Accounting for Option Repricings

For this week’s blog entry, I continue my series on how to account for modifications to equity awards—explained in 75 words or less. Today’s topic is repricing stock options.

Repricings differ from the modifications I have discussed thus far in that the primary change is to the option price, rather than vesting conditions (although frequently vesting is also extended when options are repriced). As a result, repricings can involve all four types of modifications described in ASC 718. As a practical matter, however, repricings are generally accounted for as probable-to-probable (Type I) modifications.

Substance Over Form

Repricings can take many forms. One method is to simply amend the option price. Another approach is to cancel the original option and grant the employee a new option with a lower price (or a restricted stock or unit award). Sometimes employees must agree to receive fewer shares in the new option, additional vesting requirements, or other conditions. 

Regardless of the approached used, the accounting treatment is the same.

Can you explain the accounting treatment in 75 words or less?

Just barely! As noted, repricings are typically accounted for as a probable-to-probable (Type I) modification:

1. None of the expense already recorded for the repriced option is reversed.
2. The company must recognize any remaining unamortized expense over the remaining service period.
3. The company will recognize incremental cost equal to the amount by which the fair value of the option immediately following the repricing exceeds its fair value immediately before the repricing.

Is there an analogy that could help me understand this?

It’s like trading your old car to buy a new car. You don’t get any of the money you paid for the old car back and, if you haven’t yet finished paying off the loan on the old car, you still have to pay it off. But the amount you pay for the new car will be reduced by the value of your old car at the time you trade it in (except that with stock option repricing, the old and new options aren’t being valued by a car dealer who is trying to rip you off).

How about an example?

Let’s say that the various fair values for a group of repriced options are as follows:

• Original grant date fair value: $1,000,000
• Expense recorded at time of repricing: $750,000
• Fair value just prior to repricing: $100,000
• Fair value after repricing: $400,000

The $750,000 of expense already recorded for the options is not reversed, and the company continues to record the remaining $250,000 of unamortized expense. In addition, the company recognizes incremental cost of $300,000 ($400,000 new fair value less $100,000 pre-modification fair value). 

Thus, the total expense the company will record for the options (assuming all vesting conditions are achieved) is $1,300,000. Since $750,000 of the original expense was recorded before the repricing, the expense that is recorded after the repricing is $550,000. But the company was already planning to record $250,000 of this amount, so the additional cost of the repricing is only $300,000. 

Is it possible to eliminate the incremental cost for repricings?

This can be accomplished by reducing the number of shares in the option commensurate with the increase in fair value resulting from the repricing. In our example above, the aggregate post-modification fair value is four times the pre-modification fair value. Thus, if the shares in the option are reduced using a 1 for 4 ratio (i.e., an option for 20,000 shares outstanding just prior to the repricing would be reduced to 5,000 shares), the fair value of the option before and after the modification will be the same, eliminating any incremental cost. This is often referred to as a “value-for-value exchange.”

Are there any other considerations to worry about?

So many! To learn about the securities law, tax, and other considerations that apply to award modifications, check out my blog entry “5 Things to Know About Award Modifications” and this handy table summarizing the considerations for various types of modifications.

- Barbara