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Stock-based compensation. Under ASC 718 (formerly SFAS No. 123R) Prepared by Teresa Gordon . 1. 1. 1. 1. 1. 1. 1. Two kinds of option plans. Noncompensatory Compensatory Classified as Liability or Equity See chart on next slide. Non-Compensatory Plans.

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stock based compensation
Stock-based compensation

Under ASC 718 (formerly SFAS No. 123R)

Prepared by Teresa Gordon

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two kinds of option plans
Two kinds of option plans
  • Noncompensatory
  • Compensatory
    • Classified as Liability or Equity
      • See chart on next slide
non compensatory plans
Non-Compensatory Plans
  • Discount from market price no more than cost that would have been incurred in public offering

Safe harbor rule: discount ≤ 5% of market price

  • Substantially all employees may participate on an equitable basis
  • There are no option features other than:
    • No more than 31 days after price is fixed to enroll
    • Purchase price is based solely on market price at purchase date

Also, employees can cancel participation before purchase date and get a refund

compensatory plan
Compensatory Plan
  • Any plan that fails to satisfy the three criteria
  • Note: Incentive stock options under the tax code will not necessarily be noncompensatory under GAAP
    • However, there would be no need for deferred taxes because the employee would not be taxed and the employer does not get a tax deduction
asc 718 fasb 123r the fair value method
ASC 718 (FASB 123R):The Fair Value Method
  • FASB requires the fair value method
  • The compensation cost (to be amortized to expense) is determined by an option pricing model.
    • Factors in models include:
      • Market price and exercise price
      • Risk free interest rate
      • Expected volatility of stock prices
      • Expected dividend on stock
      • Number of years until options are expected to be exercised

Additional guidance provided in SAB 107 (April 2005)

terminology
Terminology
  • Measurement date and grant date are often (but not always) the same
  • Measurement date - The date at which the equity share price and other pertinent factors, such as expected volatility, that enter into measurement of the total recognized amount of compensation cost for an award of share-based payment are fixed.
  • Grant date - The date at which an employer and an employee reach a mutual understanding of the key terms and conditions of a share-based payment award.
    • Approval by shareholders or board of directors may be required
    • The grant date for an award of equity instruments is the date that an employee begins to benefit from, or be adversely affected by, subsequent changes in the price of the employer’s equity shares.
stock option plans

Grant date

Exercise Period

Service Period

Stock Option Plans
  • Information for following examples:
    • 1,000 options for common stock
    • $3 par
    • market price $8
    • option price $6
    • Service period required is four years.

Fair value per share - $6

compensatory awards
Compensatory Awards

* See ASC 718-10-35-15

slide9

ASC 718-10-35-15

A cash settlement feature that can be exercised only upon the occurrence of a contingent event that is outside the employee’s control would NOT require classification as a liability award

complications
Requisite service period

Estimating turnover

Deferred taxes

Modification of terms

Performance conditions

Market conditions

Nonpublic companies

Grant date

Exercise Period

Service Period

Complications

Measurement Date

=

types of conditions
Types of Conditions
  • Service condition
  • Performance condition
  • Market condition
requisite service period
Requisite Service Period
  • Explicit service period: Stated in the terms of a share-based payment award.
  • Implicit service period: Not explicitly stated but inferred from an analysis of the terms and other facts and circumstances.
  • Derived service period: A service period for an award with a market condition that is inferred from the application of certain valuation techniques used to estimate fair value.
multiple service periods
Multiple service periods
  • “Or” conditions – requisite service period is the shortest of the possible periods
  • “And” conditions – requisite service period is the longest of the possible periods
    • The complications are likely when there is both a service condition and one or more performance conditions and maybe a market condition specified or implied by the terms of the award
modification of terms
Modification of terms
  • When an equity award is modified, it must be remeasured
      • Recall that liability awards are automatically remeasured on reporting dates
  • If the new award has greater fair value than the old award immediately before the modification, the excess fair value is recognized as compensation expense
stock option plans deferred taxes
Stock Option Plans & Deferred Taxes
  • If the market price upon exercise is substantially greater than the market price on the day of grant it will result in significant unrecorded compensation to the employee
  • The employee pays tax on the difference between option price and market price on the day the option is exercised

