be charged to equity, with the corresponding credit to cash. See the journal entry below.
Alternatively, if the offer to repurchase the options is considered a modification because, for example, the options will be settled in one year for cash on the basis of their fair-value-based measure at that time, the options are first reclassified as a share-based liability, and the difference ($2) between the grant-date fair-value-based measure ($10) and the current fair-value-based measure ($12) is recorded as additional compensation cost. Because the award is now a share-based liability, the entity would remeasure it at its fair-value-based amount in each reporting period until settlement, which is $15 per option one year later (the fair-value-based measure at that time). When the cash is paid to settle the liability award, the share-based liability is settled with a corresponding credit to cash. See the journal entries below.
In some cases, the repurchase of an equity-classified share-based payment award
for cash constitutes both (1) a settlement and (2)
a modification that changes the award’s
classification to a liability. For example, an
entity may modify an award to require cash
settlement but subject only a portion of the cash
payment to vesting, or it may pay a large,
nonrecurring cash dividend to all award holders in
connection with an equity restructuring but, for
unvested awards, subject a portion of the cash
dividend to vesting. The accounting for large,
nonrecurring cash dividends is different from that
in ASC 718 for dividend protected awards (see
Section 3.10) because such dividends
meet the definition of an equity restructuring
(see Section 6.5). Exchanges of stock
options or other equity instruments or changes to
their terms in conjunction with an equity
restructuring are modifications and therefore
subject to the accounting guidance in ASC
718-20-35-2A. Further, a “large, nonrecurring
dividend” is not defined in U.S. GAAP; therefore,
an entity should apply judgment when determining
whether a dividend gives rise to an equity
restructuring transaction and modification
accounting under ASC 718. An entity may wish to
seek the opinion of legal counsel when determining
whether a dividend represents an equity
restructuring that triggers a nondiscretionary
antidilution provision.
In these circumstances, the cash payment should
be allocated to (1) the portion of the awards that
has been settled and (2) the portion of the awards
that has been modified.
Example 6-34
On January 1, 20X1, Entity A granted to an employee 1,000 equity-classified
RSUs, each with a grant-date fair-value-based
measure of $10. The RSUs vest on a graded basis
over four years (25 percent each year on December
31). Entity A has a policy of recognizing
compensation cost on a straight-line basis over
the total requisite service period of four years
and has therefore recognized compensation cost of
$2,500 each year.
On January 1, 20X3, A declares a large,
nonrecurring cash dividend of $5 per share which
meets the definition of an equity restructuring.
The RSUs have (1) a nondiscretionary antidilution
provision that requires an equitable adjustment or
payment in the event of an equity restructuring
(and therefore are subject to the modification
accounting guidance in ASC 718-20-35-2A) and (2) a
fair-value-based measure of $20 per RSU on January
1, 20X3 (the $20 value includes the value of the
$5 dividend), both immediately before and after
the modification. Each RSU is entitled to the cash
dividend, including the unvested RSUs that are
subject to continued vesting on the basis of their
original vesting terms.
One acceptable approach is to separately account for the fully vested RSUs and the unvested RSUs (which have two years of remaining service). Therefore, for 500 of the RSUs that are fully vested, there is a partial cash settlement for 25 percent of the RSUs ($5 dividend per share ÷ $20 fair-value-based measure per RSU on January 1, 20X3). For the 500 unvested RSUs, there is a partial modification from an equity-classified award to a liability-classified award for 25 percent of the RSUs; the remaining 75 percent of the RSUs are deemed not to be settled or modified. The journal entries and related calculations below illustrate this approach to accounting for the partial cash settlement and modification.
6.11 Cancellations
ASC 718-20
Cancellation and Replacement
35-8 Except as described in paragraph 718-20-35-2A,
cancellation of an award accompanied by the concurrent grant of (or offer to
grant) a replacement award or other valuable consideration shall be accounted
for as a modification of the terms of the cancelled award. (The phrase offer
to grant is intended to cover situations in which the service inception
date precedes the grant date.) Therefore, incremental compensation cost shall be
measured as the excess of the fair value of the replacement award or other
valuable consideration over the fair value of the cancelled award at the
cancellation date in accordance with paragraph 718-20-35-3. Thus, the total
compensation cost measured at the date of a cancellation and replacement shall
be the portion of the grant-date fair value of the original award for which the
promised good is expected to be delivered (or has already been delivered) or the
service is expected to be rendered (or has already been rendered) at that date
plus the incremental cost resulting from the cancellation and replacement.
35-9 A cancellation of an award that is not accompanied by the concurrent grant of (or offer to grant) a replacement award or other valuable consideration shall be accounted for as a repurchase for no consideration. Accordingly, any previously unrecognized compensation cost shall be recognized at the cancellation date.
A cancellation may be accompanied by a concurrent grant of (or offer to grant) a
new (or replacement) award. Because the entity is in effect granting (or offering to grant)
an award to replace the canceled award, a cancellation accompanied by a concurrent grant of
(or offer to grant) a replacement award is accounted for in the same manner as a
modification. That is, the entity must record the incremental value, if any, conveyed to the
holder of the award as compensation cost on the cancellation date (for vested awards) or
over the remaining employee requisite service period or nonemployee’s vesting period (for
unvested awards). The incremental compensation cost is the excess of the fair-value-based
measure of the replacement award over the fair-value-based measure of the canceled award on
the cancellation date.
By contrast, a cancellation without a concurrent replacement is viewed as the
settlement of an award for no consideration. As a
result, if an entity (or grantee) cancels an
unvested award without a replacement award, any
remaining unrecognized compensation cost would
generally be recognized immediately on the
cancellation date. Note that a cancellation
differs from a forfeiture. As discussed in
Section 3.4.1, a forfeiture represents
an award for which the employee’s requisite
service is not rendered or the nonemployee’s goods
or services are not delivered (e.g., because of
termination of employment or termination of an
arrangement with a nonemployee). Therefore, an
award that will not vest because of the grantee’s
inability to satisfy a service condition is
accounted for as a forfeiture rather than as a
cancellation.
A cancellation, however, represents an award for which the employee’s requisite service is expected
to be rendered or the nonemployee’s goods or services is expected to be provided but is canceled.
Accordingly, for a forfeiture, an entity reverses any compensation cost that it has previously recognized,
whereas it does not reverse any previously recognized compensation for a cancellation. As noted above,
any remaining unrecognized compensation cost is generally recognized immediately on the cancellation
date.
Example 6-35
On January 1, 20X1, Entity A grants 1,000 at-the-money employee stock options, each with a grant-date fair-value-based measure of $9. The options vest at the end of the fourth year of service (cliff vesting). On January 1, 20X4, A cancels the options and concurrently issues replacement options. The service period of the replacement options covers the remaining one-year service period of the canceled options. The fair-value-based measure of the replacement award is $7, and the fair-value-based measure of the canceled award is $4 on the date of cancellation.
During the first three years of service, A records cumulative compensation cost
of $6,750 (1,000 options × $9 grant-date fair-value-based measure × 75% for
three of four years of services rendered). On the cancellation date (i.e., the
modification date), A computes the incremental compensation cost as $3,000, or
($7 fair-value-based measure of replacement options – $4 fair-value-based
measure of canceled options on the date of cancellation) × 1,000 options. The
$3,000 incremental compensation cost is recorded over the remaining year of
service of the replacement options. In addition, A records the remaining $2,250
of compensation cost over the remaining year of service attributable to the
canceled options. Therefore, total compensation cost associated with these
options is $12,000 ($9,000 grant-date fair-value-based measure + $3,000
incremental fair-value-based measure) recorded over four years of required
service for both the canceled and replacement options.
Example 6-36
Assume all the same facts as in the example above, except that Entity A cancels
the original options with no concurrent issuance of (or offer to issue)
replacement options. Six months later, A issues 1,000 new at-the-money employee
stock options, each with a grant-date fair-value-based measure of $12. The
options vest over the remaining six-month service period attributable to the
canceled options.
During the first three years of service, A records cumulative compensation cost of $6,750 (1,000 options × $9 grant-date fair-value-based measure × 75% for three of four years of services rendered). On the cancellation date, the options are treated as though they are fully vested. Accordingly, A records the remaining $2,250 of compensation cost attributable to the canceled options. Therefore, total compensation cost associated with the canceled options is the $9,000 grant-date fair-value-based measure.
