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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