ASC 718 Stock-Based Compensation Student)

8/2/2019 ASC 718 Stock-Based Compensation Student)

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Stock-based compensation

Under ASC 718

(formerly SFAS No. 123R)

Prepared by Teresa Gordon


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Two kinds of option plans

Noncompensatory

CompensatoryClassified as Liability or Equity

See chart on next slide


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Non-Compensatory Plans

1. Discount from market price no more thancost that would have been incurred in publicoffering

Safe harbor rule: discount 5% of market price

2. Substantially all employees may participateon an equitable basis

3. There are no option features other than:a. 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 Plan

Any plan that fails to satisfy the three criteria

Note: Incentive stock options under the taxcode will not necessarily be noncompensatoryunder GAAP

However, there would be no need for deferred

taxes because the employee would not be taxedand 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 method

The compensation cost (to be amortized toexpense) is determined by an option pricingmodel. 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 tobe exercised

Additionalguidanceprovided in

SAB 107 (April2005)


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TerminologyMeasurement date and grant date are often(but not always) the sameMeasurement date - The date at which the equityshare price and other pertinent factors, such asexpected volatility, that enter into measurement of

the total recognized amount of compensation cost foran award of share-based payment are fixed.Grant date - The date at which an employer and anemployee reach a mutual understanding of the keyterms 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 employers 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 oneach balance sheet date

until the award is settled

Measured at fair value atthe grant date and not

subsequently remeasuredAward is classified asliability if the entity can berequired under any

circumstances*to settlethe option or similarinstrument by transferring

cash or other assets

Award is classified as equityif it is an equity instrumentand the company cannot be

required to settle the optionin cash under anycircumstances.

* 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 theentity can be required under anycircumstances to settle the optionor similar instrument bytransferring cash or other assets

Award is classified as equity if it is anequity instrument and thecompany cannot be required tosettle the option in cash under anycircumstances.

Options that permit broker-assistedcashless exercise does not resultin liability classification if

1. Cashless exercise requiresa valid exercise

2. The employee is the legalowner of the shares

Provisions to provide cash to meetminimum statutory withholdingrequirements are also okay

ASC 718-10-35-15

A cash settlement feature that can

be exercised only upon theoccurrence of a contingent eventthat is outside the employeescontrol would NOT requireclassification as a liability award


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ComplicationsRequisite service period

Estimating turnover

Deferred taxes

Modification of terms

Performance conditions

Market conditions

Nonpublic companies

Grant date

Service Period

Exercise Period

Measurement Date

=


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Types of Conditions

Service condition

Performance condition

Market condition


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Requisite Service Period

Explicit service period: Stated in the termsof a share-based payment award.

Implicit service period: Not explicitlystated but inferred from an analysis of theterms and other facts and circumstances.

Derived service period:A service periodfor an award with a market condition that isinferred from the application of certainvaluation techniques used to estimate fairvalue.


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Multiple service periods

Or conditions requisite service period isthe shortest of the possible periods

And conditions requisite service period isthe longest of the possible periods

The complications are likely when there is both aservice condition and one or more performance

conditions and maybe a market condition specifiedor implied by the terms of the award


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Modification of terms

When an equity award is modified, itmust be remeasured

Recall that liability awards are automaticallyremeasured on reporting dates

If the new award has greater fair valuethan the old award immediately beforethe modification, the excess fair value isrecognized as compensation expense


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Stock Option Plans & DeferredTaxes

If the market price upon exercise issubstantially greater than the market price onthe day of grant it will result in significantunrecorded compensation to the employee

The employee pays tax on the differencebetween option price and market price on the

day the option is exercised


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Stock Option Plans & DeferredTaxes

The employer gets a tax deductionbased on the difference between the

option price and the market price onthe 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 ofcompensation expense related to optionsthat FAIL TO VEST because ofservice orperformance conditions

Credit compensation expense, and debitAPIC stock options outstanding

Failure to perform service

Paid in Capital, stock options 2,000

Compensation Expense 2,000


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Complications

Requisite service period

Estimating turnover

Deferred taxes

Performance conditions

Market conditions

Using an option pricingmodel

Nonpublic companies

Grant date

Service Period

Exercise Period

Measurement Date

=


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Awards classified as liabilities

Compensation is estimated at eachbalance 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 CASHfor the increase in the price of the stockbetween grant date and the measurement

dateIn this case, a liability is created and APBOpinion 25 and FASB 123 accounting isexactly the same butONLY for nonpublic

companiesEstimated fair values at each balance sheetdate required for public companies


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Equity or Liability Awards

The measurement date may not be thegrant date

The number of options to be issued may not becertain until the level of achievement of aperformance condition is known

Grant date

Service Period

Exercise Period

Measurement Date


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Major difference between ASC718 (FAS123R) and ASC 815

(FAS133)We re-value derivatives under ASC 815based on current economic conditions

Under ASC 718 the value ofequityawards is determined (generally) on thegrant 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 whenagreement is reached

All employee awards aretreated as compensatory

Payroll taxes are accruedas employees earn thecompensation

Grant date is the earlier of

mutual understanding, or

date when employee begins

to provide servicesCompensatory andnoncompensatory haveseparate rules

Payroll taxes are recordedat exercise date (orvesting date for restrictedstock)


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Comparing the standards

IFRS US GAAP

Deferred tax assetsrecognized when share

options have currentintrinsic value

Adjustments made basedon current stock prices

This increases the volatility

of the impact on profit andloss

Deferred taxesrecognized based on

grant date fair value ascompensation isrecognized

Deferred tax asset is notrevalued as stock prices

change


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Equity Awards vs. Liability Awards

IFRS US GAAP

IFRS classification isbased on the method of

expected settlement(cash or shares)

IF recipient has a choice,classification is based onthe expected settlement

Fixed monetary amount tobe paid in varying numberof shares = equity award

If the award CAN BEsettled in cash, it is

classified as a liabilityaward

If recipient has CHOICE, itis assumed to be cash andtherefore a liability award

Fixed monetary amount tobe paid in varying numberof shares = liability award


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Recognition of Awards

IFRS US GAAP

Recognized over therelated period of

employee service Explicit

Implicit

No derived so in rarecases, the recognition

period will be different

Recognized over therelated period of

employee service Explicit

Implicit

Derived


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Recognition for Plans with Graded Vesting

IFRS US GAAP

Must treat each trancheas a separate award

May treat each tranche asa separate award

Recognize compensationseparately over the periodof each separate tranche

May use straight-linemethod for the entire

award Recognize compensation

over the period covered byall the tranches

ASC 718 Stock-Based Compensation Student)

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