assess whether the circumstances described above necessitate recognition of a liabil 613352

Two option awards running in parallel

On 1 January 2012, an entity granted 1,000 options (the ‘A options’) to an employee, subject to non-market vesting conditions. The grant date fair value of an A option was €50.

As at 1 January 2013, the share price is significantly below the exercise price of an A option, which had a fair value at that date of €5. Without modifying or cancelling the A options, the entity awards the employee 1,000 new options (the ‘B options’). The B options are subject to non-market vesting conditions different in nature from, and more onerous than, those applicable to the A options, but have a lower exercise price. The terms of the B options include a provision that for every A option that is exercised, the number of B options that can be exercised is reduced by one, and vice versa. The fair value of a B option at 1 January 2013 is €15.

Clearly, the employee will exercise whichever series of options, A or B, has the higher intrinsic value. There are four possible outcomes:

1. Neither the A options nor the B options vest.

2. Only the A options vest.

3. Only the B options vest.

4. Both the A options and B options vest and the employee must choose which to exercise. Rationally, the employee would exercise the B options as they have the lower exercise price.

In our view, the B options are most appropriately accounted for as if they were a modification of the A options. As only one series of options can be exercised, we believe that the most appropriate treatment is to account for whichever award the entity believes, at each reporting date, is more likely to be exercised. This is analogous to the accounting treatment we suggest in Example 32.12 at 6.2.5 above and in Example 32.17 at 6.3.6 above.

If the entity believes that neither award will vest, any expense previously recorded would be reversed.

If the entity believes that only the A options will vest, it will recognise expense based on the grant date fair value of the A options (€50 each).

If the entity believes that only the B options will vest, or that both the A and B options will vest (so that, in either case, the B options will be exercised), it will recognise expense based on:

(a) the grant date fair value of the A options (€50 each) over the original vesting period of the A options, plus

(b) the incremental fair value of the B options, as at their grant date (€10 each, being their €15 fair value less the €5 fair value of an A option), over the vesting period of the B options.

A possible alternative analysis would have been that modification accounting is not applied, each award is accounted for separately, and the requirement that only one award can vest is treated as a non-vesting condition (i.e. it is a condition of exercising the A options that the B options are not exercised, and vice versa) – see 6.4 above. This treatment would result in a charge representing the total fair value of both awards at their respective grant dates. This is because the entity would recognise an expense for whichever series of options was exercised plus a charge for the cancellation of the second series (by reason of the employee’s failure to satisfy a non-vesting condition in the employee’s control, namely refraining from exercising the first series of options).