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Modifications of equity-classified awards may take many forms. Some of the more common modifications are a change in vesting conditions or a repricing of options.

4.3.1 Modifications of performance or service conditions

Under ASC 718-20-35-3 through ASC 718-20-35-4, a modification of an equity-classified award should be accounted for as follows:
  • A company should recognize compensation cost in an amount at least equal to the award's grant-date fair value, unless the company's expectation on the modification date is that the employee will fail to meet the original award's performance or service condition.
  • Compensation cost should be recognized if the award ultimately (1) vests under the modified vesting conditions or (2) would have vested under the original vesting conditions. If the award was expected to (and does) vest under the original conditions, the company would recognize compensation cost regardless of whether the employee satisfies the modified condition. This is consistent with ASC 718's use of the modified-grant-date model whereby compensation cost is not reversed for awards that vest, even if an employee does not exercise the option or does not realize any value from the exercise of the option.

Whether it is probable that an award will vest is an important factor in the recognition of compensation cost before and on the modification date. ASC 718 uses the term probable in a manner consistent with its definition in ASC 450, Contingencies, which refers to an event that is likely to occur (ASC Master Glossary). On the modification date of an equity-classified award, management should assess the probability that either the original or modified vesting condition will be satisfied. For awards with performance conditions, a probability assessment is already required each reporting period. Bearing in mind that an element of subjectivity goes into interpreting the terms probable and improbable, management should develop, document, and consistently apply a methodology for assessing the probability of achieving vesting conditions, which should be based on reasonable assumptions and all available objective evidence.
Modifications of equity-classified awards that have performance and/or service conditions can be categorized into four types. Examples of the four types of modifications can be found in ASC 718-20-55-107 through ASC 718-20-55-121.
Type I: Probable-to-probable: This type of modification does not change the expectation that the award will ultimately vest. The cumulative amount of compensation cost that should be recognized is the original grant-date fair value of the award plus any incremental fair value resulting from the modification. A Type I modification will result in incremental fair value if terms affecting the estimate of fair value have been modified (e.g., a repricing or a modification that affects expected term). The original grant-date fair value represents the minimum or "floor" amount of compensation to be recognized if either the original or the modified conditions are satisfied.
Type II: Probable-to-improbable: This type of modification changes the expectation that the award will ultimately vest. Specifically, a condition that the company anticipates will be satisfied is replaced with a condition that the company expects will not be satisfied. Type II modifications are relatively uncommon because employees are unlikely to accept this kind of change unless they receive other compensation or the company also changes other terms of the award. For Type II modifications, no incremental fair value would be recognized unless and until vesting of the award under the modified conditions becomes probable. If the original vesting conditions are satisfied, compensation cost equal to the award's original grant-date fair value would be recognized, regardless of whether the modified conditions are satisfied.
Type III: Improbable-to-probable: This type of modification changes the expectation that the award will ultimately vest. Specifically, a condition that the company expects will not be satisfied is changed to a condition that the company expects will be satisfied. In this fact pattern, the cumulative compensation cost recognized for the original award should be zero immediately prior to the modification as none of the awards are expected to vest. The incremental fair value is therefore equal to the fair value of the modified award (the value of the modified award compared to its prior zero value). The incremental compensation cost is recognized over the remaining requisite service period, if any. A Type III modification could result in the recognition of total compensation cost less than the award's grant-date fair value because at the modification date, the original vesting conditions are not expected to be satisfied.
Type IV: Improbable-to-improbable: This type of modification does not change the expectation that the award will ultimately not vest. The company would not recognize additional compensation cost on the modification date because it continues to expect that the award will not vest. Therefore, no cumulative compensation cost should be recognized for the award. If, at a future date, the company determines it is probable the employees will vest in the modified award, it should recognize compensation cost equal to the fair value of the award at the modification date. Similar to a Type III modification, because the original vesting conditions are not expected to be satisfied as of the modification date, the grant-date fair value is no longer relevant. In other words, a Type IV modification effectively establishes a new measurement date for the award (the modification date).