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stock option plans deferred taxes1
Stock Option Plans & Deferred Taxes
  • The employer gets a tax deduction based on the difference between the option price and the market price on the day the options are exercised.
  • This is probably different than what was provided in deferred tax.
  • Excess benefits are credited to APIC

22

when people quit
When people quit . . .
  • We “undo” the recognition of compensation expense related to options that FAIL TO VEST because of service or performance conditions
  • Credit compensation expense, and debit APIC – stock options outstanding
  • Failure to perform service Paid in Capital, stock options 2,000
    • Compensation Expense 2,000

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when vested options are not exercised
When vested options are not exercised
  • Perhaps market price < option price
  • No one will exercise the options
  • When they expire, the balance is transferred to APIC – expired options
  • Compensation is NOT reversed
  • Expiration of unexercised VESTED stock options:
  • Paid in Capital, stock options 2,000
  • Paid in Capital, expired options 2,000

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complications1
Requisite service period

Estimating turnover

Deferred taxes

Performance conditions

Market conditions

Using an option pricing model

Nonpublic companies

Grant date

Exercise Period

Service Period

Complications

Measurement Date

=

awards classified as liabilities

Measurement Date

Grant date

Exercise Period

Service Period

Awards classified as liabilities
  • Compensation is estimated at each balance sheet date through settlement
stock appreciation rights sars
Stock appreciation rights (SARs)
  • Sometimes the plan gives the employee CASH for the increase in the price of the stock between grant date and the measurement date
  • In this case, a liability is created and APB Opinion 25 and FASB 123 accounting is exactly the same butONLY for nonpublic companies
  • Estimated fair values at each balance sheet date required for public companies
equity or liability awards

Measurement Date

Grant date

Exercise Period

Service Period

Equity or Liability Awards
  • The measurement date may not be the grant date
    • The number of options to be issued may not be certain until the level of achievement of a performance condition is known
major difference between asc 718 fas123r and asc 815 fas133
Major difference between ASC 718 (FAS123R) and ASC 815 (FAS133)
  • We re-value derivatives under ASC 815 based on current economic conditions
  • Under ASC 718 the value of equity awards is determined (generally) on the grant date and does not change after that date
    • Note that liability awards are re-valued like derivatives under ASC 815 (derivatives)
share based compensation

Share-based Compensation

IFRS 2 vs. ASC 718(FAS 123R)

versus

comparing the standards
US GAAPComparing the standards

IFRS

Grant date is when agreement is reached

All employee awards are treated as compensatory

Payroll taxes are accrued as employees earn the compensation

Grant date is the earlier of

mutual understanding, or

date when employee begins to provide services

Compensatory and noncompensatory have separate rules

Payroll taxes are recorded at exercise date (or vesting date for restricted stock)

comparing the standards1
US GAAPComparing the standards

IFRS

Deferred tax assets recognized when share options have current intrinsic value

Adjustments made based on current stock prices

This increases the volatility of the impact on profit and loss

Deferred taxes recognized based on grant date fair value as compensation is recognized

Deferred tax asset is not revalued as stock prices change

equity awards vs liability awards
US GAAPEquity Awards vs. Liability Awards

IFRS

IFRS classification is based on the method of expected settlement (cash or shares)

IF recipient has a choice, classification is based on the expected settlement

Fixed monetary amount to be paid in varying number of shares = equity award

If the award CAN BE settled in cash, it is classified as a liability award

If recipient has CHOICE, it is assumed to be cash and therefore a liability award

Fixed monetary amount to be paid in varying number of shares = liability award

recognition of awards
US GAAPRecognition of Awards

IFRS

Recognized over the related period of employee service

Explicit

Implicit

No “derived” – so in rare cases, the recognition period will be different

Recognized over the related period of employee service

Explicit

Implicit

Derived

recognition for plans with graded vesting
US GAAPRecognition for Plans with Graded Vesting

IFRS

Must treat each tranche as a separate award

May treat each tranche as a separate award

Recognize compensation separately over the period of each separate tranche

May use straight-line method for the entire award

Recognize compensation over the period covered by all the tranches