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Seminar 21/22: Share based payments transactions

Three types of SBPT [All questions: Ask if this is a Equity or Cash settled SBPT]Equity SettledSBPT

(Equity Based)

Firm receives goods/services as consideration for equity of entity

Record in journal initial option value when its granted.

If FV of option can be measured reliably: FV of option determined on grant date, NOT adjusted

subsequently

Estimate # of options that will eventually vest at each B/Still vesting date ends, adjust them at each B/S period

After vesting date, no staff cost adjustments

If FV of option cannot be estimated reliably

Intrinsic value (Fair value of share Ex price of option) used Value is re-measured at each reporting date till full

settlement/expiry

Cash SettledSBPT

(Liability Based)

Entity receives goods/services by incurring liabilities to supplierfor cashbased on price of entitys shares

Not only need to adjust for amount of expected ESO in eachperiod, but also FV change of option given this is a liability.After vesting date, still have staff cost adjustments based onFV changes till option expires or fully exercised

Share-basedpayment withcash alternative

Entity receives goods/services and terms of arrangement provideeither entity or counter-party with choice of settlement in cash orshares.

FRS 102 Doesnt apply to:

1. Share based transaction in business combination2. Share based transaction with any party in capacity as entitys shareholder

*Measure fair vale of options given

*Period where service is rendered

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Is ESO an expense?Expenses are decreases in economic benefits during accounting period in form ofoutflows or depletions of assets/incurrence of liabilities that result in decreasesin equity other than those relating to distributions to equity participants.

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IMPORTNANT JOURNAL RECORD RULE: Vesting vs Non-vestingEven if the shares are granted on 1 Jan XXX

- It is only recognized at end of reporting period where shares havegain value through VESTING PERIOD.

- If non-vesting, it is recognized as soon as its grantedVESTING RULES

Does condition determine whether entity receives

services that entitle counterparty to SBP

Yes, Depends on service(Vesting Condition)

No, no(Non-

Does condition require onlyspecified period of service?

Yes (Service Condition)- Recognize based on time No (PerformanceCondition)

Condition related to market price

of entitys equity instrument?

Yes(Market Performance

Condition)i.e. share price performance

No(Non-Market Performance Condition)

i.e. based on vol of sales/revenue

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VESTING RULES (II):Accounting for Conditions

IllustrationsVESTING: Service & Non-Market performance condition [Illustration 6 & 7]- No Fair value @ Grant date Conditions not considered in estimating

instrument Fair value, but considered in est # of instruments expected to vest- Forfeiture True-Up: At each B/S date, est # of options that will eventually

vest, up to vesting date Adjust vesting costs (i.e. staff costs) accordinglyIf Service/Non-market condition exp to change Vesting Period ()* exp to vest

FV per option/SAR # exp to vestinitially

Total FV torecognize

Y1(100%)

Y2(80%)

Y3(70%)

$3 100 $300 100 60 50

Market Performance & Neither entity/CP may choose to meet condition(Illustration 8 & 10)- Fair value @ Grant date Conditions considered in estimating FV of

individual instrument (i.e. probability of meeting condition=inputs to valuation)- No Change Expensed over vesting periodIf Service/Non-market condition fulfillment exp to change Vesting Period ()* exp to vest

FV per option/SAR # exp to vestinitially

Total FV torecognize

Y1(100%)

Y2(80%)

Y3(70%)

$2.40*Take acc probability offulfillment

100 $240 80 80 80

VESTING AMT CONSTANT even if condition not met as earlier taken into account probability ofnon-fulfillment in FV instrument

Counterparty/Entity can choose to meet condition (Illustration 11 & 12)- Fair value @ Grant date Conditions considered in estimating FV of

individual instrument (i.e. probability of meeting condition=inputs to valuation)- Cancellation results in accelerated exp Expense everything

VestingCond.

Non-

Vesting

Cond.

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If Service/Non-market condition fulfillment exp to change Vesting Period ()* exp to vest

FV per option/SAR # exp to vestinitially

Total FV torecognize

Y1(100%)

Y2(CANCEL)

Y3

$2.40*Take acc probabilityof fulfillment

100 $240 80 160

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MEASUREMENT EQUITY SETTLED SHARE BASED PAYMENT TO THIRD PARTY

Equity settledshare basedpayment(Third party)

A. Measure goods/services from third partyFair value of goods/services* = share capital issued*Rebuttable assumption that fair value of goods/service can beestimated reliably

Fair value of machine Shares issued to buy machine

$100k $1 x 110k shares = $110k

We adopt fair value of machine = $100k

If fair value of goods/service cannot be measured reliablyValue of goods/services = fair value of equity instruments

Illustration 2 Equity shared based paymentGoods/service receive cant be recognized as assets should recognize as exp

- Firm acquire sundry lab equipment of $120k from associates-

Issued 100k ordinary shares Dr Cr

Research expenseShare Capital

120k120k

Illustration 3 Market value of goods certainProfessional valuer value land at $50m, firm issue 10m ordinary shares to buy them

Dr CrLand

Share Capital50m

50m

Illustration 4 Market value of goods uncertain [Cannot measure reliably]Firm acquire building where various valuation range from 10m to 50mFirm bought building by issuing 1m ordinary shares then priced at $22 per share

Dr Cr

LandShare Capital

22m22m

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MEASUREMENT EQUITY SETTLED SBP TO EMPLOYEES

Equitysettled sharebasedpayment

(Employee)

