1 Stock-based compensation Under SFAS No. 123 (Rev. 2004) Prepared by Teresa Gordon {With IFRS comparison at the end}

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Stock-based compensation

Under SFAS No. 123 (Rev. 2004)

Prepared by Teresa Gordon

{With IFRS comparison at the end}

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Two kinds of option plans

Noncompensatory Rules on Slide 3

Compensatory Classified as Liability or Equity See chart on Slide 4

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Non-Compensatory Plans1. Option exercise amount very close to

market price Safe harbor rule: discount ≤ 5% of market price

2. Substantially all employees may participate on an equitable basis

3. Short enrollment perioda. No more than 31 days after price is fixed

to enrollb. Purchase price is based solely on market

price at purchase dateAlso, employees can cancel participation before

purchase date and get a refund

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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.

Modified by FSP FAS 123(R)-4 (Feb 3, 2006)

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FASB 123 – 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 expire

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Conditions in Awards

Conditions may impact vesting, exercisability, exercise price, and other features that affect the fair value of an award Service conditions Performance conditions Market conditions

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Recognition of expense

When services are provided Generally grant date until the options

can be exercised (the exercise date) Also called “the service period”

Grant date

Service Period

Exercise Period

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Awards classified as equity

Compensation is measured at each the measurement date and allocated to service period

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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ComplicationsRequisite service periodEstimating turnoverDeferred taxesModification of terms

Performance conditionsMarket conditionsUsing an option pricing model Nonpublic companies

Grant date

Service Period

Exercise Period

Measurement Date?

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Examples

1. Award classified as equity2. Award classified as debt

(nonpublic)3. Award classified as debt (public

company)

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Award Classified as Equity

Information for example: 1,000 options for common stock $3 par market price $8 and option price $8 Service condition=work for company

for 4 yearsGrant date

Service Period

Exercise Period

Fair value per share - $6

Go to Excel

Example 1

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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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When vested options are not exercised

Perhaps market price < option price

“Out of the money” 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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Example 2 – SARs (Go to Excel)

Mary works for a nonpublic company. Mary will receive the difference between the current stock prices ($10) and the stock price that exists when she exercises her 1,000 SARs. She cannot exercise the options for 2 years. The options expire 5 years from the grant date

Grant date

Service Period Exercise Period

Expiration Date

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Example 3

Same facts as Example 2 but the company is publicly tradedTherefore, they must use the fair value method and estimate fair value on each balance sheet date.So this makes the SARS quite a bit more complicated!

Share-based Compensation

IFRS 2 vs FAS 123R

versus

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)

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

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

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

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