Accounting guidance for situations when stock awards (stock options, restricted stock units and other equity-based instruments) are modified after the original grant date has been in place for a long time – with the original literature that covers fair value calculations and determining how much and when compensation expense is recorded. What hasn’t been clear for a long time is when the rules for how to handle modifications need to be applied to changes in stock awards.
At a very high level, the application of “modification” accounting is important, because it often results in additional compensation cost needing to be recognized. This result is because award terms are generally changed to be more favorable to recipients to make the award more attractive to achieve its designed purpose.
Modification accounting requires that the award fair value recalculated right before the modification date, using its original terms, be compared to the award fair value immediately after the modification date using the revised terms, and any incremental value be recorded as additional expense over the remaining required service period. As a result, for awards that have been modified, generally the total expense to be recorded will be the total of the original award fair value expected to vest, plus the incremental cost resulting from the modification. This is necessarily, for purposes of this post, a high-level discussion.
After research, the FASB staff concluded that a diversity in practice in when companies should apply modification accounting should be tightened by additional guidance to clarify the intentions and reduce the judgments applied to award modifications. The result was the issuance of Accounting Standards Update No. 2017-09 (ASU 2017-09) in May 2017 that is first effective for calendar year companies in 2018.
Prior to ASU 2017-09, some companies were taking literally the previous broadly-stated definition of a “modification” (under the ASC 718-20-20 definition) as a “change in any of the terms or conditions of a share-based payment award” (emphasis added). On the other hand, other entities applied it only to what they considered substantive changes (whatever that means), and still others applied it to any changes except those that were solely administrative changes (whatever that means) in award terms.
So, the new guidance outlines more precisely when companies must apply the modification accounting rules. Modification accounting is not required when the result of the modification meets all of the following:
- The value of the modified award is the same as the value of the original award immediately before the original award is modified,
- The vesting conditions of the modified award are the same as the vesting of the original award immediately before the modification, and
- The classification of the award as a liability or an equity instrument is the same as the classification of the original award immediately before the modification.
Basically, in the most frequent situations where the awards are accounted for at fair value, if none of the inputs to the fair value model are affected by the modification, a company would not need to estimate the fair value immediately before and after the modification. In other words, the conclusion follows that the fair value measurement is the same after modification. Changes that commonly require modification accounting and additional expense include re-pricings of awards, changes in market or performance provisions, and some provision that contingently accelerate vesting.
Stock award accounting, being a complicated topic, required that this subject be discussed in a very general way. So, if you would like additional information tailored to completed or contemplated modifications, please contact us.