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Compensation toolkit: Making sense of stock award modifications · PwC's accounting podcast

0:00
SPEAKER_00: Thought Leadership from PWC.
0:06
SPEAKER_03: Welcome to PWC's Accounting Podcast.
0:10
SPEAKER_03: I'm Heather Horn.
0:11
SPEAKER_03: Thanks for tuning in to another episode in our Toolkit series, where we're taking a deep dive each month into a single topic, recapping the basics, but also focusing in on frequently asked questions and judgmental areas.
0:27
SPEAKER_03: This month we're all about stock compensation.
0:32
SPEAKER_03: So far in this series, we've covered two core concepts, vesting conditions and liability and equity classification.
0:41
SPEAKER_03: Today, we're continuing with the third baseline principle, modifications.
0:47
SPEAKER_03: Companies change the terms of awards all the time, and as Jay Sulliver and Ken Stoller, two partners in our national office, will share, the accounting for these modifications can be quite tricky and very dependent on both the terms of the awards as well as the facts and circumstances at the time of the change.
1:09
SPEAKER_03: Sometimes you can have a change without even making a change.
1:13
SPEAKER_03: And with that intriguing concept, I think it's time to get started.
1:31
SPEAKER_03: We started to get into last episode.
1:34
SPEAKER_03: So I'm glad we're hitting it this time, and that's related to modifications.
1:38
SPEAKER_03: And in particular, given everything going on with stock markets right now, maybe just to sort of give us the big picture, Jay, are you starting to see a lot of modifications coming through?
1:50
SPEAKER_02: We have seen maybe a bit more of some types of modifications recently, but we do typically see a pretty steady stream of them, even in normal times, I'll call it.
2:01
SPEAKER_02: But fair point.
2:02
SPEAKER_02: Given the current economic environment and volatility in the stock market, we certainly can understand how there can be some added pressure on companies to potentially modify awards, you know, like by changing performance targets or repricing stock options to lower exercise prices.
2:19
SPEAKER_02: So that's why we thought it'd be good to cover the broader landscape of modifications today and then also focus a bit on some of the more common types of modifications that we run into.
2:29
SPEAKER_03: Right.
2:30
SPEAKER_03: Well, and it's particularly, as I said, we we start we did start a talk to talk about them in our last episode.
2:36
SPEAKER_03: So I definitely think they clearly come up.
2:38
SPEAKER_03: So maybe given that, Ken, we probably should just start things off by talking about what we mean when we say a modification and then the basics on how to account for them.
2:51
SPEAKER_01: Sure.
2:51
SPEAKER_01: So a modification is just like it sounds, or changing the terms of an award agreement.
3:00
SPEAKER_01: Um, but not every modification of terms it results in what we refer to as an accounting modification.
3:09
SPEAKER_01: And the FASB even clarified this a couple of years ago that there are certain modifications that don't have to be run through all the modification accounting that we're going to talk about on this episode.
3:19
SPEAKER_01: So basically they said if you make some modification, but it doesn't impact either the fair value of the award or the classification of the award, equity versus liability, or any of the vesting provisions, then we don't need to treat it as an accounting modification and kind of can ignore it.
3:41
SPEAKER_01: So for the rest of the episode here, when we talk about modifications, we're talking in the context of accounting modifications.
3:49
SPEAKER_01: So those can occur in a variety of ways, and maybe we'll start with what is probably the most obvious, which is we're actually changing the legal terms of the award agreement.
4:03
SPEAKER_01: And there's a whole host of different types of modifications that we might see where we're changing the terms, but just as an example, um, Jay had actually mentioned one at the top where we're repricing a stock option.
4:14
SPEAKER_01: So we had originally granted an option, maybe it had a strike price of$10.
4:19
SPEAKER_01: Now we decide we want to adjust the strike price or the exercise price and maybe lower it to$6.
4:25
SPEAKER_01: So we're actually legally changing the terms of the instrument.
4:29
SPEAKER_01: That would be a modification, and there would be some accounting to do, which we'll talk about.
4:33
SPEAKER_01: Um, another example of an explicit modification in the terms is on the first podcast, we talked about performance and market conditions, and so maybe we had an award with a performance condition, um, maybe a revenue goal.
4:49
SPEAKER_01: And originally it was uh$100 million of revenue needs to be achieved in order to invest.
4:54
SPEAKER_01: And at some point along the way, we realize uh it's unlikely that we're going to achieve the goal, and so we're not going to, or the employees are not going to invest in the award.
5:03
SPEAKER_01: So maybe we decide we're going to make some adjustment or modification to the performance goal and reduce it maybe from 100 million down to 70 million to make it a little bit easier to achieve.
5:13
SPEAKER_01: So that would be another example of an explicit modification.
5:18
SPEAKER_01: But then there are other uh events that result in modification accounting, even though we don't actually make any explicit change in the terms of the agreement.
5:31
SPEAKER_01: So sometimes that's because the circumstances uh surrounding the award change.
5:38
SPEAKER_01: Uh, for example, and I know Jay and Nicole in the last episode were talking about liability classified awards.
5:44
SPEAKER_01: So sometimes you could have an award, and maybe it will settle in shares in most cases, but in certain events it would settle with cash.
5:54
SPEAKER_01: For example, certain types of termination events, maybe it will automatically settle in cash.
6:00
SPEAKER_01: So originally that cash settlement's not probable, and so we're treating the thing as equity classified.
6:06
SPEAKER_01: But at some point along the way, uh, if it becomes probable that the employee is going to be terminated and that cash settlement provision will kick in, then we're going to convert it to a liability, and we follow modification accounting when uh when we change it to a liability, even though there hasn't been any explicit modification to the terms at that point.
6:28
SPEAKER_01: Uh and then maybe the last example I'll give in terms of what can result in modification accounting is if we have a change in the company's intent related to the arrangement.
6:39
SPEAKER_01: And so sometimes we'll have an award where the company gets to decide whether we're going to settle the thing with shares or settle it with cash.
6:48
SPEAKER_01: And so the company's intent will determine how we're accounting for it.
6:52
SPEAKER_01: And so if the intent is to settle it with shares, we would start out accounting for it as equity.
6:57
SPEAKER_01: But if at some point along the way their intent changes and now they plan to settle it with cash, that would be treated as a modification.
7:05
SPEAKER_01: Again, even though we're not making any change in the legal uh terms of the arrangement at that time.
7:12
SPEAKER_02: And maybe Ken to even expand on that a little bit more.
7:16
SPEAKER_02: Sometimes uh not only could a company go in and legally change the terms of an award, like the examples you described, with change in the strike price, but sometimes the company might actually cancel the original award and issue a new award to replace the old one.
7:36
SPEAKER_02: And the accounting guidance says that cancellations and a concurrent replacement of awards would also be accounted for as a modification.
7:47
SPEAKER_02: And sometimes that's actually exchanging similar instruments, like one stock option for another with different terms.
7:54
SPEAKER_02: But sometimes it could even be for different kinds of instruments, like canceling a stock option and giving the employee a restricted stock award, or even more of a fixed cash payment or bonus down the road.
8:06
SPEAKER_02: Or we might see situations where a company exchanges an option on the stock of a subsidiary for an option on stock of the parent, or vice versa.
8:17
SPEAKER_02: So, you know, all of these are considered to be effectively the same as a modification, even though you're not legally modifying it, you're legally kind of swapping out one for the other.
