IFRS 2 Part 6: Modifications, Cancellations and Forfeitures
Part 6 of a 7-part series on IFRS 2: why beneficial modifications add expense but unfavorable ones are ignored, and how a cancellation differs from an ordinary forfeiture.
Quick Summary
- A modification that increases fair value adds incremental expense on top of the original grant — the original grant-date fair value is never reduced.
- A modification that decreases fair value is ignored — the entity continues to recognize the original, unmodified fair value as if the modification had never happened.
- A cancellation or non-vesting forfeiture by the entity is treated as accelerated vesting: whatever expense had not yet been recognized is taken immediately, in full.
- An ordinary forfeiture (an employee simply fails to meet a service or non-market performance condition) is not a cancellation — it runs through the normal true-up mechanism from Part 2, with no accelerated expense.
SHARE-BASED PAYMENT — 7 GUIDES
Modifications: Increases in Fair Value
A modification occurs when an entity changes the terms or conditions of an equity-settled award — repricing an out-of-the-money option, extending the vesting period, changing a performance target, or increasing the number of instruments granted. IFRS 2’s guiding principle is that a modification is only ever recognized to the extent it is beneficial to the employee; the standard is deliberately asymmetric.
If a modification increases the total fair value of the award (measured as the incremental fair value granted, being the difference between the fair value of the modified instrument and the fair value of the original instrument, both measured at the modification date), that incremental fair value is recognized as additional expense over the remaining vesting period, on top of — not instead of — the expense based on the original grant-date fair value.
Example: Repricing an Underwater Option
An entity granted options with an original fair value of $10 each, with two years of the three-year vesting period remaining, and the options are now deeply out-of-the-money. The entity reprices the exercise price downward. Immediately before and after the repricing, the options are valued at $10 (unchanged) and $16 respectively — an incremental fair value of $6. That $6 is expensed over the remaining two years of the vesting period, in addition to the original $10 being expensed over the full three-year period as originally scheduled. If the repricing had instead reduced fair value from $10 to $7, the entity would ignore the reduction entirely and continue expensing based on the original $10.
Modifications: Decreases in Fair Value, or Reduced Terms
If a modification reduces the fair value of the equity instruments granted, the entity ignores that reduction and continues to measure and recognize the services received based on the original grant-date fair value, as though the modification had not occurred. The same one-way logic applies to a modification that reduces the number of instruments granted to an employee: it is treated as a cancellation of that portion of the grant (see below), rather than as a beneficial change.
The underlying logic: IFRS 2 treats the original grant-date fair value as a floor. An entity cannot reduce previously recognized (or to-be-recognized) expense by unilaterally making an award less valuable after the fact — doing so would let entities manage reported compensation expense downward simply by amending awards they had already committed to.
Cancellations and Settlements
A cancellation occurs when the entity, or the counterparty, terminates the award before it would otherwise have vested — other than through an ordinary forfeiture caused by failing to meet a service or non-market performance condition. This includes situations where the entity buys out the award, or where the counterparty and entity agree to cancel it by mutual consent.
IFRS 2’s rule for a cancellation is unambiguous: the entity accounts for it as an acceleration of vesting, and therefore recognizes immediately whatever amount would otherwise have been recognized for services received over the remainder of the vesting period. Any payment made to the employee on cancellation (up to the fair value of the equity instruments granted, measured at the cancellation date) is accounted for as a deduction from equity; any excess payment above that fair value is recognized as an expense.
| Ordinary Forfeiture | Cancellation | |
|---|---|---|
| Trigger | Service or non-market performance condition simply not met (e.g., employee resigns) | Deliberate act by the entity or counterparty to end the award early |
| Accounting effect | Cumulative expense trued down to reflect what actually vested | Remaining unrecognized expense taken immediately (accelerated) |
| Net effect on total expense recognized | Reduces total expense recognized over the award’s life | Does not reduce total expense — merely brings recognition forward |
A failure to satisfy a non-vesting condition (as opposed to a service or performance condition — see Part 3) is also treated as a cancellation rather than a forfeiture, whether the failure is within the control of the entity, the counterparty, or a third party.
Replacement Awards
If, at the time of a cancellation, the entity grants a new award to the same counterparty and identifies that new award as a replacement for the cancelled one, the replacement award is accounted for as a modification of the original award rather than as a separate new grant — following the incremental fair value approach described above, comparing the fair value of the replacement award to the fair value of the cancelled award, both measured at the date the replacement is granted.
Practical Takeaway
The consistent thread through this Part is that IFRS 2 resists letting an entity reduce previously committed compensation expense through any subsequent action — a downward repricing is ignored, and an outright cancellation only accelerates recognition rather than eliminating it. The only way total expense over an award’s life is genuinely reduced is the ordinary, non-accelerated true-up for employees who fail a service or non-market performance condition on their own, which was covered in full in Part 2.
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