For the options issued six months later, A records $12,000 (1,000 options × $12 grant-date fair-value-based measure) of compensation cost over the remaining six-month service period of the options. Therefore, total compensation cost associated with these options is the $12,000 grant-date fair-value-based measure.
Because A did not account for the cancellation of the original options and
issuance of the new options as a cancellation and concurrent replacement (and
therefore did not apply modification accounting), A records total compensation
cost of $21,000 (i.e., $9,000 for the canceled options and $12,000 for the
options issued six months later). By contrast, if A had canceled and replaced
the original options concurrently for options worth $12 per option (and
therefore modification accounting was applied), A would record only total
compensation cost of $17,000, which is equal to the grant-date fair-value-based
measure of the canceled options ($9,000) and the incremental value conveyed to
the holders of the replacement options ($8,000), or ($12 fair-value-based
measure of replacement options – $4 fair-value-based measure of canceled options
on the date of cancellation) × 1,000 options.
Example 6-37
Assume all the same facts as
in Example 6-35,
except that on January 1, 20X4, Entity A’s stock price is significantly less
than the strike price, and the options are out-of-the-money. In addition, the
grantee (an executive-level officer) voluntarily agrees to cancel all 1,000
stock options because they are not material to the executive’s overall
compensation and she would like the shares to be used to grant new employee
awards under A’s stock incentive plan (rather than modifying the existing award
to adjust the options’ strike price).
The “return” of the options is voluntary; it is
not caused by the employee’s inability to satisfy
the service condition and vest in the awards
(i.e., employment was not terminated, and it is
assumed that the requisite services would have
otherwise been rendered over the vesting period).
Therefore, the return of the unvested options is
treated as a cancellation rather than a
forfeiture. As a result, the remaining
unrecognized compensation cost of $2,250
(remaining 25 percent of compensation cost that
would have been recognized in 20X4) is recognized
upon cancellation of the options, and the
previously recorded compensation cost of $6,750 is
not reversed.
6.12 Modifications That Change the Scope of Awards
An entity may modify or settle a liability to a grantee that is not subject to the provisions of ASC 718 by issuing awards that are subject to ASC 718 (e.g., stock options are granted in place of a cash-based profit-sharing arrangement). If a liability that was not initially within the scope of ASC 718 is modified or settled through the issuance of a new instrument that is within the scope of ASC 718, the entity should account for the transaction, as well as the new award, under ASC 718.
Example 6-38
On January 1, 20X1, Entity A entered into a long-term incentive agreement with its CFO. The earliest date on which the CFO would be entitled to receive payment under the agreement is 10 years from the date of the agreement (January 1, 20Y1). Entity A accounts for the plan in accordance with ASC 710-10-25-9 and recognizes the cost of the agreement in a systematic and rational manner over this 10-year period.
On January 1, 20X6, A and the CFO agree to terminate the agreement in exchange for A’s granting the CFO options to purchase A’s common stock. The number of stock options that will be granted is determined on the basis of the value of the long-term incentive agreement on the date of the exchange.
The value of the long-term incentive agreement on January 1, 20X6, was determined to be $2 million. The number of stock options to be issued to the CFO on that date was based on the fair-value-based measure of each stock option, determined by using an appropriate pricing model, and the $2 million value of the agreement. The stock options will vest after the CFO’s fifth year of service (cliff vesting). As of January 1, 20X6, A had recorded cumulative compensation cost and an accrued liability of $1 million associated with the long-term incentive agreement because 50 percent (for 5 of 10 years of services rendered) of the required service period had been rendered.
Although the accounting for the original agreement was not within the scope of ASC 718, such guidance is relevant in the determination of the cost of the share-based payment awards (whether newly granted or as a replacement of a prior compensation arrangement).
Therefore, A should reclassify the $1 million accrued liability as equity (APIC) and should record the difference between the $2 million aggregate fair-value-based measure of the stock options and the $1 million of cumulative compensation cost previously recognized in connection with the long-term incentive agreement ($1 million) as compensation cost over the remaining five-year service period of the stock options. See the journal entries below.
