Stock-based compensation
Under SFAS No. 123 (Rev. 2004)
Prepared by Teresa Gordon
{With IFRS comparison at the end}
1
2
Two kinds of option plans
Noncompensatory
 Rules on Slide 3
Compensatory

Classified as Liability or Equity
 See chart on Slide 4
3
Non-Compensatory Plans
1. 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 period
a.
b.
No more than 31 days after price is fixed to
enroll
Purchase price is based solely on market price at
purchase date
Also, employees can cancel participation before
purchase date and get a refund
4
Compensatory Awards
Classified as liability
Classified as equity
Remeasured at fair value on Measured at fair value at
each balance sheet date
the grant date and not
until the award is settled
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)
5
FASB 123 – Fair Value Method
FASB requires the fair value method
The 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
6
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
7
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
Exercise Period
Service Period
8
Awards classified as equity
Compensation is measured at each the
measurement date and allocated to
service period
Measurement Date
=
Grant date
Exercise Period
Service Period
9
Awards classified as liabilities
Compensation is estimated at each
balance sheet date through settlement
Measurement Date
Grant date
Exercise Period
Service Period
10
Complications
Requisite service period
Estimating turnover
Deferred taxes
Modification of terms
Grant date
Performance conditions
Market conditions
Using an option pricing
model
Nonpublic companies
Measurement Date?
Exercise Period
Service Period
11
Examples
1. Award classified as equity
2. Award classified as debt (nonpublic)
3. Award classified as debt (public
company)
12
Example 1
Award Classified as Equity
Information for example:




Go to Excel
1,000 options for common stock
$3 par
market price $8 and option price $8
Service condition=work for company for 4
years
Fair value per share - $6
Grant date
Exercise Period
Service Period
13
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
Compensation Expense
2,000
2,000
23
16
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
Paid in Capital, expired options
2,000
2,000
24
17
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
Expiration Date
Exercise Period
18
Example 3
Same facts as Example 2 but the
company is publicly traded
Therefore, 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!
23
Share-based Compensation
IFRS 2 vs FAS 123R
versus
Comparing the standards
IFRS
Grant date is when
agreement is reached
US GAAP
Grant date is the earlier of


All employee awards are
treated as compensatory
Payroll taxes are accrued
as employees earn the
compensation
mutual understanding, or
date when employee begins
to provide services
Compensatory and
noncompensatory have
separate rules
Payroll taxes are recorded
at exercise date (or
vesting date for restricted
stock)
Comparing the standards
IFRS
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
US GAAP
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
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
US GAAP
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
Recognized over the
related period of
employee service



Explicit
Implicit
No “derived” – so in rare
cases, the recognition
period will be different
US GAAP
Recognized over the
related period of
employee service



Explicit
Implicit
Derived
Recognition for Plans with Graded Vesting
IFRS
Must treat each tranche
as a separate award
US GAAP
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