When a grant’s terms are modified after issuance, it triggers modification accounting under ASC-718.
A three-step process determines the appropriate accounting treatment after a modification has occurred. Pulley’s SBC tool does this for you.
1. Identify the Modification
An equity grant modification occurs when you change the original terms of the grant. Pulley automatically detects these changes from your cap table:
Changes when terminating a stakeholder:
Accelerating vesting
Extending post termination exercise periods (PTEP)
Other changes:
Accelerating vesting (non-termination)
Repricing options
Note: Our SBC report does not currently detect or support PTEP extensions that occur outside of a termination event.
2. Identify Impacted Tranches
Not all of the grant’s tranches are impacted when a modification happens. Pulley uses the following logic to make that determination:
Note - any exercised grants are not impacted by modifications
3. Assess Modification Type
The type of modification that occurred can be determined based on the likelihood of vesting both before and after the change - whether it was Probable or Improbable an impacted tranche would vest at each point in time as follows:
Pulley’s SBC tool uses the following rules for determining each modified grant’s Modification Type based on industry standards:
Note - Type II modifications (probable to improbable vesting) and Type IV modifications (improbable to improbable vesting) are more commonly associated with performance-based grants. Performance grants are not supported in Pulley’s SBC report at this time.
Accounting Treatment
Determine any value created from the modification (Incremental Fair Value) as follows:
Calculate fair value immediately before the modification (using a Black Scholes model)
Calculate fair value immediately after the modification (using a Black Scholes mode)
Subtract post-modification from pre-modification value to get Incremental Fair Value
Note: For Type 3 modifications, pre-modification fair value is estimated at $0, so the Incremental Fair Value will equal the post-modification fair value per accounting guidance.
Expense Recognition:
Type 1 Modifications:
Continue expensing the award’s original grant-date fair value
Recognize Incremental Fair Value expense:
Immediate recognition for impacted tranches that were previously vested or accelerated
Spread over remaining service period for unvested tranches that were impacted using a straight-line methodology
Type 3 Modifications:
Stop expensing the award’s original grant-date fair value and reverse any previously recognized expense for unvested tranches
Recognize Incremental Fair Value expense:
Immediate recognition for accelerated tranches
Spread over remaining service period for unvested tranches that were impacted using a straight-line methodology
Important Considerations
Accelerations
Default: Pulley treats all accelerations as modifications
Exception: Accelerations that occur due to contractual provisions, should not be treated as a modification under ASC-718
Resolution: If a modified award is incorrectly classified, simply Exclude it from the analysis before running the report as shown below:
2. Expected Term
The term is an input used in the Black Scholes model when valuing an option pre-modification and post-modification. The term should reflect when the option holder is expected to exercise the award.
For modifications that occur in conjunction with a termination:
Expected term is clearly defined by post-termination exercise periods
For other modifications:
Assess how the modification impacted exercise expectations
Calculate pre-modification fair value using original expected term
Calculate post-modification fair value using revised expected term based on new circumstances
Default: Pulley uses time to expiration in both calculations without considering how the modification impacted exercise expectations, which is subjective
Adjust terms based on how modification changes exercise behavior if deemed necessary
Resolution: If you would like to change the term to be applied in the pre-modification and post-modification fair value calculations, you can override inputs before running the report here: