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NASPP – CT CHAPTER
Accounting for Modifications
March 13, 2013
Kevin Hassan
Managing Director
Disclaimer
The following discussion and examples do not necessarily represent the
official views of PwC, LLP with respect to any of the issues addressed.
Moreover, this presentation and the views expressed by the individual
presenter should not be relied on as legal, accounting, auditing, or tax
advice. The outcome of any individual situation depends on the specific
facts and circumstances in which the issue arises and on the interpretation
of the relevant literature in effect at the time.
Anyone viewing this presentation should not act upon this information
without seeking professional counsel and/or input from their advisors.
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Thank You
This presentation was originally prepared for the 2012 NASPP
National Conference in New Orleans.
Special thanks goes to the other presenters who were involved
in the development of the deck being used today:
• Elizabeth Dodge, Stock & Options Solutions, Inc.
• Raul Fajardo, Qualcomm Inc.
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Table of Contents
• What is a Modification and what does it mean
• Common termination modifications
• Performance award modifications
• Employee Status Changes
• Tax Accounting
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What is Modification Accounting?
718-20-35-3: 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.
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What Triggers Modification Accounting?
Changes to option/award not in original terms of grant
• Option Exchanges
- Repricings, Option-for-option, Option-for-RSU, cash
- “Value-for-value” + NO incremental expense still accounting impact
• Equity restructuring (some spin-off /stock-split transactions)
• Acquisitions
• Other changes to original terms of grant
- Extension of exercise grace period
- Allow consultant to retain option after termination
- Acceleration of vesting
- 409A Exchanges – upward repricing
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Modifications with No Accounting Impact
• Stock Split / Spin Off / Equity Restructuring
- With anti-dilution provision in plan – adjustment is automatic
• Acceleration of vesting
- Not related to termination
- No incremental expense because expected term shorter = value less
(still have to do the calculation to PROVE no additional
expense)
• Additional features that don’t impact inputs
- Permissible exercise methods
- Name changes
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Other Modifications
• Changes to grants that are modifications for tax purposes
that don’t necessarily trigger modification accounting
- For example…
- Adding Net Exercise to an ISO
- Adding any additional payment terms to an ISO
- Offer to exchange more than 30 days of ISO – treated as
modification
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Incremental Expense
ASC Topic 718
• Generally continue to account for original award, plus
account for “incremental cost” of replacement award
- Incremental cost = excess of fair value of new award over
current fair value of original award
- No negative incremental cost
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Accounting for Vesting Modifications
Four types of vesting modifications
• Type I – Probable to Probable (ASC 718-20-55-111)
• Type II – Probable to Improbable (ASC 718-20-55-113)
• Type III – Improbable to Probable (ASC 718-20-55-116)
• Type IV – Improbable to Improbable (ASC 718-20-55-118)
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Extension of Exercisable Period - Example
•
Company X grants
- 100 options on 1/1/11
- Cliff vested on 1/1/12
- Strike price of $10
- Original fair value of stock options $7
•
On 7/1/2012, participant terminates
- Market Value $8
- Since options have no intrinsic value, Company X extends exercise period from 3
months to 5 years
•
Modification Treatment:
- Before & After Valuation
- Before – Expected Term = 3 months, inputs for 3 month period
- After – Expected Term = 5 years, inputs for 5 years
◦ If service continues, may fall under non-employee accounting
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Extension of Exercisable Period - Continued
FV of Original Award at Grant Date
$7.00
Incremental Value:
FV of Modified Grant on Mod Date
$2.50
FV of Original Grant on Mod Date
$1.50
$1.00
Total Fair Value of Modified Grant
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$8.50
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Acceleration of Option Vesting - Example
• Company Y grants
- 100 stock options on 1/1/2010
- 4-year annual vesting
- Strike price of $10
- Original fair value = $7
• On 1/1/2011, participant terminates
- Company Y accelerates vesting of unvested shares
- Market Value $20
• Unvested Shares
- Type III Modification (Improbable to Probable)
- New Fair Value Calculated as of modification date, prior expense
reversed, new Fair Value booked
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Acceleration of RSU Vesting - Example
• Company Y grants
- 100 RSUs on 1/1/2010
- 4-year annual vesting
- Original fair value = $10
• On 1/1/2011, participant terminates
- Company Y accelerates vesting of unvested shares
- Market Value $20
• Unvested Shares
- Type III Modification (Improbable to Probable)
- New Fair Value SET as of modification date, prior expense reversed,
new Fair Value booked
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Cancellation of In-the-Money Options
• Company Q negotiates a cancellation of 100,000 outstanding in-themoney options with employee Smith
- Smith continues to provide service to the company
• Original Fair Value: $10 per share
• Total Fair Value: $1,000,000
• Accounting impact:
• Acceleration of remaining expense into current reporting period
• No longer any “risk of forfeiture”
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Termination Modification Calculations
The Good News:
• Often one-time calculations,
• Spreadsheet Black-Scholes models widely available
- Assuming B/S model in use
• Depending on the modification expense may be immaterial
The Bad News:
• Options - Expected Term = input driver
- Not always simple to calculate
- May require valuation model
• Even if the expense IS immaterial, you have to perform the calculation
to PROVE it
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Performance Modifications
• Changing Goals
- Assess probability of vesting before and after to determine treatment (Often
Type III)
• Removing Performance Criteria
- Assess probability of vesting before and after to determine treatment (Often
Type III)
- May not trigger incremental expense, since performance criteria do not
always impact fair value
• Service Period Changes
- Recognize remaining expense prospectively
- Some systems do not support (true down)
• Market conditions
• Adding performance goals / market conditions to existing awards
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Employee Status Changes
• Non-employee to employee
- Expense recognized as non-employee not adjusted
- Measure FV at modification date & recognize
prospectively as awards earned as employee
• Employee to non-employee
- Expense recognized as employee not adjusted
- Follow non-employee accounting and recognize
prospectively awards earned as non-employee (remeasure
through vest date)
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Tax Accounting Basics
• Corporate tax deduction for NQ/RS/RSU at exercise or
delivery
- To anticipate future deduction, company books
◦ Deferred Tax Asset (DTA) as expense recognized
(expense * corporate tax rate)
- At settlement, true up DTA to ACTUAL Tax Benefit
- Windfall – actual tax deduction exceeds book charge
- Shortfall – book charge exceeds actual tax deduction
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Tax Accounting for Modifications
• Both the old (original) and the new (incremental) expense
tied to new grant
- Both used when determining excess or deficiency for
tax accounting purposes
- Deferred tax assets (DTA) from both old and new grant
are reversed at time of settlement
- Published guidance on this treatment is scarce
◦ Prevailing practice – may be diversity in practice
- Expect deficiencies!
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