A modification of an award under ASC 718 generally will be treated as an exchange of the original award for a new award. An entity should measure book compensation cost as the excess (if any) of the fair value of the new award over the fair value that the original award had immediately before its terms were modified. In addition, an entity also will assess the potential effect of the modification on the number of awards expected to vest, including a reassessment of the probability of vesting.

For an award that is otherwise tax deductible and for which an entity had previously recorded a deferred tax asset, if the entity records additional book compensation cost as a result of the modification, there will be a corresponding increase in the deferred tax asset.

As specified in ASC 718-20-35-3(b), to the extent an equity-classified award is modified to a liability-classified award, the total recognized compensation cost should at least equal the fair value of the award at the original grant date, unless any performance or service conditions of the original award are not expected to be satisfied. As part of the modification of these awards, incremental compensation cost may need to be recorded as part of the modification. To the extent additional compensation costs are recorded as part of the modification, the related deferred tax asset will also increase as there has not yet been a tax deduction. There is an exception to this rule in situations in which the possible tax deduction of a modified award is capped. For example, an entity may offer an election to convert each share into a fixed amount of cash. In these situations, it is appropriate to adjust the deferred tax asset based on the value of the corresponding liability, regardless of whether it is greater or less than the grant date fair value, as illustrated in ASC 718-20-55-144.

Certain modifications could result in an ISO losing its qualified status and in the modified award being considered a nonqualified stock option. Whereas prior to the modification no deferred taxes were recorded on compensation expense recognized related to the ISO because it does not ordinarily result in a tax deduction, if, as a result of the modification, the award would no longer be an ISO, the entity would have to begin recording the related deferred taxes on the nonqualified award. Accordingly, on the date of the modification, deferred taxes should be recognized on all compensation cost previously recognized for the award. After that, the tax effect would be accounted for in the same manner as any other nonqualified award.