Our company previously granted employees stock options with a term of 7 years. These options were valued using the Black-Scholes model, and the expected term was calculated using the simplified method. Currently, most options are fully vested, but a few are not yet fully vested. The company has approved extending the option term to 10 years. My question is: for vested options, how should the current period expense be calculated? For options not yet fully vested, how should they be handled?

Background and Core Issue

The extension of the stock option term constitutes a modification of the original grant terms. According to accounting standards (such as IFRS 2 or ASC 718), the accounting treatment after modification needs to distinguish between vested and unvested portions, and remeasure the incremental cost based on the fair value at the modification date (i.e., the date of approval of the extension).

The original option term was 7 years, valued using the Black-Scholes model, and the expected term was determined using the simplified method (usually referring to the 'simplified method' allowed in SEC Staff Accounting Bulletin No. 107/110). After extending to 10 years, the expected term may change, thereby affecting the fair value of the options.

Treatment of Fully Vested Options

For fully vested options, the fair value at the original grant date has already been recognized as expense over the vesting period. Extending the term is a modification of vested options. According to accounting standards, the difference between the fair value at the modification date and the fair value at the original grant date (i.e., incremental fair value) should be recognized, and recognized in profit or loss over the remaining service period (if vested, usually the remaining period from modification date to the original vesting date, but if vested and no future service conditions, the incremental expense should be recognized immediately at the modification date).

Specifically, if the options are fully vested and there are no unmet service conditions, the fair value of the options should be recalculated at the modification date (based on the 10-year term and other parameters at the modification date), and compared with the fair value at the original grant date (based on the 7-year term). The difference is treated as incremental expense and recognized immediately in profit or loss (P&L) at the modification date.

Treatment of Unvested Options

For unvested options, the extension of the term is a modification, but the amortization of the original grant date fair value over the remaining vesting period should continue. At the same time, the difference between the fair value at the modification date and the fair value at the original grant date (based on the original 7-year term) should be calculated. This difference is treated as incremental expense and amortized on a straight-line basis over the remaining vesting period (or the modified service period, if the extension affects service conditions).

If the extension does not affect service conditions (e.g., only extends the exercise window), the incremental expense should be recognized over the original remaining vesting period. If the extension also changes vesting conditions (e.g., extends the service period), the amortization period should be re-estimated based on the modified vesting conditions.

Example Calculation Steps

  1. Determine the modification date: That is, the date when the board approved the extension to 10 years.
  2. Revaluation: At the modification date, use the Black-Scholes model with input parameters including: current stock price, exercise price, risk-free rate (based on 10-year term), expected volatility (based on 10-year term), expected dividend yield, and expected term (which needs to be recalculated using the simplified method, as the original 7-year term is extended to 10 years, the expected term may extend from approximately 4-5 years to approximately 6-7 years, but should be estimated based on employee exercise behavior).
  3. Calculate incremental fair value: Fair value at modification date minus fair value at original grant date (note: the original grant date fair value is already determined and is not restated due to the modification).
  4. Expense recognition：
    • Vested options: The incremental fair value is recognized immediately in profit or loss at the modification date.
    • Unvested options: The incremental fair value is amortized over the remaining vesting period, while the original grant date fair value continues to be amortized as originally planned.

Key Considerations

Extending the option term may affect the 'dilutive' nature and 'time value' of the options, but the accounting treatment only focuses on changes in fair value. Ensure that valuation parameters at the modification date are consistent with market conditions and maintain complete documentation.

Additionally, if the extension occurs after the options have expired or been exercised, the above treatment does not apply. In this case, the original options have not yet expired, and extending to 10 years is a valid modification.

It is recommended to consult professional auditors or refer to ASC 718-20-35-3 to 35-5 (US GAAP) or IFRS 2 paragraphs 27-28 (international standards) to confirm specific application details.

In summary, for vested options, the current period profit or loss should include a one-time expense for the incremental fair value at the modification date; for unvested options, the incremental expense should be allocated over the remaining vesting period, and the original expense should continue to be amortized. Ensure all calculations are based on parameters at the modification date and comply with applicable accounting standards.