8:28
SPEAKER_01: Right.
8:28
SPEAKER_01: So I guess the punchline, Heather, is there there's lots of things that can result in modification accounting.
8:35
SPEAKER_01: Uh and so I know you're asking me also about like what what is the general accounting model when we see one of these modifications.
8:42
SPEAKER_01: So maybe I'll just I'll set it up with the big picture accounting model, and then as we start working our way through, we'll we'll get into some of the nuances.
8:51
SPEAKER_01: But big picture, when we have a modification, and as Jay was just mentioning, we kind of think of it as the original award being swapped out for a new award.
9:05
SPEAKER_01: And so when we do that, we first uh we think about what the value of the original award was at the time we're swapping it out.
9:14
SPEAKER_01: So maybe the original award was worth$10, and now we're swapping it out with a new award, and the new award might be worth more.
9:22
SPEAKER_01: Maybe it's worth$12.
9:24
SPEAKER_01: So if that's the case, then we've given the employee$2 of extra value in my example.
9:31
SPEAKER_01: Uh and so that$2 we call that incremental value, and that$2 of incremental value will become additional compensation expense that needs to be recognized in addition to the original grant date value that we were already expensing.
9:47
SPEAKER_01: So that's the big picture kind of overall model for accounting for modification.
9:52
SPEAKER_01: And now as we go through, we'll get into some of the nuances.
9:56
SPEAKER_03: All right.
9:56
SPEAKER_03: So I have a question.
9:58
SPEAKER_03: It's actually a follow-on from my questions last week, and I've referenced this a few times.
10:02
SPEAKER_03: I think I was quite interested when we were talking about this this idea that intent, you know, can change the accounting for award between liability and equity.
10:13
SPEAKER_03: And in particular, obviously, people's intent, especially if these are you know longer awards, may change along the way.
10:20
SPEAKER_03: And so, Ken, you said if your intent changes, now is that just the CFO has a thought?
10:26
SPEAKER_03: Hmm, I might want to change how I'm settling these.
10:29
SPEAKER_03: Is it the board approves they're gonna do some, you know, they actually start cash settling or equity settling, I guess.
10:37
SPEAKER_03: Or is obvious my guess is it's something in between.
10:40
SPEAKER_03: So, how do you think about this idea of change in intent and how frequently do you need to think about that?
10:47
SPEAKER_01: Right.
10:48
SPEAKER_01: Well, uh as you as you suspected, it could be it could be either.
10:52
SPEAKER_01: Uh, and so there might simply be for a variety of reasons the the company, which could be the the compensation committee of the board or it could be the CEO and CFO or a combination of, decide that for whatever reason uh we want to settle these arrangements with cash, even though originally we thought we were gonna settle it with equity.
11:11
SPEAKER_01: So that uh that definitely happens.
11:14
SPEAKER_01: Or we can get into a situation where we still say our intent is to settle with equity, but we settle with cash for some reason, but we still say we're planning in the future to settle with equity, but then we do it again with cash.
11:30
SPEAKER_01: And at some point, if we start developing a pattern of doing this, then the company and then maybe the auditors of the company might say, yeah, maybe it's not appropriate to continue to say the intent is to settle with equity when we develop this pattern of settling with cash.
11:44
SPEAKER_01: And that's where it gets very judgmental because how many times does it take to develop a pattern and what's the story behind each of those cash settlements?
11:51
SPEAKER_01: And that all plays into the assessment.
11:54
SPEAKER_03: All right.
11:54
SPEAKER_03: And then you're thinking about this each reporting period, you're looking, I guess, for modifications at all, including these intent-based ones.
12:03
SPEAKER_01: Yeah, I mean, if if our accounting originally is based on the company's intent, so they're kind of asserting that they're going to settle with equity, then they need to be able to continue to support that assertion every reporting period in in order to support the continued equity treatment.
12:18
SPEAKER_03: All right.
12:18
SPEAKER_03: That's helpful.
12:19
SPEAKER_03: So then let me go back to the sort of broad model we were talking about.
12:24
SPEAKER_03: And uh, Jay, I know you chimed in with the comment when Ken was talking, but anything else that you sort of look at big picture as you're thinking about the overall model?
12:34
SPEAKER_02: Well, maybe I'll I'll share one common misconception we often hear about when people are thinking about modifications.
12:45
SPEAKER_02: And that's that people often think that when you have a modification, you have to look at the difference between the original grant aid fair value of the original award and the current fair value of the modified award.
13:02
SPEAKER_02: Whereas uh when Ken was described in the base model, he talked about you're really only looking at the difference between the current fair value of the old award and the current fair value of the modified award.
13:14
SPEAKER_02: That's the incremental value that you're giving and that we have to do the accounting for.
13:18
SPEAKER_02: But a lot of people perhaps still thinking about some guidance from years ago when you did have to do a bit of a catch-up for anything that's taken place along the way.
13:28
SPEAKER_02: The current accounting model says you don't.
13:31
SPEAKER_02: The idea is that the original award has gone up in value since the grant date, let's say.
13:38
SPEAKER_02: Uh, but that's great.
13:39
SPEAKER_02: And you know, the employees already benefited from that.
13:42
SPEAKER_02: And as we've described in some past podcasts in this series, the company does not have to record expense as the value of the award goes up and doesn't get to reduce expense as the value of the award goes down.
13:57
SPEAKER_02: So the fact that the award has gone up in value from the grant date to right before the modification is great for the employee, but doesn't affect the company's accounting at all.
14:07
SPEAKER_02: So what we're really just trying to account for is what extra value, what incremental value did the company give the employee over and above what they already had.
14:17
SPEAKER_02: So that's what we're trying to account for.
14:19
SPEAKER_02: In most cases, we'll we'll come back to some different permutations around that.
14:23
SPEAKER_02: But the base model is we're just looking at that incremental value.
14:26
SPEAKER_02: But we often get questions about and maybe confusion about do I have to take sort of a catch-up all the way from what I originally started with back when I granted it to the new value.
14:36
SPEAKER_02: And that's not generally the case.
14:38
SPEAKER_03: All right.
14:38
SPEAKER_03: So then, Jay, because you definitely caught my attention with that, just to summarize, when I'm thinking about the change in value simplistically, it's change in value from what the employee had the day the modification occurred.
14:52
SPEAKER_03: So if before the modification what they had was worth$1,000, after the modification was worth$1,100, that you only account for that$100.
15:01
SPEAKER_03: And what's happened before that has nothing to do with the modification accounting.
15:06
SPEAKER_03: I I'm sure we'll get into something where it might matter, but at least big picture.
15:10
SPEAKER_03: Is that fair?
15:11
SPEAKER_02: That is correct.
15:12
SPEAKER_02: So for example, in your case, if at the time of original grant it was only worth$300, the fact that it's gone from$300 to$1,000 doesn't matter.
15:22
SPEAKER_02: You don't have to do a catch-up to go from$300 to your new value of$1,100.
15:26
SPEAKER_02: It's only the difference from the$1,000 that it was worth immediately before the modification to the$1,100 that it's worth immediately after.
15:35
SPEAKER_03: All right.
15:35
SPEAKER_03: So then it seems fairly straightforward as long as you are focused on identifying the modifications.
15:42
SPEAKER_03: You make sure you you get it in the right period and you know the change in value before and after the modification, then you calculate the difference and you recognize over the remaining vesting periods.
