7.3.2
Modifications that decrease the value of an award
This type of modification does not occur very often, as the effect would be somewhat
demotivating and, in some cases, contrary to local labour regulations. However, there have
been occasional examples of an award being made more onerous – usually in response to
criticism by shareholders that the original terms were insufficiently demanding.
The general requirement of IFRS 2 (as outlined at 7.3 above) is that, where an award is
made more onerous (and therefore less valuable), the financial statements must still
recognise the cost of the original award. This rule is in part an anti-avoidance measure
since, without it, an entity could reverse the cost of an out-of-the-money award by
modifying it so that it was unlikely to vest (for example, by adding unattainable non-
market performance conditions) rather than cancelling the award and triggering an
acceleration of expense as in 7.1 above.
7.3.2.A
Decrease in fair value of equity instruments granted
If the modification decreases the fair value of the equity instruments granted (e.g. by
increasing the exercise price or reducing the exercise period), the decrease in value is
effectively ignored and the entity continues to recognise a cost for services as if the
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awards had not been modified. [IFRS 2.B44(a)]. This approach also applies to reductions in
the fair value of an award by the addition of a market condition or by making an existing
market condition more onerous. [IFRS 2.B44(a), B44(c)]. Although IFRS 2 has no specific
guidance on the point, we assume that reductions in the fair value resulting from the
addition or amendment of a non-vesting condition are similarly ignored.
Example 30.22: Award modified by replacing a non-market condition with a
market condition
At the beginning of year 1, an entity grants 1,000 share options to each of its 10 employees, with exercise
conditional upon the employee remaining in the entity’s employment for three years, and an earnings per
share (EPS) target (non-market condition) being met over the three year period. The fair value of the share
options is £15 per option at the date of grant.
At the end of year 1, the entity estimates that all the employees will remain in service until the end of year 3
and that the EPS target will be met. It therefore records a cost of £50,000 for the award in year 1
(£15 × 10 employees × 1,000 options × 1/3).
During year 2, the entity reassesses the arrangement and replaces the EPS target with a share price target
(market condition) that must be achieved by the end of year 3. At the date of modification, the fair value
of the option with the market condition is £12 and the fair value of the original option is £17. Therefore
the fair value of the awards has decreased as a result of the modification but, under IFRS 2, this decrease
is not accounted for and the entity must continue to use the original grant date fair value. An expense
must be recognised based on this grant date fair value unless the award does not vest due to failure to
meet a service or non-market performance condition specified at the original grant date. At the original
grant date the conditions were a service condition and a non-market performance condition. With the
removal of the non-market performance condition, the only condition that has been in place since grant
date is the service condition.
At the end of year 2 the entity estimates that nine employees will fulfil the service condition by the end of
year 3. It therefore records a cumulative expense in year 2 of £90,000 (£15 × 9 employees × 1,000 options ×
2/3) and an expense for the year of £40,000 (£90,000 – £50,000).
At the end of year 3 the share price target has not been met but eight employees have met the service
condition. The entity therefore recognises a cumulative expense of £120,000 ((£15 × 8 employees ×
1,000 options) and an expense for the year of £30,000 (£120,000 – £90,000).
It can be seen that the only expense reversal relates to those employees who have
forfeited their options by failing to fulfil the employment condition. There is no reversal
of expense for those employees who met the service condition but whose options did
not vest (in real terms) because the market condition was not met. In IFRS 2 terms the
options of those eight employees vested because all non-market conditions were met
and so the entity has to recognise the grant date fair value for those awards. This is the
case even though the original grant date fair value did not take account of the effect of
the market condition (unlike an award with a market condition specified from grant
date). This outcome is the result of the different treatment of market and non-market
conditions under IFRS 2 and the requirement to recognise an expense for an award with
a market condition provided all other conditions have been met (see further discussion
at 6.3.2 above).
7.3.2.B
Decrease in number of equity instruments granted
If the modification reduces the number of equity instruments granted, IFRS 2 requires
the reduction to be treated as a cancellation of that portion of the award (see 7.4 below).
[IFRS 2.B44(b)]. Essentially this has the effect that any previously unrecognised cost of the
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cancelled instruments is immediately recognised in full, whereas the cost of an award
whose value is reduced by other means continues to be spread in full over the remaining
vesting period.
