1111111 stock-based compensation under asc 718 (formerly sfas no. 123r) prepared by teresa gordon
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1111111
Stock-based compensation
Under ASC 718
(formerly SFAS No. 123R)
Prepared by Teresa Gordon
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Two kinds of option plans
NoncompensatoryCompensatory Classified as Liability or Equity See chart on next slide
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Non-Compensatory Plans1. Discount from market price no more
than cost that would have been incurred in public offering
Safe harbor rule: discount ≤ 5% of market price
2. Substantially all employees may participate on an equitable basis
3. There are no option features other than:
a. No more than 31 days after price is fixed to enroll
b. Purchase price is based solely on market price at purchase date
Also, employees can cancel participation before purchase date and get a refund
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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
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ASC 718 (FASB 123R):The Fair Value Method
FASB requires the fair value methodThe 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)
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TerminologyMeasurement date and grant date are often (but not always) the sameMeasurement 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.
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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.Grant date
Service Period
Exercise Period
Fair value per share - $6
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Compensatory AwardsClassified as liability Classified as equity
Remeasured at fair value on each balance sheet date until the award is settled
Measured at fair value at the grant date and not subsequently remeasured
Award is classified as liability if the entity can be required under any circumstances* to settle the option or similar instrument by transferring cash or other assets
Award is classified as equity if it is an equity instrument and the company cannot be required to settle the option in cash under any circumstances.
* See ASC 718-10-35-15
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Awards classified as liability Awards classified as equity
Measurement date = settlement date Measurement date = grant date (generally)
Award is classified as liability if the entity can be required under any circumstances to settle the option or similar instrument by transferring cash or other assets
Award is classified as equity if it is an equity instrument and the company cannot be required to settle the option in cash under any circumstances.
Options that permit broker-assisted cashless exercise does not result in liability classification if
1. Cashless exercise requires a valid exercise
2. The employee is the legal owner of the shares
Provisions to provide cash to meet minimum statutory withholding requirements are also okay
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
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ComplicationsRequisite service periodEstimating turnoverDeferred taxesModification of terms
Performance conditionsMarket conditionsNonpublic companies
Grant date
Service Period
Exercise Period
Measurement Date =
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Types of Conditions
Service conditionPerformance conditionMarket condition
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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.
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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
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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
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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 employeeThe 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 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
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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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Underwater options
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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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Complications
Requisite service periodEstimating turnoverDeferred taxes
Performance conditionsMarket conditionsUsing an option pricing model Nonpublic companies
Grant date
Service Period
Exercise Period
Measurement Date =
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Awards classified as liabilities
Compensation is estimated at each balance sheet date through settlement
Grant date
Service Period
Exercise Period
Measurement Date
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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 dateIn this case, a liability is created and APB Opinion 25 and FASB 123 accounting is exactly the same but ONLY for nonpublic companiesEstimated fair values at each balance sheet date required for public companies
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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
Grant date
Service Period
Exercise Period
Measurement Date
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Major difference between ASC 718 (FAS123R) and ASC 815 (FAS133)
We re-value derivatives under ASC 815 based on current economic conditionsUnder 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)
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Share-based Compensation
IFRS 2 vs. ASC 718(FAS 123R)
versus
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Comparing the standardsIFRS US GAAP
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 rulesPayroll taxes are recorded at exercise date (or vesting date for restricted stock)
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Comparing the standardsIFRS US GAAP
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
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Equity Awards vs. Liability Awards
IFRS US GAAP
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
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Recognition of Awards
IFRS US GAAP
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
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Recognition for Plans with Graded Vesting
IFRS US GAAP
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