15:54
SPEAKER_03: So like I said, fairly straightforward, but I'm sure there's more to it.
15:58
SPEAKER_01: Good summary.
16:00
SPEAKER_02: Certainly.
16:01
SPEAKER_02: So yeah.
16:02
SPEAKER_02: So I would say, well, that's the baseline, and you know, we'll call it that's the general model behind it.
16:08
SPEAKER_02: The guidance definitely talks about a number of different kinds of modifications based on the vesting conditions of the awards, like we talked about a couple of podcasts ago, and the probability assessments around those, as well as the classification of the award as either equity or liability that we talked about in last week's podcast.
16:30
SPEAKER_02: Uh, and we hinted at this notion in both of those podcasts, but maybe I'll talk a little bit more here about the impact of the ving conditions to start.
16:39
SPEAKER_02: So the guidance here talks about four different types of changes based on the probability of the vesting of the award before the change and after the change.
16:50
SPEAKER_02: And vesting in this case just means either working long enough to vest, meaning a service condition or hitting a performance target like an earnings or revenue target.
16:59
SPEAKER_02: Uh as we've said in some other the other podcasts, the likelihood of hitting stock price targets or a market condition isn't considered because those conditions are already factored into the grant aid fair value.
17:13
SPEAKER_02: They're not considered in the as a probability assessment of whether you're recognizing the expense or not.
17:19
SPEAKER_02: So they're not part of the notion of is it probable you're going to vest or not.
17:23
SPEAKER_02: So we're just talking about service or performance conditions here.
17:26
SPEAKER_02: And since the award can either be probable of vesting or not probable of vesting, both before and after, that's how you get four different combinations that the guidance talks about.
17:39
SPEAKER_02: And uh interestingly, they're actually just numbered type one through type four in the uh in the guidance.
17:45
SPEAKER_02: And while all of those can exist, and and we do run into all of them, there's probably two types that we run into the most, and maybe I'll focus on at least to start.
17:57
SPEAKER_02: Uh the first one is a type one or a probable to probable modification.
18:04
SPEAKER_02: So an example of this might be the repricing example that Ken has has given previously.
18:10
SPEAKER_02: So you're lowering the exercise price to something lower, maybe because the stock price has gone down.
18:17
SPEAKER_02: But that doesn't really impact the probability of the person working long enough to vest, might impact whether they choose to exercise it or not, but it doesn't affect the likely doesn't affect the probability of sticking around long enough to vent in it.
18:30
SPEAKER_02: So in this case, because the award was probable before the change and after the change, it's considered a type one modification.
18:36
SPEAKER_02: And it basically would go through the basic model that Ken described.
18:40
SPEAKER_02: You'd look at the incremental difference between the fair value immediately before, immediately after.
18:46
SPEAKER_02: The lower exercise price when you run that through a valuation model does lead to a higher fair value of the award.
18:53
SPEAKER_02: So you'll have incremental compensation cost.
18:55
SPEAKER_02: And as you said, Heather, that would get recognized either prospectively over the remaining requisite service period, or if it's already a fully vested award, it would be recognized immediately.
19:07
SPEAKER_03: Hey, Jay, before you go on, let me ask a question.
19:10
SPEAKER_03: So the example you just gave, the value went up.
19:14
SPEAKER_03: I presume there would be cases where you could still be, let's say, type one, but the value goes down.
19:19
SPEAKER_03: So at do you reverse expense then?
19:22
SPEAKER_03: Is it immediate catch-up?
19:23
SPEAKER_03: And if we're getting to this later, I can save my question.
19:26
SPEAKER_02: So um no, um, I don't know we were planning to get to it, but no, fair question.
19:32
SPEAKER_02: Unfortunately, in this case, and there's a lot of things in the stock comp guidance that are a I'll call it a one-way street.
19:39
SPEAKER_02: So you recognize incremental compensation expense, but you don't get to reverse compensation expense if the value went down, if somehow you convinced the employee to take something worth less than they had before.
19:52
SPEAKER_03: I somehow guessed that.
19:53
SPEAKER_03: That's actually why I asked the question.
19:55
SPEAKER_03: Uh okay, that's helpful to know.
19:57
SPEAKER_03: So then I think you said there's two common types.
20:00
SPEAKER_03: So type one, uh, which is probable to probable, and then what's the other one?
20:04
SPEAKER_02: So the other one we see a fair bit is a type three modification, which is an improbable to probable modification.
20:13
SPEAKER_02: So perhaps a common example of this would be a situation where an employee is going to leave the company and they would forfeit an unvested award.
20:27
SPEAKER_02: But the company modifies the term so that the employee will vest in it anyways, on their way out the door, let's say.
20:35
SPEAKER_02: So that's a change that's going from improbable of vesting because it was about to be forfeited to being probable of vesting.
20:41
SPEAKER_02: So that's this type three change.
20:44
SPEAKER_02: So in this case, what you're uh ultimately doing is a little or seems a little different, anyways.
20:51
SPEAKER_02: Um, you're reversing all of the old expense from the original award that's no longer probable of vesting.
20:59
SPEAKER_02: And you would establish effectively a new uh grant date fair value for the sort of new or modified award, so today's fair value.
21:09
SPEAKER_02: And then you would have to recognize that new fair value either immediately if it's fully vested at that point, or perhaps over some maybe shorter requisite service period if the company imposed that as part of the part of the change.
21:24
SPEAKER_01: Jay, I I I heard you catch yourself right there where you said the type three uh seems a little different than than the type one.
21:31
SPEAKER_01: And um, you know, just just reflecting on a lot of conversations I've had with companies about type threes and and where it feels like that that type three model that you just described is different than the type one.
21:42
SPEAKER_01: But from my perspective, they're both still following the general overarching principle that we've talked about, which is calculate the incremental value before and after.
21:54
SPEAKER_01: Um it's just that with the with the type three, because the award was Improbable before, like in your example, the person was going to leave the company and they were going to forfeit the award.
22:06
SPEAKER_01: And so it was improbable at that point.
22:08
SPEAKER_01: The value at that point is zero.
22:10
SPEAKER_01: Like we talked about in the first episode with performance conditions, where we're assessing probability.
22:15
SPEAKER_01: If the performance condition or service condition is not probable, then we're not recognizing any expense or the value is zero.
22:22
SPEAKER_01: So in these type three modifications, we when we're thinking about the value immediately before the modification of the original award, that value is zero because it was not probable.
22:33
SPEAKER_01: And then of course we're modifying it to make it probable because we're allowing them to vest.
22:38
SPEAKER_01: And so the value after is whatever the current fair value is.
22:42
SPEAKER_01: And so the incremental value ends up being the full fair value of the new award because we're going from$0 to whatever the fair value is.
22:51
SPEAKER_01: So it's still, you know, in my mind, it's it's it's the same model, but the the FASB felt it important to point out that you can have this difference so that we wouldn't get any confusion uh when we're when we're thinking about what that incremental value is.
23:05
SPEAKER_03: Jay, before I go on um to other types of modifications, you said there are four types.
23:10
SPEAKER_03: I know you also said they were less common, the other two, but I guess the other two must be improbable to improbable, and then probable to improbable.
23:20
SPEAKER_03: So do you see those?
23:22
SPEAKER_03: Uh, you know, how do we think about those?
23:26
SPEAKER_02: Uh we do see them a little bit.
23:29
SPEAKER_02: Um probably uh more we see the improbable to improbable, which is a type of four, than we would see the probable to improbable, because why would an employee be willing to accept something like that?
23:45
SPEAKER_02: Um but the improbable to improbable, we run into uh maybe one place where we run into it is uh situations where uh an award only vests upon, say, an IPO of the company, which we see.
24:03
SPEAKER_02: And uh that's usually not considered probable until it happens.
24:08
SPEAKER_02: Uh and so if you make a change before the company's gone public, you've technically uh changed it from an improbable award to an improbable award.
24:17
SPEAKER_02: And it does require you to remeasure the new value, sort of like the type three.
24:22
SPEAKER_02: It's just you wouldn't record it until it happens uh down the road.
24:26
SPEAKER_02: So that's that's one example we run into it.
24:29
SPEAKER_02: There could be some cases with performance conditions as well, where um maybe you take a target that you don't think you're going to hit, you're way off from hitting it, as facts and circumstances have played out, and you want to make it easier to hit, but maybe it's still kind of tough.
24:44
SPEAKER_02: It's kind of a stretch goal.
24:46
SPEAKER_02: And so you could have some improbable to improbable ones there as well, but they're nowhere near as common collectively as the type one and type three, at least in our in our experience.
24:57
SPEAKER_03: All right.
24:57
SPEAKER_03: Very helpful perspective.
24:59
SPEAKER_03: So, Ken, going back to you, any other types of modifications that listeners should be looking for?
25:06
SPEAKER_01: Yeah, so like all the modification accounting that we've been talking about up until now is um changes related to vesting in some way.
25:16
SPEAKER_01: And so we have to go through all of this type one through four stuff that Jay was talking about.
25:20
SPEAKER_01: Um but you can also have modifications, as I mentioned uh at the top of the episode, that change the classification of an award.
25:27
SPEAKER_01: So we might not change the vesting provisions at all, but because of some modification that's been made, we can be converting from an equity classified instrument to liability or vice versa.
25:39
SPEAKER_01: Uh and so the guidance has um kind of the the rules that we follow when we're when we're going through one of those classification modifications.
25:47
SPEAKER_01: Um so uh let me talk about equity liability first because that's a that's a bit more involved.
25:54
SPEAKER_01: Um and as I mentioned, it could be an explicit modification that's being made.
25:58
SPEAKER_01: So we're changing the terms.
25:59
SPEAKER_01: Originally it was going to settle in shares, and now we're changing the terms of the award to say it's gonna settle in cash.
26:05
SPEAKER_01: Um or it can be just one of these changes, as we were talking about, that the company's intent to settle in shares changes to cash, and so we're going through this equity to liability modification.
26:17
SPEAKER_01: So as Jay and Nicole described in the in the last episode, talking about liability arrangements, and any award that's a liability, we're gonna be recognizing at fair value.
26:30
SPEAKER_01: And so if we're if we had an award that started out as equity, let's just say it had an original value of 10 bucks.
26:36
SPEAKER_01: So we were expensing that fixed$10 over the service period.
26:40
SPEAKER_01: And at some point along the way, let's say halfway through the vesting period, we decide we're gonna change the terms and convert it from equity to liability.
26:49
SPEAKER_01: So now we've got to set up a liability at whatever the current fair value is.
26:54
SPEAKER_01: And so maybe if the stock price has come up from that ten dollars up to say$18.
27:00
SPEAKER_01: So we're halfway through and we've expensed five dollars of the original ten dollars so far, but now we've got to get a liability onto the books, and we're halfway through, and the current value is$18, so that would be a$9 liability that we got to record, which means we've got to get an additional$4 of expense recognized.
27:21
SPEAKER_01: We originally originally had recognized five, and now we've got to get it up to nine, and so we've taken an additional four dollars.
27:27
SPEAKER_01: So that we call that a mark to market charge sometimes, or a cumulative catch-up charge, to get us up to the value of the liability.
27:35
SPEAKER_01: And then from that point forward, now we're going to be just kind of doing normal liability, mark-to-market accounting for the remainder of the uh of the vesting period.
27:44
SPEAKER_01: So that's the that's kind of the big deal with an equity to liability is you've got this mark-to-market charge that you're going to have to recognize when you get your liability onto the books for the first time.
27:55
SPEAKER_01: And then the other important caveat, uh, and this goes back to Jay's one-way street uh notion earlier, is anytime we start as equity classified, then we're not going to be allowed to recognize less than the original grant value, even if we convert it into a liability that's being marked to market.
28:20
SPEAKER_01: It's another one of these anti-abuse provisions because you know, if if we had a$10 value originally and then the value goes up, we don't have to recognize any additional expense.
28:30
SPEAKER_01: But the fact is we didn't want, if the opposite happened and the share price went down, the company to be able to convert it from equity to a liability and then reverse some of the expense, right?
28:40
SPEAKER_01: So it's like if we're we're getting the benefit of having this fixed value up front if it's equity classified, but you have to live with it even if you decide to convert it into a liability at some point down the road.
28:51
SPEAKER_01: So uh if the so the if the original value was 10, and let's say the value did come down to$6, when we modify it, we've got to get the liability set up based on that$6.
29:03
SPEAKER_01: Uh in our example, we're halfway through, so it'd actually be a five, uh$3 liability.
29:09
SPEAKER_01: But we're stuck recognizing the full$10 of expense throughout the period, even though the liability will be based on the fair value.
29:17
SPEAKER_01: Again, it's it's a one-way street provision.
29:21
SPEAKER_03: Ken, on that one-way street though, let's say then now you're in this like mark to market model and it goes up to$12.
29:28
SPEAKER_03: So it had dropped to six, now it goes up to$12.
29:31
SPEAKER_03: So then do you have to go to the 12 for your mark to market?
29:35
SPEAKER_01: Yes.
29:35
SPEAKER_01: So I yeah, I would I would think of it as kind of a uh a greater of expense model, right?
29:41
SPEAKER_01: So you're your the minimum amount you're gonna expense is the$10.
29:44
SPEAKER_01: That's your floor.
29:45
SPEAKER_01: But if the value of the liability goes above the floor, then you're gonna have that additional expense to recognize.
29:51
SPEAKER_03: Well, they definitely thought of a lot of nuances when they designed, um when they they issued uh this guidance.
29:58
SPEAKER_03: So all right.
29:59
SPEAKER_03: So then how about the the other direction?
30:01
SPEAKER_03: So now if I have an award that was a liability, so I was marking it to market, and now I'm switching to equity.
30:08
SPEAKER_03: And I guess maybe before you say the counting, what's the circumstance that would result in that?
30:15
SPEAKER_03: That would be if you were intent had changed from cash selling to share selling?
30:21
SPEAKER_01: Yep, yep.
30:21
SPEAKER_01: It could be that sometimes maybe we'll see it if uh maybe we've got an arrangement and we didn't have enough authorized shares to be able to settle it all in shares, and then we get approval to increase our share pool, and so now we'll be able to settle it all with equity.
30:36
SPEAKER_01: And so now uh we're our kind of intent to settle in shares has changed.
30:40
SPEAKER_01: So that yeah, it could be for those reasons.
30:42
SPEAKER_02: And and another one tying into our last podcast, it could be that maybe there was a, I'll call it an offensive put feature that the employee could exercise whenever they wanted, and it didn't have to be a mature share that we talked about last week.
