On the Horizon - January 15, 2013

Current practice issue

Special dividends may impact accounting for share-based compensation

In anticipation of higher individual income tax rates on dividend income, some entities declared large special dividends in the last quarter of 2012, which could impact the accounting for share-based payments awarded by the granting entity.

In some instances, these special dividends are so large that companies may adjust existing share-based payments arrangements to equalize the value of those awards before and after the special dividend. Typically the exercise price or number of shares or both are adjusted. For example, a very large dividend might have a significant impact on the fair value of an underlying share of stock: If an option has an exercise price of $5 per share and the fair value of an underlying share is $10 before the dividend and $7 after the dividend, the option holder would lose value if the exercise price is not adjusted. Thus, some companies consider whether to modify the award.

FASB Accounting Standards Codification® ASC 718-20-35-6, Compensation – Stock Compensation: Awards Classified as Equity, requires an adjustment to a share-based payment award in conjunction with an equity restructuring (which includes a recapitalization through a large, nonrecurring dividend) to be accounted for as a modification. The only exception is if an award is modified to add an antidilution provision that is not made in contemplation of an equity restructuring. We believe that modifying an award to add an antidilution provision in light of a large special dividend would not meet this exception.

Accounting for a modification that occurs as a result of an equity restructuring requires a comparison of the fair value of the modified award to the fair value of the original award immediately before the modification. The entity is required to recognize any incremental fair value resulting from the modification over the award's remaining vesting period or immediately if the award is fully vested.

If the modified award contains a properly structured antidilution provision to equalize the award's fair value before and after the equity restructuring, there would be no resulting incremental fair value after the modification to equalize value. For instance, market participants would have anticipated the adjustment to the option's exercise price and/or to the number of options so that the fair value of the award immediately before the modification would approximate the fair value of the modified award.

If, however, an award does not contain...

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