FASB Amends the Scope of Modification Accounting for Share-Based Payment Arrangements
On May 10, 2017, the FASB issued ASU 2017-09, which amends the scope of modification accounting for share-based payment arrangements. The ASU provides guidance on the types of changes to the terms or conditions of share-based payment awards to which an entity would be required to apply modification accounting under ASC 718. Specifically, an entity would not apply modification accounting if the fair value, vesting conditions, and classification of the awards are the same immediately before and after the modification.
When ASU 2016-09 was issued in March 2016 under the Board’s simplification initiative, it made a change to ASC 718 regarding the exception to liability classification of an award related to an employer’s use of a net-settlement feature to withhold shares to meet the employer’s statutory tax withholding requirement. Under ASU 2016-09, the net settlement of an award for statutory tax withholding purposes does not result, by itself, in liability classification of the award as long as the amount withheld for taxes does not exceed the maximum statutory tax rate in the employee’s relevant tax jurisdiction(s). Before an entity adopts ASU 2016-09, the exception applies only when the entity repurchases or withholds no more than the number of shares necessary for the minimum statutory tax withholding requirement to be met.
Upon adopting ASU 2016-09, some entities may change the net-settlement terms of their share-based payment arrangements from the minimum statutory tax rate to a higher rate up to the maximum statutory tax rate. Some constituents questioned whether they would be required to apply modification accounting under ASC 718-20-35-3 if they changed existing awards in this manner. On the basis of discussions with the FASB staff, we noted in our April 21, 2016, Heads Up that if entities made such a change, they would not be required to apply modification accounting.
The FASB staff subsequently conducted research on whether the Board should change the scope of the modification guidance in ASC 718 given that ASC 718-20-20 defines a modification as a “change in any of the terms or conditions of a share-based payment award” (emphasis added). As a result of that broad definition, there may be diversity in practice regarding the types of changes to share-based payment awards to which an entity applies modification accounting. For example, some entities may apply it only to substantive changes while others may apply it broadly to all changes other than solely administrative ones. Accordingly, to provide clarity and reduce diversity, cost, and complexity, the FASB issued ASU 2017-09.
The effect of an entity’s application of modification accounting depends on whether the original awards are expected to vest, and such effect could be significant. If the entity applies modification accounting to equity-classified awards, and the original awards are expected to vest (because of any service or performance conditions) on the modification date, the entity may incur incremental compensation cost. The entity compares the fair-value-based measurement of the awards immediately before the modification with the fair-value-based measurement of the awards immediately after the modification. If the fair-value-based measurement after the modification is higher than it is before the modification, the entity generally recognizes incremental compensation cost over any remaining requisite service period. If, instead, the original awards are not expected to vest on the modification date, the entity generally recognizes any compensation cost for the modified awards on the basis of the revised fair-value-based measurement on the modification date (as opposed to the original grant-date fair-value-based measurement).
Examples 1 and 2 illustrate the effects of an entity’s application of modification accounting depending on whether the original awards are expected to vest (See examples in PDF).
Key Provisions of the ASU
Scope of Modification Accounting
The ASU limits the circumstances in which an entity applies modification accounting. When an award is modified, an entity does not apply the guidance in ASC 718-20-35-3 through 35-9 if it meets all of the following criteria:
- “The fair value (or calculated value or intrinsic value, if such an alternative measurement method is used) of the modified award is the same as the fair value (or calculated value or intrinsic value, if such an alternative measurement method is used) of the original award immediately before the original award is modified.”
- “The vesting conditions of the modified award are the same as the vesting conditions of the original award immediately before the original award is modified.”
- “The classification of the modified award as an equity instrument or a liability instrument is the same as the classification of the original award immediately before the original award is modified.”
The ASU also removes the guidance in ASC 718 stating that modification accounting is not required when an entity adds an antidilution provision as long as that modification is not made in contemplation of an equity restructuring.
We do not expect practice to change as a result of the Board’s removal of the guidance in ASC 718 on an entity’s addition of an antidilution provision to awards. If an entity adds such a provision but does not contemplate an equity restructuring, the fair-value-based measurement of the awards would generally remain the same. Accordingly, as long there are no other changes to the awards that would affect vesting or classification, the entity does not apply modification accounting. If the entity contemplates an equity restructuring, however, it applies modification accounting and may need to recognize significant incremental compensation cost.