30:58
SPEAKER_02: And now six months have passed since they received the share or exercised the option.
31:04
SPEAKER_02: So now it went from being a liability arrangement because they could put back an immature share to now being they're in the shoes of a shareholder, and now they're just an equity holder at that point.
31:14
SPEAKER_02: So that's another time we see a shift from liability to equity classification.
31:19
SPEAKER_03: All right.
31:19
SPEAKER_03: That's helpful.
31:20
SPEAKER_03: So then what what's our accounting in this case?
31:22
SPEAKER_01: Yeah, more straightforward when we're going from liability to equity, because as you point out, Heather, we're already marking the liability to market.
31:30
SPEAKER_01: So at the time we convert it from liability to equity, we'll take our final mark, measure it at whatever the fair value is at the point of the modification, but then we get to fix it because now we're equity classified.
31:43
SPEAKER_01: And so in my using my earlier numbers, if the fair value was 18 of the liability at the time of the modification, 18 would be kind of the final measurement that we're using.
31:52
SPEAKER_01: And then we would just continue to recognize that fixed 18 over the remaining service period.
31:58
SPEAKER_03: All right, that's helpful.
31:59
SPEAKER_03: So what are we talked along the way about some of the examples, but I do think examples are one of the best ways to understand some of these uh models.
32:09
SPEAKER_03: So any other common examples you'd highlight where we see modifications?
32:14
SPEAKER_03: And Ken, I'll go to you for that.
32:16
SPEAKER_01: Well, may maybe to riff on one example Jay was was mentioning earlier, which is an employee who's terminating, and so we make some modification to the terminating uh employee's award.
32:28
SPEAKER_01: We also see in in cases where an employee is terminating, uh, maybe they maybe the award they were holding is already vested.
32:36
SPEAKER_01: Uh, and this this would be in the case of a stock option, uh, and it's already vested, but it's very common with a stock option to have a provision that says if and when you leave, uh the period that you have to exercise is going to be shortened to maybe only 30 days or 90 days after the point at which you terminate.
33:00
SPEAKER_01: Uh, and what some companies will do is make a modification to that provision to allow the employee to hold the option for a longer period of time before it expires, and you know, so they'll have a longer period of time to exercise.
33:15
SPEAKER_01: Uh so that would be an example of a type one because it was probable.
33:20
SPEAKER_01: In fact, it was already vested, so it was clear, it's clearly probable to probable.
33:24
SPEAKER_01: Um, but we're still gonna have to run it through this uh this model of figuring out the incremental value, and there probably is gonna be incremental value because the the award originally uh only had another 30 days of life left in it, and now we're adding you know, whatever it might be years that they're gonna be able to hold it uh after termination, and that increase in the life of the award will generally increase the value, and so that would be additional or incremental expense, uh, and would take that expense immediately if the employee doesn't have to work uh in order to earn that benefit.
33:58
SPEAKER_03: All right, definitely a lot to think about there.
34:00
SPEAKER_03: So then let me ask another question, and I think, James, you may have started to touch on this, which would be changing performance conditions.
34:09
SPEAKER_03: And especially given, I think maybe this dates back to 2020 with COVID, and then since then we've had a lot more volatility and uncertainty.
34:19
SPEAKER_03: You know, I think companies were seeing them adjusting performance targets.
34:23
SPEAKER_03: So if you do have that type of modification, what is the model?
34:28
SPEAKER_03: Uh how do you account for that?
34:30
SPEAKER_02: Just like the modifications of service festing conditions that I talked through before, changes to the performance targets also fall into one of those same four types based on the probability of hitting the targets before and after the change.
34:47
SPEAKER_02: So, as you said, like one example we might run into could be where maybe the company had issued an award with a revenue target of some sort.
34:56
SPEAKER_02: And maybe in this case, the company is actually doing really well.
34:59
SPEAKER_02: Maybe they're in an industry that's been positively affected based upon the current uh economic circumstances and they expect to hit the target.
35:08
SPEAKER_02: And in fact, maybe they because of high inflation or otherwise, they actually think they're going to easily hit the target and exceed the target.
35:16
SPEAKER_02: So maybe they want to make the target a little bit harder to hit to motivate people to continue to grow.
35:22
SPEAKER_02: And so the company raises the target to a new number, to their new forecast, but they still think it's an achievable target.
35:30
SPEAKER_02: Uh so they've changed it and both the old and the new target were probable.
35:38
SPEAKER_02: So it's a type one modification because it was probable to probable, and you would just be evaluating for incremental fair value.
35:47
SPEAKER_02: But interestingly, uh when you're in the accounting model, if you're just changing the target and not either the number of shares or options or the other terms of an option, um there may not be any change in the accounting fair value because probability, as we've said a few times over these past few weeks, is not factored into determining the fair value for performance condition awards.
36:14
SPEAKER_02: So uh it may very well be there's no change in fair value, at least from an accounting perspective, to have to record here from an incremental value perspective.
36:24
SPEAKER_02: However, there is one trick or yet another anti-abuse provision, since we've been talking about a few of those here, as the FASB try to think about other ways that a company might try to avoid recognizing that original grant date fair value.
36:39
SPEAKER_02: So the thought here is that if the award's modified when it was probable beforehand, and let's say you in my example, you made the target harder to hit, uh but the guidance says that if the original target is met, uh even if the new target is not met, so you would have hit the old target, but because the company changed it, you didn't hit the new target, and therefore you never actually legally vest in the award, you still have to recognize the expense because you hit the original target.
37:11
SPEAKER_02: And you know, again, the comp the the FASBI is trying to avoid you being able to change the terms to avoid recognizing expense uh down the road.
37:21
SPEAKER_02: So what's tricky here is you have to keep track of this award pretty carefully because you have to track both the old target and the new target.
37:27
SPEAKER_02: The new target, because that's what's legally going to drive vesting, but the old target because actually that's what's going to drive the accounting here.
37:33
SPEAKER_03: So this seems a little lose-lose because the company still has expense.
37:38
SPEAKER_03: Employees are probably mad that their target got changed.
37:41
SPEAKER_03: So it's interesting to me that that this is something uh that we see in practice.
37:47
SPEAKER_01: But sometimes there might be some quid pro quo, like in the example that Jay provided.
37:51
SPEAKER_01: If if we're making the target harder, which to your point, Heather, that's not a great thing for the employee.
37:57
SPEAKER_01: Maybe it's coupled with some other change that they're that's being made, which is beneficial.
38:01
SPEAKER_01: And so even though we're making the target harder, maybe it's a stock option and we're reducing your exercise price to make it up to you that way.
38:08
SPEAKER_01: And so they're will, you know, they're happy to have that uh kind of the offset there.
38:13
SPEAKER_01: Okay.
38:13
SPEAKER_01: And then to James point, if we achieve the original target, then we have to at least take that original expense, even though if we don't hit the new target, we don't have to take that incremental expense that would come with the right repricing of the option.
38:28
SPEAKER_03: All right, that's helpful.
38:29
SPEAKER_03: And I guess it probably goes without saying, but with my auditor hat on, even if there's no accounting here, this is definitely something uh the company should be documenting that they looked at it and there is no accounting that needs to be done because um I'm sure your auditors will be asking if there were changes to the awards.
