I started this series on modifications by discussing how modifications to non-market performance conditions are accounted for. Today I return to the topic of performance awards, to focus on modifications to market conditions.
A market condition is a vesting requirement that is tied the company's stock price. It could be an actual stock price target or goals related to the company's total shareholder return or market capitalization.
Modifications to market conditions are accounted for in a manner similar to repricings. (Think about it: an option price is essentially a form of market condition.) While it’s true that market conditions govern the extent to which awards will vest, the likelihood that the condition will be achieved is incorporated into the award’s fair value and this fair value is recorded as an expense regardless of the vesting outcome. Thus, whether the award is probable or improbable of vesting before and after a market condition is modified doesn’t really impact how the modification is accounted for.
Sure can! Modifications to market conditions are typically accounted for as probable-to-probable (Type I) modifications:
Let’s say that the various fair values for a market-conditioned award are as follows:
The $75,000 of expense already recorded for the award is not reversed, and the company continues to record the remaining $25,000 of unamortized expense. In addition, the company recognizes incremental cost of $20,000 ($60,000 new fair value less $40,000 pre-modification fair value).
Thus, the total expense the company will record for the award (assuming all time-based vesting requirements are met) is $120,000. Since $75,000 of the original expense was recorded before the modification, the expense that is recorded afterwards is $45,000. But the company was already planning to record $25,000 of this amount, so the additional cost of the modification is only $20,000.
So many! To learn about the securities law, tax, and other considerations that apply to award modifications, check out my blog entry “5 Things to Know About Award Modifications” and this handy table summarizing the considerations for various types of modifications.