4.3.2 Modifications in connection with termination of employment

Companies often decide to modify awards concurrent with an employee's termination of employment. For example, this might occur because the employee is a senior executive and a modification is agreed to in connection with a resignation or involuntary termination in order to avoid an acrimonious separation. Two common modifications made in connection with termination of employment are: (1) acceleration of the vesting of unvested awards and (2) extension of the award's post-termination exercise period for vested options.
For unvested awards, the company needs to assess whether it expects the original vesting conditions to be satisfied as of the modification date. If the employee would have forfeited the awards upon termination according to the awards' original terms, the awards would not be expected to vest under the original vesting conditions (i.e., vesting was improbable).
If the employee would have forfeited the awards upon termination under the original terms, and the company chooses to accelerate vesting or allow continued vesting, the modification is a Type III modification (improbable to probable). Therefore, incremental fair value is equal to the fair value of the modified awards on the modification date. This incremental compensation cost is recognized over the requisite service period, which may result in immediate recognition if the awards do not require further service, or over the period through a defined date if the employer requires the individual to work through a specified separation date in order to earn the award. This accounting treatment applies regardless of the company’s accounting policy for forfeitures (as described in SC 2.7).
In some instances, the original terms of an award provide for automatic acceleration of vesting upon involuntary termination of employment. When involuntary termination becomes probable, the accelerated vesting is not treated as a modification (assuming it is consistent with the award's original terms) since it is not a discretionary action; however, the requisite service period may have changed. The change in requisite service period should be recognized on a prospective basis (see SC 2.6.10 for additional information).
A modification to extend the exercise period of a vested option is treated as a Type I modification because it does not change the expectation that the award will vest (i.e., it is already vested). Incremental fair value is equal to the difference between the fair value of the modified award and the fair value of the original award (immediately before it was modified). The expected term of the option prior to the modification should take into account any truncation of term that would occur pursuant to the option's original terms upon termination of employment. For example, option plans typically provide for a 30- to 90-day exercise period after termination of employment. The expected term of the modified option should consider the new exercise period. An extension of the exercise period generally results in some amount of incremental compensation cost, assuming no other terms were modified. Incremental compensation cost is recognized immediately because the options are vested.
Example SC 4-1, Example SC 4-2, Example SC 4-3, and Example SC 4-4 illustrate the accounting for modifications in connection with termination of employment.
EXAMPLE SC 4-1
Modification to awards in connection with termination of employment – no ongoing service
SC Corporation enters into an agreement with its CFO in connection with the termination of the CFO's employment. Under the original terms of the CFO's stock option award, the CFO would forfeit all unvested options upon termination of employment and would be permitted a period of 90 days from the termination date to exercise their vested options. Pursuant to the termination agreement, the CFO's outstanding stock options are modified as follows:
  • The exercise period of vested options is extended to one year
  • All unvested options are immediately vested, with an exercise period of one year
The CFO will immediately cease providing services to SC Corporation upon signing of the termination agreement.
How should SC Corporation account for the modification of the options?
Analysis
The modification of the vested options is a Type I (probable to probable) modification and the modification of the unvested options is a Type III (improbable to probable) modification.
The modification of the vested options is a Type I modification because the options are already vested (i.e., the modification does not change the expectation that the awards will vest; the awards are probable of vesting both before and after the modification). The incremental fair value is calculated as of the modification date. The fair value of the options before the modification is based on the current stock price and an exercise period of 90 days, since the original terms of the award permitted only 90 days to exercise upon termination of employment. The fair value after the modification is also based on the current stock price, but the exercise period should be determined considering the revised one-year exercise period. This will result in some incremental compensation cost due to the longer expected term, which should be recognized immediately because the options are vested.
The modification of the unvested options is a Type III modification because prior to the modification, the unvested options are not probable of vesting as the CFO would have otherwise forfeited the award upon termination of employment. Accordingly, any compensation cost previously recognized for the unvested options should be reversed. The incremental fair value is equal to the fair value of the modified award, which is measured based on the current assumptions determined as of the modification date (e.g., the current stock price and an expected term based on a one-year exercise period). The resulting compensation cost is recognized immediately because the CFO is no longer providing any service to SC Corporation to earn the options.
EXAMPLE SC 4-2
Modification to awards in connection with termination of employment – continuing service period
SC Corporation granted stock options to its CFO that vest in five equal tranches; one tranche fully vests at the end of each of the five years. Upon termination of employment, any unvested options are forfeited and the CFO would be permitted a period of 90 days from the termination date to exercise their vested options.
Halfway through year three, SC Corporation and the CFO agree to a separation agreement. Pursuant to the termination agreement, SC Corporation and the CFO agree to the following modifications to the CFO’s outstanding stock options:
  • The exercise period of vested options is extended from the original 90-day period to one year from the date of termination
  • All unvested options are immediately vested, with the same one-year exercise period
