Accounting for Cancellations for No Consideration

This week, I return to my series on how to account for modifications to equity awards—explained in 75 words or less. Today’s topic is cancellation of equity awards for no consideration.

It is unusual that equity awards are canceled for no consideration, but sometimes executives will allow an equity award to be canceled to return shares to the plan (i.e., to prevent a shortfall) or during times of financial constraint. Rank and file employees might agree to the cancellation of steeply underwater stock options.

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

Sure—this one is easy! The canceled award must still be fully expensed:

1. None of the expense already recorded for the canceled award is reversed.
2. Any remaining unamortized expense is recognized immediately in the period of cancellation.

Wait, that can’t be right

Yep, it’s right. The FASB views the cancellation of an equity award for no consideration as truncating the service period, which means that all remaining expense must be immediately recognized. Once an equity award is granted, the only way a company can avoid recognizing expense for it is if the vesting conditions are not fulfilled. Voluntary surrender of the award by the holder does not eliminate any of the expense the company has to recognize for it.

How about an example?

Let’s say that an executive is granted an RSU with a fair value of $1,000,000 that vests in four annual increments. After the first vesting increment has vested, the executive agrees to the cancellation of the award and receives no consideration in exchange.

• At the time of the cancellation, the first 25% of the award has already been paid out and the executive won’t be giving those shares back, so the $250,000 of expense recognized for those shares is not reversed. 
• In addition, the remaining $750,000 of expense is recognized in full in the period in which the cancellation occurs (to the extent that it hasn’t already been recognized).

What if the award in the example is an unexercised stock option?

The accounting treatment is the same. The $250,000 of expense already recognized is not reversed (even if the vested shares are also canceled) and the remaining $750,000 of expense is recognized in the period in which the cancellation occurs.

What if the award holder receives consideration in exchange for the cancellation?

The accounting treatment will depend on what the consideration is. If the award holder receives a new equity award, the cancellation and regrant would be accounted for in the same manner as a repricing (see “Accounting for Option Repricings”). If the consideration is cash or other assets, well that is a different blog entry for a different day—stay tuned.

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.