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As noted earlier, modifying an award may cause an equity-classified award to become a liability-classified award or vice versa.

4.4.1 Equity-to-liability modification of awards

When accounting for a modification that changes an award's classification from equity to liability, a company should do the following:
  • Determine the portion of the requisite service period that the employee has completed.
  • Recognize a liability that equals the modified award's modification-date fair value, multiplied by the percentage of the requisite service period completed at the date of the modification. If the liability equals the amount recognized in equity for the original award, the entry to recognize the liability is simply a credit to liability and a debit to equity. If the liability exceeds the amount recognized in equity for the original award, the incremental amount is recognized as compensation cost currently. If the liability is less than the amount recognized in equity, the residual amount simply remains in equity, generally as additional paid-in capital.
  • For each reporting period after the modification date, adjust the liability so that it equals the portion of the requisite service provided multiplied by the modified award’s fair value at the end of the reporting period. Changes in the liability are recorded as increases or decreases to compensation cost, except that the amount of compensation cost is subject to the floor of the original equity award’s grant date fair value. If the liability value declines below the amount that represents the portion of the requisite service period multiplied by the original equity award’s grant date fair value, that difference is credited to equity rather than compensation cost. In that case, compensation cost is being recognized based on the grant date fair value of the original equity award (rather than the liability value).

An example of a modification that causes an award’s classification to change from equity to liability, including illustrating the “floor principle,” can be found in ASC 718-20-55-123 through ASC 718-20-55-133. Example SC 4-6 illustrates the accounting for an equity-to-liability modification.
EXAMPLE SC 4-6
Accounting for a modification that results in a change to an award's classification
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 company decides to issue cash-settled stock appreciation rights (SARs) to replace the options. The fair value of the SARs (and the original stock options) is $45 on the modification date.
How should SC Corporation account for the exchange of stock options for SARs?
Analysis
Because the original award had three-year cliff-vesting provisions, the SC Corporation would have recognized compensation cost of $11.76 per year per option (1/3 × $35.29). On the modification date (October 1, 20X2), the fair value of each cash-settled SAR is $45. The company should have recognized $15 in compensation cost for each SAR (1/3 of the $45 fair value). Because the pro rata fair value of the liability ($15) is more than the pro rata grant-date fair value of the original award ($11.76), an adjustment would be made to cumulative compensation cost at the time of the modification. The company would record the following journal entries:
Through September 30, 20X2:
Dr. Compensation expense
$11,760,000
Cr. Additional paid-in capital
$11,760,000
To recognize stock-based compensation cost for the first year of the award's service period
View table

On October 1, 20X2 (the modification date):
Dr. Compensation expense
(($15.00 – $11.76) × 1,000,000)
$3,240,000
Dr. Additional paid-in capital
$11,760,000
Cr. Stock-based compensation liability
$15,000,000
To recognize the effect of the modification
View table

4.4.2 Liability-to-equity modification of awards

The floor principle does not apply to a modification that results in a company reclassifying an award from a liability to equity. To account for such a modification, a company should do the following:
  • Remeasure the liability as of the modification date and reclassify the liability to additional paid-in capital
  • Recognize the incremental value associated with the modification as compensation cost equal to the excess, if any, of the modified award’s fair value over the original award’s fair value immediately prior to the modification. Generally, the equity-classified award will not be remeasured after the modification date
  • Account for the award as equity, going forward, so long as there are no further changes

An example of a modification that causes the award’s classification to switch from liability to equity can be found in ASC 718-20-55-135 through ASC 718-20-55-138.
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