The NASPP Blog

This week, we feature another installment in our series of guest blog entries by NASPP Conference speakers. Today’s entry is written by Elizabeth Dodge of Stock & Option Solutions, who will lead the session “The Mod Squad: A Guide to Modification Accounting for Stock Plan Professionals.”

The Mod Squad: A Guide to Modification Accounting for Stock Plan Professionals
By Elizabeth Dodge of Stock & Option Solutions

In our session “The Mod Squad: A Guide to Modification Accounting for Stock Plan Professionals” my co-panelists, Kevin Hassan, of PwC and Raul Fajardo of Qualcomm, and I tackle some of the most common (and least understood) modifications of equity compensation awards.

One of the most common types of “unplanned” modifications I see in my consulting work, which we will cover in our presentation, is that of vesting modifications.

The text of the ASC 718 standard says this about modification accounting:
Modifications of Awards of Equity Instruments

51. 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:

a. 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 Statement 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. …
b. 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 (1) the portion of the grant-date fair value of the original award for which the requisite service is expected to be rendered (or has already been rendered) at that date plus (2) the incremental cost resulting from the modification.

But then the examples in ASC 718-20-55-111 through ASC 718-20-55-118 go on to delineate four, count them four, different types of vesting modifications, with two different treatments:

1. Type I: Probable to Probable: Recognize fair value of original award + incremental expense, if any.
2. Type II: Probable to Improbable: Recognize fair value of original award + incremental expense, if any.
3. Type III: Improbable to Probable: New fair value only. Reverse expense for any unvested shares.
4. Type IV: Improbable to Improbable: New fair value only. Reverse expense for any unvested shares.

Type II and Type IV are incredibly uncommon, but we DO see a good number of Type I and Type III. Type I are often triggered by option exchanges, or any modification to already vested shares, like an extension of exercise grace period at termination. Type III modifications are also quite common at the time of termination when unvested shares are accelerated.

How do you handle the modifications? First, decide if they are Type I or Type III. If the shares are vested, chances are good you are dealing with a Type I. If the shares would have been cancelled if not for the termination, then chances are good you have a Type III. If a Type I, perform two fair value calculations: one before the change, and one after, and compare the expense to determine your incremental expense. If a Type III, you need only one fair value calculation, using the attributes of the grant after the modification. Calculate how much expense has already been booked for the unvested shares in the grant and true up (or down) to the new fair value.

There is good news about most modifications, especially those at the time of termination: they are generally fairly simple one-time calculations where all the expense is booked immediately. Once and done. The bad news is that most systems have limited support for modification accounting and the inputs can be quite tricky. What is the expected term of an underwater option before it is exchanged for a new option? Is it the remaining expected term from the original grant date fair value? The remaining contractual life? An expected term calculated by a Monte Carlo simulation? Each company must decide for itself. A few examples in the standard seem to point to remaining contractual term, but the Monte Carlo simulation approach seems to fly past audit as well. No two audit firms, or audit partners, seem to have the same opinions.

Join me and my talented co-panelists in New Orleans as we wrestle modification accounting to the ground and give you a solid understanding of the required treatment and some varying interpretations. Laissez Les Bon Temps Roulez!

Don’t miss this session, “The Mod Squad: A Guide to Modification Accounting for Stock Plan Professionals,” presented by Elizabeth Dodge of Stock & Option Solutions, Kevin Hassan, of PwC, and Raul Fajardo of Qualcomm at the 20th Annual NASPP Conference in New Orleans, October 8-11.