The CFO will continue to provide service during a transition period of three months from the date the separation agreement was reached. None of the original awards that were not yet vested would vest during the three-month transition period based on their original terms. The CFO must complete the transition period in order to be eligible for the accelerated vesting of unvested options (i.e., outstanding unvested options will be forfeited unless the CFO provides service for three additional months). Assume the compensation cost recognized to date is $700,000 and the fair value of the modified award is $1,000,000.
How should SC Corporation account for the modification of the options?
Analysis
The calculation of incremental fair value resulting from the modification is the same as described in Example SC 4-1. The incremental compensation cost calculated for the vested options would be recognized immediately, consistent with Example SC 4-1.
For the unvested options, the recognition of compensation cost will depend on whether SC Corporation elects to estimate forfeitures or to account for forfeitures when they occur. If SC Corporation's policy is to estimate forfeitures, it would reverse the compensation cost previously recognized and recognize the entire fair value of the modified award over the remaining three-month service period. If SC Corporation's policy is to account for forfeitures when they occur, we believe there are two acceptable views:
  • View A: Assume a substantive forfeiture of the original award occurs on the modification date as it was exchanged for the modified award at a time when it was not probable of vesting. Therefore, the guidance for a Type III (improbable-to-probable) modification should be followed. The cumulative compensation cost recognized for the original award should be reversed ($700,000) and the fair value of the modified award ($1,000,000) should be recognized over the remaining service period. This is the same as the accounting outcome for a company that elects to estimate forfeitures.
  • View B: Assume forfeiture of the original award does not occur until the CFO terminates employment. Under this view, the original award is not yet forfeited; therefore, expense should not be reversed at the time of the modification. Over the remaining three-month service period, SC Corporation would recognize compensation cost equal to the difference between the modified award's fair value (on the modification date) and the previously recognized amount of the grant-date fair value of the original award($1,000,000 fair value of the modified award less $700,000 previously recognized compensation cost or $300,000 "incremental compensation cost"). If the modified award's fair value is less than the previously recognized compensation cost, SC Corporation would not recognize any further compensation cost and the difference between the previously recognized amount and the modified award's fair value would be reversed upon the CFO's termination of service. For example, if the modified award's fair value was $500,000, no cost would be recognized over the remaining service period and $200,000 ($700,000 previously recognized compensation cost less $500,000 fair value of modified award) would be reversed at termination.
Under either View A or View B, the cumulative amount of recognized compensation cost for the award will be the same, which is equal to the fair value of the modified award on the modification date.
EXAMPLE SC 4-3
Modification of awards to extend the post-termination exercise period
SC Corporation's option plan includes terms that allow employees a 30-day period to exercise vested options upon termination of employment. On January 1, 20x9, SC Corporation modifies the terms of the plan to extend the post-termination exercise period to 90 days. Assume that all of the options are probable of vesting and none of the employees are currently expected to terminate employment.
How should SC Corporation account for the modification?
Analysis
The modification is a Type I (probable to probable) modification because the options are probable of vesting both before and after the modification. SC Corporation should calculate any incremental fair value resulting from the extension of the post-termination exercise period and the resulting impact, if any, to the expected term assumption. Because the modification is not being done in connection with an employee's termination, the expected term would not necessarily increase by 60 days as a result of the 60-day increase in the post-termination exercise period. The fair value before the modification would be based on an expected term for an option with a 30-day post-termination exercise period, while the fair value after the modification would be based on an expected term for an option with a 90-day post-termination exercise period.
The determination of the extent to which this modification impacts the expected term assumption will depend on the relevant facts and circumstances. Any incremental compensation cost would be recognized immediately for vested options and over the remaining requisite service period for unvested options.
EXAMPLE SC 4-4
Modification of awards in connection with termination of employment – WARN Act
SC Corporation announces on September 15 that it will be restructuring its business operations, resulting in the shutdown of one of its facilities and the termination of 300 employees. The restructuring, shutdown, and terminations were not probable prior to September 15. SC Corporation's restructuring plan falls under the WARN Act, which requires employers with 100 or more employees to notify affected employees 60 days in advance of a plant closing or mass layoff. Also under the Act, all employees are legally employed and paid by SC Corporation until the end of the 60-day notification period (in this case, November 14). The terminated employees will cease providing services immediately on September 15.
Employees affected by this layoff have unvested options that will legally continue to vest through November 14 based upon the above provisions, even though no further service is required. Awards that do not vest by November 14 will be forfeited according to their original terms.
Has SC Corporation modified the terms of the options that will vest between September 15 and November 14?
Analysis
No. A modification to the terms of the award has not occurred because the continued vesting of the awards through November 14 pursuant to the WARN Act is deemed to be an original term of the award. That is, SC Corporation was required to allow vesting of these options under the original terms of the award, which implicitly included the requirements of the WARN Act. However, SC Corporation should adjust the requisite service period for these options since further service will not be required beyond September 15 in order to retain the awards. Accordingly, any unrecognized compensation cost for options that will vest between September 15 and November 14 should be recognized on September 15.