38:48
SPEAKER_03: So just from a good control perspective.
38:51
SPEAKER_03: So, with all that said, I think in this environment, I know Jay, you said this is a company that's benefiting, maybe they control some supply chains or otherwise, but um, we are also seeing some companies struggling.
39:03
SPEAKER_03: So I'm assuming we're seeing companies modifying performance targets downward.
39:08
SPEAKER_03: And so maybe the company's doing that to incentivize the employees, move it down, say hey, it's achievable again.
39:15
SPEAKER_03: Uh so how do we think about those types of award or those types of changes?
39:20
SPEAKER_02: Right, right.
39:21
SPEAKER_02: Yeah, certainly not uncommon, both today's environment as well as just in general for this a lot of the same reasons, right?
39:28
SPEAKER_02: You want to continue to motivate employees, incentivize employees.
39:32
SPEAKER_02: And if they feel like their stock options or stock awards are basically completely worthless because they're never going to hit the target because of whatever's going on, then it's not so motivational.
39:44
SPEAKER_02: They may not want to stay at the company anymore.
39:45
SPEAKER_02: So we do see a lot of these downward revisions of targets to kind of keep the right balance of motivation.
39:53
SPEAKER_02: Uh and sort of just like we talked about with the service vesting conditions, you would evaluate this as a type three, let's say an improbable to probable modification, if you're in a situation where maybe you've now determined the original target is not probable of being hit, and you're lowering it to one that you do think is reasonable of being hit.
40:16
SPEAKER_02: So if that fact pattern, you're in a type three or improbable to probable modification.
40:21
SPEAKER_02: And just like we said for the service condition awards, there's a new measure of compensation cost for the award based upon the current fair value at the time the modification is made.
40:33
SPEAKER_02: And that would be recognized over the remaining service period, if there is one, if it's probable.
40:40
SPEAKER_02: Interestingly, here we've talked about a lot of anti-abuse or floor provisions.
40:44
SPEAKER_02: This is actually a spot where there is not a floor provision.
40:47
SPEAKER_02: Uh so because the thought was, hey, the original award wasn't probable, we recognize no expense on it, ultimately, it's gone now because we've modified it into this new award.
40:58
SPEAKER_02: That new fair value could be lower than the original grant date fair value, right?
41:05
SPEAKER_02: If the company's not doing well, maybe the stock price has come down as well.
41:08
SPEAKER_02: And so the today fair value for that modified award could be lower than the original grant date fair value of the original award.
41:16
SPEAKER_02: And that's okay in this case.
41:17
SPEAKER_02: Not unlike all the other ones we've been talking about so far, where you can't recognize less.
41:21
SPEAKER_02: In this case, because it wasn't probable before, you you uh you could.
41:26
SPEAKER_02: And in fact, if the new target is not met, ultimately you don't have to recognize expense on that either.
41:34
SPEAKER_03: All right.
41:35
SPEAKER_03: So then we've talked about service conditions and performance conditions.
41:39
SPEAKER_03: So then, Ken, how about market conditions?
41:42
SPEAKER_03: How do I think about changes to awards with market conditions in them?
41:46
SPEAKER_01: Yeah, and Jay had kind of alluded to this earlier in that uh market conditions don't incorporate uh probability assessment.
41:56
SPEAKER_01: Instead, we kind of bake that into the value of the award.
42:00
SPEAKER_01: We do that uh upfront when it's granted.
42:03
SPEAKER_01: We do the same thing if we modify an award with a market condition.
42:09
SPEAKER_01: So it's like say say we had an award and you've got to achieve a stock price goal of$20 in order to vent.
42:17
SPEAKER_01: Uh and then we modify it uh to make it a little bit easier.
42:20
SPEAKER_01: Now we only have to achieve a$15 share price in order to v.
42:25
SPEAKER_01: So we we don't go through this type one through four assessment like with the service and performance awards where we're assessing the probability of whether we'll achieve that original$20 share price or not.
42:36
SPEAKER_01: Uh again, that's not part of the market condition model.
42:39
SPEAKER_01: So instead, we're simply coming up with the value before.
42:44
SPEAKER_01: And when we come up with that value, because there's a market condition, it would we would have to incorporate the uh the market condition into the value with a$20 share price goal.
42:54
SPEAKER_01: And then we would determine the value immediately after the modification, where the share price goal is now only$15.
43:00
SPEAKER_01: And because we made it easier, the value of the arrangement will go up, and the amount that it goes up by is the incremental value, and then the incremental value is going to be expense in addition to the original grant date value.
43:14
SPEAKER_01: So basically the same model in terms of coming up with the incremental value.
43:17
SPEAKER_01: There's just not the uh the probability assessment in there.
43:21
SPEAKER_01: Um and of course, as you would expect, in the real world, we have uh added complexity because sometimes an award will have a market condition, but also have performance conditions and service conditions.
43:32
SPEAKER_01: So then you got to tie it all together.
43:34
SPEAKER_01: You're still assessing probability and this type one through four thing for the performance or service elements of the award, but the market element doesn't have a separate probability assessment.
43:45
SPEAKER_01: That just all gets baked into the value.
43:47
SPEAKER_03: So then do you wind up having to like bifurcate accounting?
43:51
SPEAKER_03: You don't, because you just build it those two, consider them together.
43:55
SPEAKER_03: Is that right?
43:56
SPEAKER_01: Right.
43:56
SPEAKER_01: So you might so you might say the award was probable based on On the service or performance condition, the award was probable before and after.
44:04
SPEAKER_01: So it's a type one.
44:06
SPEAKER_01: So that means we're just comparing the fair value before and after.
44:10
SPEAKER_01: But when we can come up with those values, we have to bake in the impact of the market condition before and after to figure out what the incremental is at it.
44:20
SPEAKER_01: Whereas if it was a type three, if it was improbable before, because maybe a performance condition was not probable, the value would be zero before, and then the value after would be whatever it is with the new market condition.
44:32
SPEAKER_03: All right.
44:33
SPEAKER_03: So definitely a lot to think about there.
44:36
SPEAKER_03: Anything else can kind of looping all the way back to the service period, because I think often I feel like that almost underlies all of this.
44:46
SPEAKER_03: Anything else we should be thinking about if we are modifying uh the requisite service period?
44:53
SPEAKER_01: Yeah, so um maybe I'll start with, because we can we could shorten the service period or we could lengthen it.
44:58
SPEAKER_01: Maybe I'll just start with shortening the service periods a little bit more straightforward.
45:03
SPEAKER_01: So uh if if we let's say we had an award that originally had a four-year service period, and then some at some point along the way we decide to shorten it to three years, uh then that is a modification.
45:15
SPEAKER_01: We run it through the model, but there's not gonna, if that was the only thing we were changing, that wouldn't typically change the fair value before and after, right?
45:23
SPEAKER_01: So it's the same value that we're spreading, but now we're gonna spread it over that new shorter period.
45:28
SPEAKER_01: Um, and that is a prospective change.
45:32
SPEAKER_01: So there's not like any catch-up adjustment because now we're one-third of the way through instead of one-fourth of the way through.
45:38
SPEAKER_01: We don't do a catch up when it's just a change in the service period period.
45:41
SPEAKER_01: So we just take whatever the remaining expense is for that award and then just spread that over the new shorter period.
45:50
SPEAKER_03: All right.
