Financial Reporting Financial Reporting
  March 2006   

 Issues Covered



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How are modifications of grants treated?

A modification is defined broadly as any change to an award's terms, including exercise price, number of shares, life, vesting conditions, settlement provisions, etc. Modifications encompass changes in conjunction with an equity restructuring, such as a spin-off, stock split or dividend, rights offering, or large nonrecurring cash dividend. Modifications may result from original performance targets being set too high, changes in business plans or restructuring, assignment of new job duties, change in control leading to acceleration of vesting, or acceleration of vesting in contemplation of retirement. Other types might include modifications to change an award's classification from liability to equity or vice versa or to serve as inducement for certain behavior (e.g., lower exercise price if employees exercise within the next 30 days).

A modification is viewed as the cancellation of the original award in exchange for the modified award. As a result, for equity awards, compensation cannot be less than the original grant date estimate of fair value, unless the original award was likely to be forfeited. If the fair value of the modified award exceeds the fair value of the original award as of the modification date (not the fair value as of the grant date), the incremental fair value, plus any remaining unamortized compensation from the grant date valuation of the original award, are combined and amortized over the remaining vesting period of the modified award (or charged off immediately if there is no remaining vesting period). Total recognized compensation cost for a modified award should be at least equal to the fair value of the award at grant unless, at modification, performance or service conditions of the original award are not expected to be satisfied. A key point to consider here is the effect of the modification on the number of instruments expected to vest.

Practical note: If the value of an award drops after grant date because a company's stock price declines, can the company modify its outstanding awards to trigger a new measurement of compensation at the new, lower stock price?

For liability awards, fair value is remeasured every period and would decrease as the stock price declines. For equity awards, fair value is not remeasured after grant date. For equity awards it generally is impossible to trigger a new, lower measure of fair value, because Statement 123(R) states that total compensation cost cannot be less than the fair value measured at grant date. The one exception is that if it appears probable that the original award is going to be forfeited, then compensation would be zeroed out on the original award and compensation on the new award would be measured at the new, lower stock price.

How Statement 123(R) differs from Opinion 25

Because the Opinion 25 model is so different from the fair value model, modifications are treated very differently under Opinion 25, and it is difficult to make a meaningful comparison. In 2000 and 2001, the FASB and the EITF provided extensive guidance on accounting for modifications under Opinion 25.

How Statement 123(R) differs from Statement 123

Accounting for modifications under Statement 123 is similar in concept to the accounting under Statement 123(R). As a result of the extensive recent work on accounting for different kinds of modifications under Opinion 25, Statement 123(R) contains more examples of modifications and more implementation guidance than Statement 123.

Continue Reading - How are changes in estimates treated?


Copyright © 2006, BDO USA,LLP. Material discussed in this Financial Reporting newsletter is meant to provide general information and should not be acted upon without first obtaining professional advice appropriately tailored to your individual facts and circumstances.