4.3.3 Modification of stock options during blackout periods

At times, a company will impose blackout periods that suspend employees' ability to exercise their stock options. These blackout periods are generally planned in advance to coincide with a company's quarterly and annual earnings releases. However, a company may also impose unplanned temporary or indefinite blackout periods for other reasons.
During these blackout periods, there are circumstances where employees may have outstanding vested stock options that are due to expire prior to the end of the blackout period. As a result, the employees will not have the ability to exercise their options prior to the awards being forfeited. For example, a company may impose a blackout period that is anticipated to be in place for several months. During that indefinite period, the company may terminate an employee whose vested options expire 30 days after termination. As a result, the employee will not have the ability to exercise the options prior to the end of the 30-day post-termination exercise window (i.e., the awards will expire).
A company may determine that based on the terms of its option plan, certain employees will not have the ability to exercise their options prior to expiration and the company is under no legal obligation to deliver any value (e.g., cash) to the employees in lieu of exercising the options. As a result, a company may decide to extend the options' term for a period of time to provide their employees with the ability to exercise their options after the blackout period has been lifted. In these cases, if the holders cannot exercise and there is no obligation to deliver value to the employee, then the modification to extend the term beyond the blackout period is considered a Type I modification as the options are already vested and the modification only impacts the employee's ability to exercise and not the probability of vesting. However, when calculating the fair value of the options immediately before the modification, the fair value is zero because the option holder cannot exercise the option and receive value. Accordingly, the value transferred to the employee (that is, the incremental fair value) is the full fair value of the modified option on the date of the modification. Further, because the award was fully vested prior to the modification, no amount of previously recognized compensation cost (associated with these options) should be reversed.
When evaluating fact patterns similar to the one described above, careful consideration should be applied to the particular facts and circumstances, including whether the holders have an ability to exercise, whether the holder can exercise but not sell the underlying shares, the vesting status of the options, any legal obligation to deliver value to the employee, and other considerations. Any of these considerations could impact the accounting result.
At times, the modifications discussed above occur when the holders of the outstanding options are no longer employees of the company. Pursuant to ASC 718-10-35-10, a share-based award granted to an employee that is subject to ASC 718 shall continue to be subject to the recognition provisions of ASC 718 throughout the life of the share-based award, unless its terms are modified when the holder is no longer an employee. As such, once post-employment modifications occur, the modification of the award should be accounted for pursuant to the modification guidance in ASC 718, but after the modification, the recognition and measurement of the award should be determined by reference to other GAAP (e.g., ASC 480 and ASC 815). Application of either of those sections of the codification could subject the award to liability classification.
We believe modifications that are concurrent with an employee's termination (for example, extension of exercise term upon termination of employment) are generally made in consideration of past employment. Therefore, the award should continue to be accounted for under ASC 718 after the modification. Judgment may be required in determining whether a modification is concurrent with an employee's termination. See SC 4.10 for more information on transitioning from ASC 718 to other GAAP.