In addition, upon an equity restructuring, it is not uncommon for an entity to make employees “whole” (in accordance with a preexisting nondiscretionary antidilution provision) on an intrinsic-value basis when the awards are stock options. In certain circumstances, the fair-value-based measurement of modified stock options could change as a result of the equity restructuring even if the intrinsic value remains the same. Under the ASU, an entity compares the intrinsic value before and after a modification in determining whether to apply modification accounting only “if such an alternative measurement method is used”; thus, if an entity uses a fair-valuebased measure to calculate and recognize compensation cost for its share-based payment awards, it would still be required to apply modification accounting when the fair-value-based measurement has changed, even if the intrinsic value is the same immediately before and after the modification (see example in PDF).
If an entity modifies its awards and concludes that it is not required to apply modification accounting under the ASU, it must still consider whether the modification affects its application of other guidance. For example, under ASC 718-10-35-9 through 35-14, if an entity modifies an award after the holder is no longer an employee, the modification may be subject to other U.S. GAAP (unless the modification is made solely to reflect an equity restructuring that meets certain criteria).
Clarifications Related to the Fair Value Assessment
The ASU clarifies how an entity would calculate fair value under ASC 718-20-35-2A(a) in determining whether modification accounting is required.
Determining Whether a Fair Value Calculation Is Required
ASC 718-20-35-2A(a) states, “If the modification does not affect any of the inputs to the valuation technique that the entity uses to value the award, the entity is not required to estimate the value immediately before and after the modification.”
In paragraph BC16 of the ASU, the Board noted that it does not expect that an entity will always need to estimate the fair-value-based measurement of a modified award. An entity might instead be able to determine whether the modification affects any of the inputs used in the valuation technique performed for the award. For example, if an entity changes the net-settlement terms of its share-based payment arrangements related to statutory tax withholding requirements, that change is not likely to affect any inputs used in the method performed by the entity to value the awards. If none of the inputs are affected, the entity would not be required to estimate the fair-value-based measurement immediately before and after the modification (i.e., the entity could conclude that the fair-value-based measurement is the same).
Considering Whether Compensation Cost Recognized Has Changed
In paragraph BC13 of the ASU, the Board clarified that the evaluation should be based on whether the fair value has changed, not on whether the compensation cost recognized has changed.
If an entity makes a modification that changes the fair value of an award, modification accounting would be applied. The Board clarified that the entity’s assessment does not take into account whether the compensation cost recognized has changed. For example, if the modification changes the fair value of the award but it is not probable that the award will vest both immediately before and after the modification (a “Type IV improbable-to-improbable” modification), there may be no change in compensation cost recognized on the modification date because there is no compensation cost before and after the modification (compensation cost is recognized only if it is probable that the award will vest). However, modification accounting would be required (and a new measurement determined as of the modification date) because the fair value has changed.
Determining the Unit of Account
In paragraphs BC19 and BC20 of the ASU, the Board discusses the unit of account to apply in the determination of whether an award’s fair value is the same immediately before and after the modification. The discussion addresses questions from stakeholders about whether an entity should compare the value of an award immediately before and after a modification on the basis of (1) “the total instruments in an award to an employee that are modified” or (2) “each individual instrument awarded to an employee that is modified.” The Board indicates that the unit of account to apply in the fair value assessment should be consistent with that applied under other guidance in ASC 718 and with the definition of an award in the ASC master glossary. That is, an entity should use as the unit of account the total of all modified instruments in the award rather than each individual modified instrument awarded to the employee.
The ASC master glossary defines an award as follows:
The collective noun for multiple instruments with the same terms and conditions granted at the same time either to a single employee or to a group of employees. An award may specify multiple vesting dates, referred to as graded vesting, and different parts of an award may have different expected terms. References to an award also apply to a portion of an award. (See examples in PDF.)
Determining Whether the Fair Value Is the Same
In determining whether the fair value of an award is the same immediately before and after a modification, some practitioners have expressed uncertainty about whether the fair value must be exactly the same (i.e., a binary assessment) or whether they can apply judgment on the basis of the significance of the change in fair value. The Board decided not to provide guidance on the use of judgment in this assessment, observing that entities must use judgment to apply other aspects of ASC 718 and do so without specific guidance. Accordingly, an entity may need to use judgment in certain circumstances to determine whether the fair value of an award is the same immediately before and after a modification.
While in many circumstances it may be clear whether the fair value of an award is the same immediately before and after a modification, an entity may need to use judgment when such value is not exactly the same. For example, an entity may reasonably conclude that the fair value is the same when a difference is de minimus and the facts and circumstances indicate that the intent of the modification is to retain the original fair value.
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