How should an entity account for the extension of the contractual term of a vested option during a blackout period?
Answer
The extension of the option’s contractual term should be accounted for as a modification. See Q&A 4-15 for a discussion of the accounting for a modification. If, at the time of the modification, the original option is not exercisable because of a blackout period and the entity is not obligated to settle the option in cash or other assets, the option has no value to the holder. The determination of whether the entity is obligated to settle in cash or other assets may require the opinion of legal counsel. In accordance with ASC 718-20-35-3, the incremental compensation cost is the excess of the fair-value-based measure of the modified award on the date of modification over the fair-value-based measure of the original award immediately before the modification. Since the original option’s value is zero, the incremental value would be the fair-value-based measure of the modified option because the entity has, in substance, replaced a worthless option with an option that the employee (or former employee) will have an opportunity to exercise in the future. Further, because the award is fully vested, the compensation cost would be recognized in full on the date of the modification.
4-18 Modification That Changes an Award’s Classification From Equity to Liability
QuestionHow does an entity account for a modification that results in a change in an award’s classification from equity to liability?
Answer
A modification that changes an award’s classification from equity to liability is accounted for in the same manner as any other modification. See Q&A 4-15 for a discussion of the accounting for a modification of a share-based payment award.
3 As defined in ASC 718-10-20, a blackout period is a “period of time during which exercise of an equity share option is contractually or legally prohibited.”
To record a new liability award, the entity recognizes a share-based liability for the portion of the award related to prior service, multiplied by the modified award’s fair-value-based measure. If the fair-value-based measure of the modified award is less than or equal to the fair-value-based measure of the original award, then the offsetting amount is recorded to APIC (i.e., final compensation cost cannot be less than the grant-date fair-value-based measure). If, on the other hand, the based measure of the modified award is greater than the fair-value-based measure of the original award, then the excess is recognized as compensation cost either immediately (for vested awards) or over the remaining service (vesting) period (for unvested awards). Because the award is now classified as a liability, it is remeasured at a fair-value-based measure each reporting period.
Note that if an entity cash settles a fully vested equity award rather than modifies its terms to reclassify the award as a liability (i.e., to allow for cash settlement), the resulting accounting would be different. That is, the cash settlement, as long as it is transacted at the award’s then-current fair-value-based measure, would result in no additional compensation cost pursuant to ASC 718-20-35-7. In addition, see Q&A 4-36 for a discussion of a cash settlement at less than the current fair-value-based measure. In contrast, if the fair-value-based measure of the modified liability award was greater than the grant-date fair-value-based measure of the equity award on the date of modification, then the modification would result in additional compensation cost.
Example 1
On January 1, 20X1, Entity A grants 1,000 “at-the-money” share-settled SARs, each with a grant-date fair-value-based measure of $3. The SARs vest at the end of the fourth year of service (cliff vesting). On December 31, 20X2, A modifies the SARs from share-settled SARs to cash-settled SARs. The fair-value-based measure of the SARs on December 31, 20X2, and December 31, 20X3, is $4 and $5, respectively.
Because the modification only affects the settlement feature of the SARs (i.e., cash settlement versus share settlement), presumably the fair-value-based measure of the modified SARs equals the fair-value-based measure of the original SARs immediately before modification. Accordingly, there is no incremental value conveyed to the holder of the SARs and, therefore, no incremental compensation cost has to be recorded in connection with this modification from an equity to a liability award.
Because the modified-date fair-value-based measure is greater than the grant-date fair-value-based measure, A (1) reclassifies the amount currently residing in APIC, $1,500 (1,000 SARs × $3 grant-date fair-value-based measure
× 50% for two of four years of services rendered), as a share-based liability and (2) records the excess $500 (($4 modified-date fair-value-based measure – $3 grant-date fair-value-based measure) × 1,000 SARs × 50% for two of four years of services rendered) as additional compensation cost to record the new liability award at its fair-value-based measure, with a corresponding adjustment to share-fair-value-based liability in the period of modification. See the journal entries below.
Journal Entry: December 31, 20X1
Compensation cost 750
APIC 750
To record compensation cost for the year ended December 31, 20X1.
Journal Entry: December 31, 20X2
Compensation cost 750
APIC 750
To record compensation cost for the year ended December 31, 20X2.
Journal Entry: Date of Modification
APIC 1,500
Compensation cost 500
Share-based liability 2,000
To record the award as a liability on the date of modification.
Now that the SARs are classified as a liability, A is required to remeasure the SARs at their fair-value-based measure each reporting period until settlement pursuant to ASC 718-30-35-2. In addition, see Q&A 3-35 for a discussion of the differences in accounting treatment of equity and liability awards. See the journal entry below.
Journal Entry: December 31, 20X3
Compensation cost 1,750
Share-based liability 1,750
To remeasure the liability award at the fair-value-based measure at the end of the next reporting period (December 31, 20X3) [(1,000 SARs × $5 fair-value-based measure × 75% for three of four years of services rendered) – $2,000 compensation cost previously recognized].
Example 2
Alternatively, assume all the same facts as above, except that the fair-value-based measure of the SARs on the date of modification (December 31, 20X2) and December 31, 20X3, is $2.50 and $2, respectively. Entity A reclassifies the portion of the SARs’ modified-date fair-value-based measure of $1,250 (1,000 SARs × $2.50 fair-value-based measure × 50% for two of four years of services rendered) currently residing in APIC as a share-based liability. See the journal entries below.
Journal Entry: December 31, 20X1
Compensation cost 750
APIC 750
To record compensation cost for the year ended December 31, 20X1.
Journal Entry: December 31, 20X2
Compensation cost 750
APIC 750
To record compensation cost for the year ended December 31, 20X2.
Journal Entry: Date of Modification
APIC 1,250
Share-based liability 1,250
To record the award as a liability on the date of modification.
Now that the SARs are classified as a liability, in accordance with ASC 718-30-35-2, A is required to remeasure the SARs at their fair-value-based measure each reporting period until settlement. If the value of the liability award at settlement is less than its date fair-value-based measure, then total compensation cost will equal the grant-date fair-value-based measure, with a portion of that value remaining in equity. On the other hand, if at settlement the value of the liability award is greater than its grant-date fair-value-based measure, total compensation
cost will equal the liability award’s value at settlement. This is consistent with the requirement in ASC 718 that compensation cost for an equity award (the original treatment of this award before modification) should generally be recorded at least at its grant-date fair-value-based measure. See the journal entries below.
Journal Entries: December 31, 20X3
Compensation cost 750
APIC 750
To record compensation cost based on the grant-date fair-value-based measure ($3) and the continued employee service (one of four years).
APIC 250
Share-based liability 250
To remeasure the liability award at the fair-value-based measure at the end of the next reporting period (December 31, 20X3) [(1,000 SARs × $2 fair-value-based measure × 75% for three of four years of services rendered) – $1,250 share-based compensation liability previously recognized].