45:51
SPEAKER_03: So then I'm guessing, based on what you said at the beginning about shortening versus extending, that there's some additional considerations when it's extended.
46:00
SPEAKER_03: So, Jay, how should I think about that?
46:03
SPEAKER_02: Well, spoiler alert, um, yes, here comes another anti-abuse provision that's in the guidance.
46:10
SPEAKER_02: Uh that if the new requisite service period is longer than the original requisite service period, so instead of shortening it from four years to three years, in Ken's example, they extend it from four years to five years or six years or whatever the case may be.
46:26
SPEAKER_02: Again, maybe because they provided some other quid pro quo as as part of doing that.
46:31
SPEAKER_02: Um in that case, uh, while you would uh potentially uh you know look to some of that incremental value if you gave out incremental value and take that over the longer period, for purposes of the original grant aid fair value, you still have to track whether the employees worked that original four-year period in this case.
46:56
SPEAKER_02: And if they did, but even if they leave, let's say, somewhere in year five or year six, and they never actually earn the award and legally vest in the award, you still have to take the expense that they would have had had to take for working that original four-year period.
47:16
SPEAKER_02: And again, that's another anti-abuse provision that says that you can't just do something to try to avoid recognizing expense by stretching out in this case the uh service period to some ridiculously long period, right?
47:32
SPEAKER_02: So instead of maybe going from four to five years, they say, you know what, this awards the stock price really gone down, it's not really worth anything anymore, no one cares.
47:40
SPEAKER_02: We're gonna change it from four years to 30 years, right?
47:43
SPEAKER_02: And now you say, well, no one's gonna work 30 years or 40 years or whatever to earn it.
47:48
SPEAKER_02: And so now it's not probable anymore.
47:50
SPEAKER_02: Now we can just reverse the expense if people don't work long enough or take all the expense over 30 years that we started with.
47:58
SPEAKER_02: We we can't we can't end up avoiding expense or uh stretching out expense that was sort of part of that original grant date fair value, but just by stretching out the vesting period.
48:10
SPEAKER_02: So it creates more kind of dual tracking of sort of accounting numbers and legal numbers uh to keep keep track of.
48:17
SPEAKER_02: So it is a complicated situation.
48:19
SPEAKER_02: And we do run into it here and there when we see when we saw a company's repricing options, right?
48:25
SPEAKER_02: When stock prices would come down, companies say, all right, we'll give you something, we'll give you a benefit here by lowering the strike price and giving you more of a benefit.
48:34
SPEAKER_02: But the quid pro quo is you got to work another year or two in order to earn it.
48:39
SPEAKER_02: So it's not that unusual of a situation, even though it sounds a little odd, like why would an employee be willing to take a longer vesting period?
48:47
SPEAKER_02: But sometimes, again, it's an exchange for something else.
48:50
SPEAKER_02: So we do see it, but it does create this complicated bit of tracking and again, unusual accounting in light of what the actual legal terms are.
48:59
SPEAKER_02: Companies often struggle with this notion of wait, the person didn't earn the award, but I still have to recognize expense.
49:06
SPEAKER_02: And I guess if uh we've probably said it enough times over these last three weeks that there's an awful lot of places in the guidance where you end up having to do that.
49:14
SPEAKER_01: And Heather is probably once again imagining what these Excel spreadsheets must look like to do all of this tracking, just like in previous episodes.
49:21
SPEAKER_03: Yes, good controls, good controls.
49:23
SPEAKER_03: I don't normally talk about controls on these episodes, but definitely, definitely here.
49:28
SPEAKER_03: So that is my reminder for the listeners.
49:31
SPEAKER_03: But of course, Jay and Ken, you guys are actually answering questions on this topic.
49:35
SPEAKER_03: So maybe starting with you, Jay, what are your thoughts?
49:39
SPEAKER_03: What would be your advice to companies and engagement teams dealing with these uh types of modifications?
49:45
SPEAKER_02: Well, maybe building on what you're you just said there, Heather, I mean, there's a lot of weeds to get into when you're dealing with modifications.
49:55
SPEAKER_02: And so I guess I'd offer a reminder to carefully evaluate the terms of all the award agreements and fully understand the changes that are being made in a modification, as well as really assess the facts and circumstances associated with vesting conditions that are going on right now, because they really drive very different accounting at that time.
50:18
SPEAKER_02: And there's an awful lot of different models to apply, outcomes to account for, and a lot of these anti-abuse or floor provisions that you have to contend with.
50:28
SPEAKER_02: And maybe also to remember that just because you didn't legally change anything in the award doesn't mean you might not have a modification if the facts and circumstances have changed, and maybe you have to rethink your classification assessment as equity or liability.
50:43
SPEAKER_02: So um with most things in accounting, you have to account for actual transactions that take place or actual changes that take place.
50:51
SPEAKER_02: Here, you can have accounting without a change in the actual terms of the agreement.
50:57
SPEAKER_03: All right.
50:58
SPEAKER_03: And Ken, how about your perspective?
51:00
SPEAKER_01: Yeah, maybe I'll just mention that um determining what the what the modification date is is important because as we've been talking about throughout the the episode, we're we're doing that assessment of the before value and the after value at the modification date, and then we're going to be recognizing our expense from that date forward.
51:20
SPEAKER_01: So that date is important.
51:22
SPEAKER_01: Uh, and the guidance isn't very clear on how do you determine when your modification date occurs, and sometimes it might be more obvious than others.
51:33
SPEAKER_01: Um in general, we come back to the guidance on how you determine an initial grant date for an award, and there is more guidance surrounding that.
51:43
SPEAKER_01: And so we tend to think about it the same way.
51:45
SPEAKER_01: Um, and so generally it's focused on when the modification is approved by whoever at the entity needs to approve it, the comp committee or or otherwise.
51:55
SPEAKER_01: Um, and there's a mutual understanding of what all the key terms and conditions of the modified award are.
52:04
SPEAKER_01: And so following that grant date guidance when thinking about modification date is uh is what I would advise.
52:10
SPEAKER_03: All right.
52:11
SPEAKER_03: Well, definitely great reminders.
52:13
SPEAKER_03: And maybe last I'll call say question, serious question.
52:17
SPEAKER_03: Uh, where should our guests go to get uh more information?
52:21
SPEAKER_03: Our guests, our listeners.
52:23
SPEAKER_03: You are you're my guest.
52:24
SPEAKER_03: Hopefully you don't need to go look at this for more information.
52:27
SPEAKER_03: Jay?
52:29
SPEAKER_02: Well, I think we look we spent some time looking at it as well.
52:31
SPEAKER_02: It's always good to refresh on what the guidance says.
52:34
SPEAKER_02: And certainly everything we've talked about today, we do cover in more detail in our stock-based compensation guide, uh especially chapter four, which deals with modifications.
52:47
SPEAKER_02: And we do have a number of other podcasts about different stock comp topics.
52:52
SPEAKER_02: And in particular, there was one that we've done in the past called a refresh on stock comp basics before you modify your stock options.
53:02
SPEAKER_02: And that talked about some of the concepts that we've talked about today, as well as some other ones, some accounting for changes to awards and spin-offs or stock splits or large dividend payments that the company might make.
53:15
SPEAKER_02: Uh, so listeners can go back and check those out in our library as well.
53:21
SPEAKER_02: Excellent.
