Accounting for Stock Comp for Web

8/3/2019 Accounting for Stock Comp for Web

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Accounting for Stock

Compensation


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Two Main QuestionsHow should compensation expense bedetermined?

Over what periods should compensationexpense be allocated?


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TermsStock Option

Grant Date

Vested Date

Exercise Date

Intrinsic Value Method APB 25Fair Value Method SFAS No 123


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TermsIntrinsic Value Method APB 25

Fair Value Method SFAS No 123


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Intrinsic Value MethodTotal compensation cost is computed asthe excess of the market price of the

stock over the option priceon the date when both the number of

shares to which employees are entitled

and the option or purchase price forthose shares are known


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Fair Value MethodEstimate fair value of the optionsexpected to vest on the date they are

grantedValue of the option is based upon anoption pricing model


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Allocating Compensation

ExpenseCompensation is recognized over theservice period


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ExampleNovember 1, 2000, Kirk Company approve aplan - 5 executives options to purchase 2,000shares each of the company's $1 par value

common stock.Options are granted on January 1, 2001

May be exercised within next 10years

Expected period of benefits to co = 2years

The option price per share is $60, the marketprice of the stock @ date of grant is $70 pershare


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Intrinsic Value MethodMarket value of 10,000shares at date of grant

($70 per share)

$700,000

Option price of 10,000shares at date of grant($60 per share)

600,000

Total compensationexpense (intrinsic

value)

$100,000


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Journal Entries Intrinsic

Value MethodAt date of grant 1/1/2001 no entry

To record compensation for 2001

Compensation Expense $50,000

Paid in Capital Stock Options $50,000

To record Compensation for 2002Compensation Expense $50,000



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Intrinsic Value Method Cont.To record the exercise of 20% of the shareson June 1,2004 (regardless of stock price

Cash $120,000

Paid in Capital Stock options 20,000

Common Stock $2000

Paid-in Capital in excess of Par 138,000


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Fair ValueAssume they use the Black-Scholesoption pricing model results in a total

fair value of $220,000Therefore, compensation is $220,000


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Journal EntriesFair Value

MethodAt date of grant 1/1/2001 no entry

To record compensation for 2001

Compensation Expense $110,000


To record Compensation for 2002Compensation Expense $110,000



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Fair Value Method Cont.To record the exercise of 20% of the shareson June 1,2004 (regardless of stock price

Cash (2000x60) $120,000

Paid in Capital Stock options 44,000

Common Stock $2000

Paid-in Capital in excess of Par 162,000


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NoteGenerally, the stock option price isgreater than the market price of the

sharesTherefore, using the intrinsic value is $0

So no compensation expense is

recorded


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What to do????While SFAS 123 recommends the fairvalue method, it is not required.


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Another ExampleRose Communications


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Rose CommunicationOn 1/1/2003 Rose grants options that permitkey executives to acquire 10,000,000 of thecompanys $2 per share common stock within

the next 8 years, but not before 12/31/06The exercise price is the market price ongrant date of $35 per shareThe appropriate option pricing model valued

the options at $8 per optionTotal compensation is to be expensed overthe 4 year vesting period


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What is the compensation

expense under both methodsIntrinsic Value Method

Exercise price = market

price therefore nointrinsic value

Therefore, nocompensation expense

Fair Value Method

$8 x 10,000,000 =

$80,000,000$80,000,000/4=

$20,000,000 per yr


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Journal Entries - fvTo Record Compensation

Compensation Expense $20,000,000

Paid In CapitalStock option $20,000,000


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Journal Entries - FVAssume half (5 mil) of the shares areexercised on 7/11/2009 when the

market price is $50 per shareCash $175,000,000

Paid-in Capital-stock options 40,000,000

Common Stock $10,000,000Paid-in Capital-excess of par 205,000,000


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Journal Entries - FVAssume the other half expires unused

Paid-in Capital-stock options $40,000,000

Paid-in Capital-expired stck op $40,000,000


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Tax IssuesIncentive Plan - Qualified Plans favorable taxtreatment to the executive employer

receives not tax deduction for compensation no deferred tax consequences

Nonqualified plan offers favorable taxtreatment to the employer deduct the

difference between exercise price and marketprice at the exercise date


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Qualified vs. Non QualifiedQualified Incentive plan recipients pays notax at time of grant or when options are

exercised Instead, Pay capital gain whenstock is sold. Co. gets no deduction

Non-qualified plan pay tax when optionsare exercised. Employer deducts difference

between market & exc. price at exercise date


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Tax Issues with FV (40% tax rate)

To record compensation 12/31/03-06

Compensation Expense $20,000,000

Paid In CapitalStock option $20,000,000

Deferred tax asset $8,000,000

Income tax expense $8,000,000


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Assume all 10 mill. Exercised on 12/31/08

Cash $350

Paid-in Cap.-Stock option 80

Com Stock $20

Paid in capital 410


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Assume the market price is $50 when employee

exercises the option

Income tax payable 60

Deferred tax asset 32

Paid in capitaltax effect of s.o. 28


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DisclosureTo comply with SFAS you must disclosethe impact of the fair value method


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Theory - NeutralityEconomic consequences issue

FASB believes the neutrality concept

should be followed others disagreed


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The DebateJune 1993 Exposure Draft

Reaction

Equity Expansion Act of 1993

Late 1994

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Accounting for Stock Comp for Web