the mod squad: a guide to modification accounting for stock plan...
TRANSCRIPT
The Mod Squad: A Guide to Modification Accounting for Stock Plan Professionals
Elizabeth Dodge, CEP, Stock & Option Solutions, Inc.Raul Fajardo, CEP, Qualcomm, Inc.Kevin Hassan, CPA, PricewaterhouseCoopers, LLP
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Disclaimer
The following discussion and examples do not necessarily represent the official views of Stock & Option Solutions, Inc., Qualcomm, Inc., or PricewaterhouseCoopers, LLP with respect to any of the issues addressed. Moreover, this presentation and the views expressed by the individual presenters 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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Agenda
Common termination modifications
Performance award modifications
ESPP modifications
Employee Status Changes
Tax accounting and Diluted EPS implications of modifications
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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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Accounting for Vesting Modifications
Before ↓After →Modification
Probable Improbable
Probable Probable to ProbableType I (ASC 718-20-55-111)
FV of original awardOther Modification – measure
incremental expense (new award)
Probable to ImprobableType II (ASC 718-20-55-113)
FV of original awardUpdate forfeiture estimateOther Modification – measure
incremental expense (new award)
Improbable Improbable to ProbableType III (ASC 718-20-55-116)
FV of modified award onlyOther Modification – included
in FV of modified award
Improbable to ImprobableType IV (ASC 718-20-55-118)
FV of modified award onlyOther modification – included in
FV of modified awardNo expense impact - improbable
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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 $1.00 $1.50
Total Fair Value of Modified Grant $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-the-money options with employee Smith
– Smith continues to provide service to the company
Original Fair Value: $10 per shareTotal Fair Value: $1,000,000Accounting impact:
– Acceleration of remaining expense into current reporting period
– No longer any “risk of forfeiture”
What if it was a non-employee instead?
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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 conditionsAdding performance goals / market conditions to existing awards
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Value of ESPP ComponentsPlan Feature
Description Fair Value Component
Discount % of discount Discount
Lookback Ability to purchase at LOWER market value between beginning of offering period market value & purchase date market value.Ability to benefit from increasein stock price.
Call Black-ScholesOption
No beginning price limit
Ability to purchase MORE shares if price declines (number of shares to be purchased not limited by Ability to benefit from decreasein stock price.
Put Black-Scholes Option
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ESPP – Expense Modifications
Certain design features trigger modification accounting– Resets – resets lookback price– Rollovers – new offering with lower price– Increases in contributions within an offering period
Design features that do not trigger modifications, but require special attention
– Decreases in contributions – IGNORE!– Voluntary withdrawals without termination – IGNORE!– Salary changes, bonuses – adjust expense
Only true up to actual shares purchased for:– Terminations– Salary changes, bonuses, etc.– Generally DO NOT True up to “actual shares purchased”
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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)
– What if service does not continue and/or service is non-substantive?
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Tax Accounting 101
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) 1
– At settlement, true up DTA to ACTUAL Tax Benefit
If Result Impact
Actual Tax Benefit > DTA Excess / Windfall Increase APIC
Actual Tax Benefit < DTA Deficiency / Shortfall Decrease APIC / Increase Tax Expense
1 At same time Deferred Tax Benefit reduces income tax expense.
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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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Diluted EPS Impact
EPS Under ASC 260 in Four “Easy” Steps1. Assume all vested & exercised/released2. Weight shares for time outstanding3. Calculate assumed proceeds / buyback shares
a. Exercise Proceeds (price) Not for RS/RSUs
b. Average Unamortized Expense
c. Hypothetical Tax Benefit / Deficiency
4. Compare weighted shares outstanding to buyback shares
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Contact Information
Elizabeth Dodge, CEPVice President, Product ManagementBus: (408) 979-8700E-mail: [email protected]
Kevin Hassan, CPAManaging DirectorBus: (203) 539-4049Email: [email protected]
Raul FajardoManager, FinanceBus: (858) 651-4865Email: [email protected]