53:22
SPEAKER_03: So now we are up to my favorite part, which should be stumped the guests and Ken to bring you up to speed.
53:28
SPEAKER_03: You and Jay were two for two.
53:30
SPEAKER_03: And then Jay and Nicole, I would give like one and a half-ish for two.
53:35
SPEAKER_03: They were directionally correct for the second question.
53:38
SPEAKER_03: Yes.
53:39
SPEAKER_03: So today I actually have three questions for you.
53:41
SPEAKER_03: And if you'll allow me to use some accounting humor, I would say the third is probably fairly improbable.
53:48
SPEAKER_03: Uh, but the other two, we will see.
53:51
SPEAKER_03: Um so first one which tax rule in 2017 is said to have impacted a lot of in-flight performance awards and produced, in I'll use the word, inordinate amount of modifications.
54:06
SPEAKER_01: 2017.
54:10
SPEAKER_01: I don't know for sure.
54:12
SPEAKER_01: I'm gonna say 162M.
54:15
SPEAKER_03: Jay, any thoughts on a big tax bill that happened in like December, caused a lot of accountants to work over the holidays that year.
54:25
SPEAKER_02: Right.
54:25
SPEAKER_02: Well, I guess that amongst other things, that tax bill reduced the corporate tax rate.
54:31
SPEAKER_02: Correct.
54:32
SPEAKER_02: And so it changed perhaps companies' forecasts of their EPS or net income figures.
54:40
SPEAKER_02: And so to the extent they had stock awards with performance conditions tied to net income or EPS, I could I could certainly see how maybe they had to rethink what those targets would look like now that the tax rate has come down, which presumably caused the company's net income to go up.
54:59
SPEAKER_03: Correct.
54:59
SPEAKER_03: So that was the Tax Cuts and Jobs Act.
55:01
SPEAKER_03: But I think your description, Jay, give you uh uh a full point for that, considering you've got the substance of what the question was asking for.
55:11
SPEAKER_03: All right, so next question.
55:13
SPEAKER_03: This is these are gonna start to get historical.
55:15
SPEAKER_03: So which FASBE standard, well, it technically is not a FASB standard, which standard, and I'll just give this part away, accounting principles board standard issued in 1972, allowed companies to avoid recording stock options as an executive comp expense on their income statements as long as they were granted at the fair market value.
55:38
SPEAKER_03: Oh, sorry, as long as they were at fair market value on the day they were granted, and inadvertently sparked the stock option backdating scandal that we talked about last week.
55:47
SPEAKER_03: So do you guys remember what predated 123 and 123 are?
55:53
SPEAKER_02: Yes, we do.
55:54
SPEAKER_03: All right.
55:55
SPEAKER_03: I should have known.
55:56
SPEAKER_03: Who wants to go on this one?
55:58
SPEAKER_01: Jay seems very confident, so I'll go first and say APB25.
56:03
SPEAKER_03: You are also you are both correct because Jay's nodding.
56:07
SPEAKER_03: So yep, that was um issued in 1972, and that was the authoritative guidance all the way until we had uh FAS 123R.
56:16
SPEAKER_03: So it's a fairly long period of time.
56:18
SPEAKER_02: Unless you count the many other interpretations that along the way to tweak that and pull out some things and eliminate the ability to do certain things.
56:30
SPEAKER_02: Like reprice options became very negatively impacted back by another standard they issued along the way.
56:36
SPEAKER_03: All right, well, maybe we'll have to have some more of the history next next week.
56:40
SPEAKER_03: So this next one, though, I really think is going to stretch you.
56:43
SPEAKER_03: And I'm gonna just tell you now, this is something that happened more than 50 years ago, so that's my hint.
56:48
SPEAKER_03: What bill did lawmakers pass that included a provision to allow stock options to be taxed at the lower capital gains rate of 25% when sold rather than as ordinary income, which sharply increased popularity of stock options and compensation packages?
57:05
SPEAKER_01: You say the tax bill?
57:07
SPEAKER_03: It was um they well, it just says what bill.
57:11
SPEAKER_03: No, no, what bill.
57:13
SPEAKER_03: Or even if you want to say when around this happened, I will give you at least partial credit.
57:18
SPEAKER_03: Any thoughts?
57:19
SPEAKER_01: Well, when I'm gonna say 50 years ago.
57:22
SPEAKER_03: No, it's not more than 50 years ago.
57:24
SPEAKER_03: It could have been like 200 years ago.
57:26
SPEAKER_01: 51 years ago is my guess.
57:28
SPEAKER_03: How about today, any guess?
57:29
SPEAKER_02: Well, income taxes were only introduced in the early 1900s anyway, so it's not too much.
57:35
SPEAKER_02: There you go.
57:35
SPEAKER_02: So now we've triangulated.
57:37
SPEAKER_02: I don't know the bill.
57:38
SPEAKER_02: I mean, I I was thinking as well what you said, Ken, about like tax code sections, and there's things like section 83 that deals with the taxation of stock awards and sort of when are you in ordinary income versus capital gains, and and section 409 and 409A, that I think that's a little bit more recent that also applies to it.
57:59
SPEAKER_02: So we're we're used to we're familiar, Heather, with those kinds of provisions, tax code.
58:06
SPEAKER_02: Yeah, because those certainly affect a lot of the um this the structuring that we see in plans is to try to make sure they can uh meet these various tax rules.
58:16
SPEAKER_03: So maybe you may be hitting the right answer because I have a bigger picture answer, but maybe this is the section.
58:23
SPEAKER_03: So Revenue Act of 1950.
58:26
SPEAKER_03: So prior to the passing of the bill, stock options were basically non existent because of tax consequences.
58:33
SPEAKER_03: After, so starting in 1951, 18% of the country's top executives had stock options added to their comp packages.
58:41
SPEAKER_03: And by 1960s, more than half had stock options.
58:44
SPEAKER_03: And I bet if we check today, it's probably close to 100%, Ken.
58:50
SPEAKER_01: 100% of executives with stock options.
58:53
SPEAKER_03: Executives are getting stock comp as part of their stock packages or as part of their comp packages.
58:58
SPEAKER_03: Yes.
58:58
SPEAKER_01: Yes, stock comp in some form, sure.
59:00
SPEAKER_01: Yeah.
59:00
SPEAKER_03: Yeah.
59:01
SPEAKER_03: So I guess technically this was 72 years ago, but I didn't think I should give you quite that exact event.
59:08
SPEAKER_03: So in any event, very interesting uh that that is the history of stock options.
59:13
SPEAKER_03: So Bo, thank you as always for joining me.
59:15
SPEAKER_03: I really appreciate the insight.
59:17
SPEAKER_01: Thanks for having us, Heather.
59:18
SPEAKER_01: Yes, thank you.
59:20
SPEAKER_03: That's our show for today.
59:22
SPEAKER_03: We'll have another industry-specific ESG episode for you tomorrow, back with our guest host, Casey Herman, U.S.
59:30
SPEAKER_03: ESG leader.
59:32
SPEAKER_03: So that you never miss any of our audio content, follow the PWC Accounting Podcast wherever you listen to your podcasts.
59:40
SPEAKER_03: And to stay up to date on all the latest accounting and reporting news, sign up for our newsletter at viewpoint.pwc.com.
59:50
SPEAKER_03: From Thought Leadership at PWC, I'm Heather Horn.
59:54
SPEAKER_03: Thanks for tuning in.
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