In situations where a decrease in the number of equity instruments is combined with
other modifications so that the total fair value of the award remains the same or
increases, it is unclear whether IFRS 2 requires an approach based on the value of the
award as a whole or, as in the previous paragraph, one based on each equity instrument
as the unit of account. This is considered further at 7.3.4 below.
7.3.2.C
Additional or more onerous non-market vesting conditions
Where a non-market vesting condition is modified in a manner that is not beneficial to
the employee, again it is ignored and a cost recognised as if the original award had not
been modified, as shown by Example 30.23 (which is based on IG Example 8 in the
implementation guidance to IFRS 2). [IFRS 2.B44(c), IG15, IG Example 8].
Example 30.23: Award modified by changing non-market performance conditions
or service conditions
At the beginning of year 1, the entity grants 1,000 share options to each member of its sales team, conditional
upon the employee remaining in the entity’s employment for three years, and the team selling more than
50,000 units of a particular product over the three year period. The fair value of the share options is £15 per
option at the date of grant. During year 2, the entity believes that the sales target is insufficiently demanding
and increases it to 100,000 units. By the end of year 3, the entity has sold 55,000 units, and the modified share
options are forfeited. Twelve members of the sales team have remained in service for the three year period.
On the basis that the original target would have been met, and twelve employees would have been eligible
for awards, the entity would recognise a total
cost of £180,000 (12 employees × 1,000 options × £15) in
accordance with the minimum cost requirements of paragraph 27 of IFRS 2. The cumulative cost in years 1
and 2 would, as in the Examples above, reflect the entity’s best estimate of the original 50,000 unit sales
target being achieved at the end of year 3. If, conversely, sales of only 49,000 units had been achieved, any
cost booked for the award in years 1 and 2 would have been reversed in year 3, since the original target of
50,000 units would not have been met.
It is noted in IG Example 8 that the same accounting result would have occurred if the
entity had increased the service requirement rather than modifying the performance
target. Because such a modification would make it less likely that the options would
vest, which would not be beneficial to the employees, the entity would take no account
of the modified service condition when recognising the services received. Instead, it
would recognise the services received from the twelve employees who remained in
service for the original three year vesting period. Other modifications to vesting periods
are discussed below.
7.3.3
Modifications with altered vesting period
As noted at 7.3.1 above, where an award is modified so that its value increases, IFRS 2
requires the entity to continue to recognise an expense for the grant date fair value of
the unmodified award over its original vesting period, even where the vesting period of
the modified award is longer. This appears to have the effect that an expense may need
to be recognised for awards that do not actually vest, as illustrated by Example 30.24
(which is based on Example 30.19 above).
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Example 30.24: Award modified by reducing the exercise price and extending the
vesting period
At the beginning of year 1, an entity grants 100 share options to each of its 500 employees, with vesting
conditional upon the employee remaining in service over the next three years. The entity estimates that the
fair value of each option is €15.
By the end of year 1, the entity’s share price has dropped, and the entity reprices its share options. The repriced
share options vest at the end of year 4. The entity estimates that, at the date of repricing, the fair value of each
of the original share options granted (i.e. before taking into account the repricing) is €5 and that the fair value
of each repriced share option is €7.
40 employees leave during year 1. The entity estimates that a further 70 employees will leave during years 2
and 3, and a further 25 employees during year 4, such that there will be 390 employees at the end of year 3
(500 – 40 – 70) and 365 (500 – 40 – 70 – 25) at the end of year 4.
During year 2, a further 35 employees leave, and the entity estimates that a further 30 employees will leave
during year 3 and 30 more in year 4, such that there will be 395 employees at the end of year 3 (500 – 40 –
35 – 30) and 365 (500 – 40 – 35 – 30 – 30) at the end of year 4.
During year 3, 28 employees leave, and hence a total of 103 employees ceased employment during the
original three year vesting period, so that, for the remaining 397 employees, the original share options would
have vested at the end of year 3. The entity now estimates that only a further 20 employees will leave during
year 4, leaving 377 at the end of year 4. In fact 25 employees leave, so that 372 satisfy the criteria for the
modified options at the end of year 4.
