Modification of non-market performance condition in employee’s favour
At the beginning of year 1, the entity grants 1,000 share options to each member of its sales team, with exercise conditional upon the employee remaining in the entity’s employment for three years, and the team selling more than 50,000 units of a particular product over the three year period. The fair value of the share options is £15 per option at the date of grant.
At the end of year 1, the entity estimates that a total of 48,000 units will be sold, and accordingly records no cost for the award in year one.
During year 2, there is so severe a downturn in trading conditions that the entity believes that the sales target is too demanding to have any motivational effect, and reduces the target to 30,000 units, which it believes is achievable. It also expects 14 members of the sales team to remain in employment throughout the three year performance period. It therefore records an expense in year 2 of £140,000 (£15 × 14 employees × 1,000 options × 2/3). This cost is based on the originally assessed value of the award (i.e. £15) since the performance condition was never factored into the original valuation, such that any change in performance condition likewise has no effect on the valuation.
By the end of year 3, the entity has sold 35,000 units, and the share options vest. Twelve members of the sales team have remained in service for the three year period. The entity would therefore recognise a total cost of £180,000 (12 employees × 1,000 options × £15), giving an additional cost in year 3 of £40,000 (total charge £180,000, less £140,000 charged in year 2).
The difference between the accounting consequences for different methods of enhancing an award could cause confusion in some cases. For example, it may sometimes not be clear whether an award has been modified by increasing the number of equity instruments or by lowering the performance targets, as illustrated