4.3.4 Repricing of unvested options

The repricing of unvested options with a performance or service condition is a modification that should be accounted for under ASC 718-20-35-3 through ASC 718-20-35-4. A repricing, however, would not impact the probability of vesting. Assuming the award is otherwise probable of vesting, a company that makes such a modification should:
  • Measure compensation cost for the difference between the fair value of the modified award and the fair value of the original award on the modification date
  • Recognize, over the remaining requisite service period, the sum of the incremental compensation cost and the remaining unrecognized compensation cost for the original award on the modification date

Example SC 4-5 illustrates the accounting for repricing of unvested options.
EXAMPLE SC 4-5
Accounting for a repricing of unvested options
On October 1, 20X1, SC Corporation grants its employees 1,000,000 stock options that have an exercise price of $60 and a three-year cliff-vesting service condition. The options' exercise price equals the fair value of the stock on the grant date. The award's fair value is $35.29. SC Corporation recognizes compensation cost using the straight-line attribution method. On October 1, 20X2, which is one year into the three-year requisite service period, the market price of the company's stock declines to $40 per share, prompting the company to reduce the options' exercise price to $40 (no other changes to the award's terms were made). SC Corporation calculates the incremental fair value by calculating the fair value of the award immediately before and immediately after the modification. The fair value of the award immediately before the repricing is based on assumptions (e.g., volatility, expected term, etc.) reflecting the current facts and circumstances on the modification date and therefore, differs from the fair value calculated on the grant date. For simplicity, no pre-vesting forfeitures were assumed. Other significant information is as follows:
Original award
Modified award
Fair value on modification date
$18.36
$24.59
Exercise price
$60.00
$40.00
Unrecognized compensation cost per option on October 1, 20X2 ($35.29 * 2 years remaining / 3-year vesting period)
$23.53
n/a
View table
The additional compensation cost stemming from the modification is $6.23 per option ($24.59 fair value of modified award less $18.36 fair value of original award on modification date) and the total compensation cost to recognize prospectively per option is $29.76 ($23.53 remaining unrecognized compensation cost + $6.23 incremental fair value).
The total remaining compensation cost of $29,760,000 ($29.76 * 1,000,000 options) would be recognized ratably over the modified award's two-year requisite service period. Accordingly, SC Corporation's compensation cost would be $14,880,000 per year from October 1, 20X2 through September 30, 20X4.

4.3.5 Modifications of awards to accelerate vesting upon certain events

Many stock-based compensation awards contain provisions that provide for vesting to automatically accelerate upon a change in control event. Companies also sometimes modify an outstanding award to add this type of "change in control" provision. As discussed in SC 2.5.3, a change in control of the company is generally not viewed as probable until it occurs. Thus, a modification to add a change in control provision does not change the expectation of whether the awards will vest and does not change the attribution of expense (until the change in control occurs). If the original vesting conditions are expected to be satisfied as of the modification date, a modification to add a change in control provision does not result in any incremental fair value. This is because the awards are expected to vest both before and after the modification (since the change in control is not yet probable), and the change in control provision itself does not change the fair value of the award. When the change in control occurs, the company will recognize the remaining grant-date fair value because the requisite service period has been completed.
In other instances, companies modify awards to accelerate vesting in anticipation of the sale of a business unit. For example, a company might accelerate the vesting of awards held by employees of a business unit that will be sold (who will be terminating employment) because those employees otherwise would have forfeited the awards. In this scenario, the company should assess whether the sale of the business is probable at the time the awards are modified. Unlike a change in control, we believe a sale of a business unit could be probable before it occurs. A company should consider its assessment of when the business unit meets the held for sale criteria in ASC 360 as that assessment also involves assessing whether the sale transaction is probable. If the sale is determined to be probable, the modification to accelerate vesting would likely be a Type III modification (improbable to probable).

4.3.6 Modifications to the requisite service period of awards

The modification of an award may affect the award's requisite service period. If the modified requisite service period is equal to or shorter than the original requisite service period, compensation cost should be recognized over the remaining portion of the modified requisite service period. For example, a company grants an award with a performance condition and a four-year requisite service period. One year after the  grant date, the company modifies the original performance condition and replaces it with a new performance condition that has a two-year requisite service period. The award was expected to vest both before and after the modification; therefore, it is a Type I (probable to probable) modification. The company would recognize compensation cost over the modified requisite service period of two years (as opposed to the remaining portion of the original requisite service period of three years), starting from the modification date.
If the modified requisite service period is longer than the original requisite service period and, at the modification date, the original vesting terms are expected to be satisfied, the company should track whether the employees complete the original requisite service period. ASC 718-20-55-107 requires a company to recognize compensation cost at least equal to the original grant-date fair value if the awards ultimately would have vested under the original vesting conditions.
For example, a company grants options with a grant-date fair value of $9 per option and a three-year service period. Two years after the grant date, the company reduces the options' exercise price and increases the service period from the remaining one year of the original vesting requirement to three years (i.e., requiring two additional years of service). The incremental fair value of the award, as a result of the modification, is $4 per option. Therefore, the total remaining compensation cost that the company should recognize is $7 (unrecognized compensation cost for original option of $3 plus incremental fair value of $4). We believe, there are two approaches to address this issue:
  • Pool approach: Under this approach, the company would recognize $7 over the remaining three years of the modified requisite service period.
  • Bifurcated approach: Under this approach, the company would recognize (1) the $3 of unrecognized compensation cost over the original award's remaining one-year requisite service period and (2) the $4 of incremental value over the three-year modified requisite service period.
Under either approach, if an employee does not complete the three-year modified requisite service period, some or all compensation cost related to the employee's awards should be reversed depending on when the employee leaves. If the employee completes one year of service, the compensation cost related to the original award ($3) should not be reversed, because the employee would have vested under the original vesting conditions. Either approach is acceptable, and the choice is an accounting policy decision which should be disclosed in the financial statements, if material, and consistently applied.

4.3.7 Modifications of awards with market conditions

As discussed in SC 2.5.2, awards with market conditions are measured and accounted for differently than awards with performance or service conditions. At the grant date, a company does not assess (or reassess after the grant date) whether it is probable that a market condition will be satisfied, because the effect of the market condition is reflected in the fair value of the award. Instead, the recognition of compensation cost is solely dependent upon the employee completing the requisite service.
ASC 718 does not provide specific guidance on how to account for the modification of an award with a market condition. However, the general principles of modification accounting also apply to awards with market conditions, except that the accounting is not based on whether the company expects the market condition to be satisfied as of the modification date. Instead, the market condition is reflected in the fair value measurements used to calculate incremental fair value on the modification date.
If the employee is expected to complete the requisite service at the time of the modification, a company will recognize compensation cost equal to the unrecognized grant-date fair value of the original award plus any incremental fair value (if any) arising from the modification over the remaining requisite service period.

4.3.8 Modifications of awards by nonpublic companies

Nonpublic and public companies follow the same principles for modification accounting. However, in some cases, nonpublic companies can elect to use alternative measurement methods, such as calculated value or intrinsic value, for certain awards (see SC 6). If a nonpublic company is applying an alternative measurement method, that method should be used instead of "fair value" when calculating incremental value resulting from a modification.
For example, if a nonpublic company modifies an award measured using calculated value, it should measure incremental value based on the difference between the calculated value of the modified award and the calculated value of the original award at the modification date.
Another example is the modification of a liability award measured using intrinsic value. If the modification causes the award to become equity-classified, intrinsic value is no longer an acceptable measurement method (except in unusual situations described in SC 2.2.3). Nonpublic companies generally must use fair value or calculated value to measure equity-classified awards. In this situation, we believe the incremental compensation cost should be based on the difference between the fair value (or calculated value) of the modified equity-classified award and the intrinsic value of the original liability award at the modification date.
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