6.13 Modifications When a Holder Is No Longer an Employee, a Nonemployee Is No Longer Providing Goods or Services, or a Grantee Is No Longer a Customer
ASC 718-10
Awards May Become Subject to Other Guidance
35-9 Paragraphs 718-10-35-10
through 35-14 are intended to apply to those instruments
issued in share-based payment transactions with employees
and nonemployees accounted for under this Topic, and to
instruments exchanged in a business combination for
share-based payment awards of the acquired business that
were originally granted to grantees of the acquired business
and are outstanding as of the date of the business
combination.
35-9A Paragraph superseded by
Accounting Standards Update No. 2020-06.
35-10 A freestanding financial
instrument or a convertible security issued to a grantee
that is subject to initial recognition and measurement
guidance within this Topic shall continue to be subject to
the recognition and measurement provisions of this Topic
throughout the life of the instrument, unless its terms are
modified after any of the following:
- Subparagraph superseded by Accounting Standards Update No. 2019-08.
- Subparagraph superseded by Accounting Standards Update No. 2019-08.
- A grantee vests in the award and is no longer providing goods or services.
- A grantee vests in the award and is no longer a customer.
- A grantee is no longer an employee.
35-10A Only for
purposes of paragraph 718-10-35-10, a modification does not
include a change to the terms of an award if that change is
made solely to reflect an equity restructuring provided that
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.
35-11 Other modifications of
that instrument that take place after a grantee vests in the
award and is no longer providing goods or services, is no
longer a customer, or is no longer an employee should be
subject to the modification guidance in paragraph
718-10-35-14. Following modification, recognition and
measurement of the instrument shall be determined through
reference to other applicable GAAP.
35-12 Once the classification of an instrument is determined, the recognition and measurement provisions of this Topic shall be applied until the instrument ceases to be subject to the requirements discussed in paragraph 718-10-35-10. Topic 480 or other applicable GAAP, such as Topic 815, applies to a freestanding financial instrument that was issued under a share-based payment arrangement but that is no longer subject to this Topic. This guidance is not intended to suggest that all freestanding financial instruments shall be accounted for as liabilities pursuant to Topic 480, but rather that freestanding financial instruments issued in share-based payment transactions may become subject to that Topic or other applicable GAAP depending on their substantive characteristics and when certain criteria are met.
35-13 Paragraph superseded by Accounting Standards Update No. 2016-09.
35-14 An entity may modify (including cancel and replace) or settle a fully vested, freestanding financial instrument after it becomes subject to Topic 480 or other applicable GAAP. Such a modification or settlement shall be accounted for under the provisions of this Topic unless it applies equally to all financial instruments of the same class regardless of the holder of the financial instrument. Following the modification, the instrument continues to be accounted for under that Topic or other applicable GAAP. A modification or settlement of a class of financial instrument that is designed exclusively for and held only by grantees (or their beneficiaries) may stem from the employment or vendor relationship depending on the terms of the modification or settlement. Thus, such a modification or settlement may be subject to the requirements of this Topic. See paragraph 718-10-35-10 for a discussion of changes to awards made solely to reflect an equity restructuring.
ASC 718-10-35-10 indicates that a share-based payment award that is subject to
ASC 718 does not become subject to other applicable GAAP unless the award is
modified when the individual is no longer an employee or, for nonemployee awards,
the award is vested and the individual is no longer providing goods or services or,
for customers, the award is vested and the grantee is no longer a customer.
Modifications made to an award when the holder is no longer an employee should be
accounted for under ASC 718-10-35-11, which refers to ASC 718-10-35-14. If the
modification or a settlement does not apply equally to all financial instruments of
the same class regardless of whether the holder is (or was) an employee, a
nonemployee providing goods or services, or a customer, the above sections on
modifications and settlements apply, and any incremental fair-value-based measure is
recognized as compensation cost. After the modification, the award will become
subject to other applicable GAAP (e.g., ASC 815 and ASC 480). Note that once the
award becomes subject to other applicable GAAP, ASC 718’s guidance on classification
(including the exceptions to liability classification) no longer applies. See
Section 5.8 for
further discussion of the accounting for awards that become subject to other
guidance.
However, in accordance with ASC 718-10-35-10A, if the terms of an award are
modified solely to reflect an equity restructuring, the award is not subject to
other applicable GAAP as long as 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.