Modification Accounting Clarified in New FASB Proposal
On November 17, the Financial Accounting Standards Board (FASB) released an exposure draft affecting the application of modification accounting guidance under ASC 718.
According to the FASB, the definition of a modification was previously too broad, leading to diversity in practice. Companies made judgment calls regarding the substantive nature of a modification. For example, some companies applied the modification guidance if they decided the change was substantive, but skipped applying it otherwise. Others sidestepped modification guidance when the change was perceived to be purely administrative.
Summary of the Proposed Changes
The proposal includes a slight change to the glossary definition of Modification in ASC 718. The old definition was, “A change in any of the terms or conditions of a share-based payment award” (emphasis ours). The proposed revised definition omits the phrase “any of.”
More importantly, the new guidance will state that modification accounting must be applied, unless the modification leaves three key attributes unchanged:
- The fair value
- The vesting conditions
- The classification of the award as an equity or liability instrument
The FASB acknowledges that some modifications that fall in the categories above will not have an accounting impact. Even so, the clarification is intended to provide direction about when to consider the modification guidance. Essentially, the FASB is saying that “substantive” means changes that affect the fair value, vesting conditions, or award classification.
What prompted this proposal? Feedback that the FASB received during the comment period for what became ASU 2016-09. One of the proposals up for comment was allowing companies to withhold for taxes up to the statutory maximum. Companies wanted to know whether changing award agreements to allow this would constitute a modification. Most would consider this non-substantive, but others might have looked to apply modification accounting.
The FASB’s proposal provides some examples of changes that would and would not require modification accounting:
Examples of changes that would not require modification accounting
- Changes that are administrative in nature, such as a change to the company name, company address, or plan name
- Changes in an award’s net settlement provisions related to tax withholdings that do not affect the classification of the award
Examples of changes that would require modification accounting
- Repricing of options that results in a change in value of those options
- Changes in a service condition
- Changes in a performance condition or a market condition
- Changes in an award that result in a reclassification of the award (equity to liability or vice versa)
- Adding a change in control provision whereby awards are immediately vested upon occurrence of the event
Notably, disclosure requirements related to the scope and cost of modifications will remain the same. That is, paragraph 718-10-50-2(h)(2) will apply for all modifications. The FASB took this position because they believe this information is useful to financial statement users regardless of whether modification accounting is applied.
Next Steps: Comments and Transition
Not surprisingly, the proposed change would be applied on a prospective basis. The cost of a retrospective change would certainly outweigh the benefit. The effective date will be determined following the comment period, which ends January 6, 2017.
If you’ve run into a number of modifications, it could be worthwhile to submit a comment. These are the questions the FASB has put up for consideration.
Question 1: Do you agree with the amendments in this proposed Update about when an entity is required to apply modification accounting? If not, why?
Question 2: Should new or different disclosures be included in Topic 718 as a result of the amendments in this proposed Update? If yes, what are those disclosures and why would they be useful to financial statement users?
Question 3: Are the transition requirements appropriate? If not, what transition approach is more appropriate and why?
Question 4: How much time would be needed to adopt the amendments in this proposed Update? Should the amount of time needed to apply the amendments in this proposed Update by entities other than public business entities be different from the amount of time needed by public business entities? Should early adoption be permitted? If yes to either question, please explain why.
Having had the good fortune of seeing many different modifications over the years, we’ll continue to keep our eye on the FASB’s updates in this area. Ultimately, the clarifications aren’t a major surprise. The guidance is in line with what we’ve observed as best practice. We welcome the added transparency it offers.