In our view IFRS 2 requires the entity to recognise:
• the cost of the original award at grant date (€15 per option) over a three year vesting period beginning
at the start of year 1, based on the ongoing best estimate of, and ultimately the actual, number of
employees at the end of the original three year vesting period;
• the incremental fair value of the repriced options at repricing date (€2 per option, being the €7 fair value
of each repriced option less the €5 fair value of the original option) over a three year vesting period
beginning at the date of repricing (end of year one), but based on the ongoing best estimate of, and
ultimately the actual, number of employees at the end of the modified four year vesting period.
This would be calculated as follows:
Cumulative
Expense for
Year Calculation of cumulative expense
expense (€)
period (€)
Original award
Modified award
1 390 employees × 100
options × €15 × 1/3
195,000
195,000
2 395 employees × 100
365 employees × 100
options × €15 × 2/3
options × €2 × 1/3
419,333
224,333
3 397 employees × 100
377 employees × 100
options × €15
options × €2 × 2/3
645,767
226,434
4 397 employees × 100
372 employees × 100
options × €15
options × €2
669,900
24,133
It may seem strange that a cost is being recognised for the original award in respect of
the 25 employees who leave during year 4, who are never entitled to anything.
However, in our view, this is consistent with:
• the overall requirement of IFRS 2 that the minimum cost of a modified award
should be the cost that would have been recognised if the award had not been
modified; and
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• IG Example 8 in IFRS 2 (the substance of which is reproduced in Example 30.23 above)
where an expense is clearly required to be recognised to the extent that the original
performance conditions would have been met if the award had not been modified.
Moreover, as Examples 30.23 and 30.24 illustrate, the rule in IFRS 2 requiring
recognition of a minimum expense for a modified award (i.e. as if the original award had
remained in place) applies irrespective of whether the effect of the modification is that
an award becomes less valuable to the employee (as in Example 30.23) or more valuable
to the employee (as in Example 30.24).
Where a modified vesting period is shorter than the original vesting period, all of the
expense relating to both the original and modified elements of the award should, in our
view, be recognised by the end of the modified vesting period as no services will be
rendered beyond that point. In this type of modification – as distinct from a change of
estimate where there is a variable vesting period (see 6.2.3 above) – we believe that an
entity has an accounting policy choice between retrospective and prospective
adjustment of the vesting period as at the modification date. The overall expense
recognised between grant date and vesting date will be the same in both cases, but there
will be timing differences in the recognition of the expense, with retrospective
accounting resulting in a higher expense as at the modification date itself.
7.3.4
Modifications that reduce the number of equity instruments granted
but maintain or increase the value of an award (‘value for value’
exchanges and ‘give and take’ modifications)
As discussed at 7.3.2.B abo
ve, cancellation accounting has to be applied to a reduction
in the number of equity instruments when a modification reduces both the number of
equity instruments granted and the total fair value of the award. [IFRS 2.B44(b)]. This
approach is consistent with the fact that part of the award has been removed without
compensation to the employee. However, a modification of this kind is rarely seen in
practice because of the demotivating effect and, in some jurisdictions, a requirement to
pay compensation to the counterparty. An entity is more likely to modify an award so
that the overall fair value remains the same, or increases, even if the number of equity
instruments is reduced. These types of modification, sometimes known as ‘value for
value’ exchanges or ‘give and take’ modifications, are considered below.
Where an entity reduces the number of equity instruments but also makes other changes
so that the total fair value of the modified award remains the same as, or exceeds, that of
the original award as at the modification date, it is unclear whether the unit of account for
accounting purposes should be an individual equity instrument or the award as a whole.
Examples 30.25 and 30.26 below illustrate the two situations and the two approaches.
Example 30.25: Modification where number of equity instruments is reduced but
total fair value of award is unchanged
At the beginning of year 1, an entity granted an employee 200 share options with a grant date fair value
of £9 and a vesting period of three years. During years 1 and 2, the entity recognises a cumulative
expense of £1,200 (200 × £9 × 2/3). At the end of year 2 the exercise price of the options is significantly
higher than the market price and the options have a fair value of £5 per option. On this date, the entity
modifies the award and exchanges the 200 underwater options for 100 ‘at the money’ options with a
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fair value of £10 each. The total fair value of the new awards of £1,000 (100 × £10) equals the total fair
value of the awards exchanged (200 × £5), as measured at the modification date.
View 1 is that the unit of account is an individual option. Taking this approach, the decrease in the number of options
from 200 to 100 will be accounted for as a cancellation with an acceleration at the modification date of any
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 518
