Occupy Mall Street (OMS) is a leading real estate management firm what owns over 100 shopping malls across the United States. OMS went public in 2009 and with the continual growth of the business and increase in stock price through 2011, the company decided to grand stock options to its executives to encourage retention.
On January 1, 2012, OMS granted 1,000 employee shares options that cliff vest after 4-year service period. The exercised price was $30 per share. Using the Black-Scholes pricing model, the fair market value of the awards on the grant date was $15. On the grant date, OMS stock was trading at $30 per share.
On January 1, 2014, OMS wanted to provide additional retention incentive to its employees.
OMS modified the exercise price to $20 per share. Using the Black-Scholes pricing model, the fair value of the awards was $12 per share and $9 before the terms were modified. There were no other terms of the stock option award affected. There were no forfeitures.
How much compensation cost should OMS recognize in each year of the award’s service period?
2012 and 2013 should be $3,750
2014 and 2015 should be $5,250
By applying ASC-718-10-30-2: A share-based payment transaction with employees shall be measured based on the fair value of the equity instruments issued.
Also, to apply ASC 718-20-55-10: states that the total compensation cost recognized over the requisite service period shall be calculated by using the grant-date fair value of all share options that actually vest.
Therefore, for 2012 and 2013, OMS should calculate the compensation cost for each year at $3,750.
(1000 shares x $15 FV @ grant date/4 years)
To provide the additional incentives for the years 2014 and 2015, we need to apply
FSB ASC 718- 20-35-3: which states, 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…. The effects of a modification shall be measured as follows: a. incremental cost is measure as the excess of the fair value of the modified award immediately before its terms are modified… b. thus the total compensation cost measured at the date of a modification shall be the sum of the following: 1. The portion of the grant-date fair value of the original award for which the requisite service is expected to be rendered (or has already been rendered) at that date. 2. The incremental cost resulting from the modification.”
Therefore, OMS, should calculate the compensation cost for each of years 2014 and 2015 at $5,250.
Incremental cost portion is ($12-$9) *1,000/2 years =$1,500
Compensation cost (1000 x $15/4 years) =$3,750
Issue 2: How would the accounting for these awards change if the modification to the terms (i.e., exercise price) of the award was made on January 1, 2017.
OMS should recognize $3,000 compensation expense on January 1, 2017.
According to 718-20-55-94 and 96, Case A: Modification of Vested Shares Options, states “The modified share options are immediately vested, and the additional compensation cost is recognized in the period the modification occurs”.
Therefore, OMS should recognize its additional compensation cost in 2017 when the award changed and the additional compensation cost recognized from the modification is as follows:
Fair value of modified share option at January 1, 2017 $12
Less: Fair value of original share option at January 1, 2017 $ 9
Additional compensation cost to be recognized $ 3
In addition, 718-20-5-96: “Previously recognized compensation cost is not adjusted. Additional compensation cost is recognized…”
This leads OMS to recognize $3,000 (1000 shares * $3) compensation expense on January 1, 2017.
Additional facts leading in to issue 3:
The above facts are assumed to be the same, but now there is a performance condition, which the award will only vest if cumulative net income over the 4-year service period is greater than $10 million. (Performance condition). December 31, 2013, OMS had to revise the cumulative net income down to $9 million due to the loss of several tenants. Management determined that the performance condition had become improbable to achieve.
The Following year, December 31, 2014, management’s concluded that the award’s performance condition was improbable of achievement. In response to this, management reduced the performance condition down to $8 million of the cumulative net income over the four-year period.
The modification did not affect any other terms or conditions of the awards nor did it affect the options per share fair-value based measure.
How would the Year 2 accounting change if management determined that the performance condition was improbably of achieving on December 31, 2103?
FASB ASC 718-10-25-20, Accruals of compensation cost for an award with a performance condition shall be based on the probable outcome of that performance condition—compensation cost shall be accrued if it is probable that the performance condition will be achieved and shall not be accrued if it is not probable that the performance condition will be achieved.
In regards to OSM, the award contains a performance condition, which is the cumulative net income over the 4-year period greater than $10 million. As management concluded that the performance condition was improbable to achieve on December 31, 2013, the compensation cost shall not be accrued in 2013, therefore, they need to reverse the previously recognized compensation cost, which was $3750 in 2013. Therefore, $0 should be recognized as the cumulative amount of cost at the end of 2013.