B. Services received from employeesMeasurement = fair value of equity instrument granted*market value of employee service not available*Accounting for terms/conditions which instruments are granted

Fair value of emp service FV of option granted

$100k $1 x 110k shares = $110k

*We adopt fair value of options = $110k

If fair value of instrument cannot measure reliably (i.e. unlistedshares, no liquidity) = Measure services/increase in equity based onintrinsic value of equity instrument granted

Fair value calculation for ESO

Option pricing models to measure fair value. Taking into account:Exercise price of option Expected volatility of share priceCurrent price of underlying shares Dividend expected

Life of option*How long employee hold option & notcontractual period

Risk free interest rate

For Equity Settled SBPT (Calculation of ESO/# of options)Fair value of ESO (i.e. option value) is determined on grant date andnot adjusted for subsequent change in market conditions;

ONLYamount of expected ESO granted in future is adjusted eachperiod (based on total expected attrition at grant date)

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Illustration 5 Vesting based on Length of service[No Attrition, Vesting FV of option can be measured reliably, ESO for employees]

Firm grants 5 executives options to purchase 200,000 shares each (total: 1m)Option exercise price: $5 per share

Granted on 1 Jan 20x2, will vest at 1 Jan 20x5 [Vesting period = 3 years]Option exercisable from 1 Jan 20x5 to 31 Dec 20x8 [Exercise period = 4 year]s

FV of option on 1 Jan 20x2 $1.50 [measured reliably = no change after grant date]Firm expects all employees to stayTotal fair value of options = 1.50 x 1m = 1.5m

Event Dr Cr

For 3 years investing period

Each periodrecorded: vests500k

Staff Cost (1.5m /3)Capital Reserve

Hence total vested in 3 years: 500k x 3 = 1.5m

500k500k

If exercise atend of vesting

Cash (1m shares x Ex value $5)*Capital Reserve (Empty capital reserve)^

Share Capital (Increase in share cap)

5m1.5m

6.5mIf neverexercise tillexpiry

Capital Reserve Stock OptionCapital Reserve General reserve

Note: Expenses NOT reversedas service wereprovided, instead this is transferred to general

reserve for distribution as dividends

1.5m1.5m

*Cash Cash employee paid to buy shares^Cap Reserve Used to record value of service provided by employees

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Illustration 6 Vesting based on Length of service with attrition

Firm grants top 20 executives, 50,000 share options each (total = 1mil)Option exercise price = $1FV of option on 1 Jan 20x2 $1.50 [measured reliably = no change after grant date]

Event Dr Cr

2007 Jan 1 No entry, havent vest

Year 20072 employees left,Expected to stay: 14

Staff CostCapital Reserve ESO(14 emp x 50,000 x 1.5 x 1/3)

350K350K

Year 20081 employee left,Expected to stay: 15

Staff CostCapital Reserve ESO(15 emp x 50,000 x 1.5 x 2/ 3) 350k

400k400k

Year 2009 (End)2 employee leftTotal left: 15

Staff CostCapital Reserve ESO(15 emp x 50,000 x 1.5 x 3/3) 750k

375k375k

Exercise*if never ex till expiry,see illustration 5.

Cash (15 x 50,000 x $1 ex price)Capital reserve (empty capital reserve)

Share capital

750k1.125m

1.875m

Illustration 7Vesting based on Non-Market performancew attrition

Firm grants 10 executives options to buy 10,000 shares eachOption exercise price: $5 per shareFV of option on grant date = $3 [measured reliably = no change after grant date]

Vesting Conditionso 31 Dec 20x2: If sales increase by > 20%o 31 Dec 20x3: If average sales increase over two year > 15%o 31 Dec 20x4: If average sale increase over 3 year > 10%

Event Dr CrYear 20x2Fail condition,

Exp employee tostay: 8

Staff CostCapital Reserve ESO

(3 x 10,000 x 8 emp x 1/3)Recognized given expectations to achievecondition next period. Hence considered vested

120k120k

Year 20x3Fail condition,Exp employee tostay: 7

Staff CostCapital Reserve ESO(3 x 10,000 x 7 emp x 2/3) 120k

Recognized given exp to achieve condition nextperiod. Hence considered vested

20k20k

Year 20x4 (end)Pass condition,Total stayed: 8

Staff CostCapital Reserve ESO(3 x 10,000 x 8 emp x 3/3) 140k

100k100k

Question: What if fail vesting period in the end?? DERECOGNIZE first 2 years?Illustration 8Vesting based on Market condition with attrition

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[Attrition, Vesting, FV of option can be measured reliably, ESO for employees]Firm grants CEO to purchase 500,000 shares at $5 per share

- Granted on 1 Jan 20x2, vest on 31 Dec 20x4- Option cannot exercise unless market price increase to at least $8 on Dec 20x4

Binomial fair pricing: 1.20 [measured reliably = no change after grant date]

Event Dr Cr

For all 3 years Staff CostCapital Reserve ESO(1.20 x 500,000 x 1/3)

200k200k

Record exercise or non-exercise referencing illustration 5

Even if fail to meet requirements, will still be vested.Given the fair pricing has taken into account the probability of fulfillment

Illustration 9 Modification of terms and conditions of ESOBy right value of option recordedshouldnt change UNLESSterms of ESO changeEntity should recognize effects of modification that increase total fair value of options

- Firm grants top 5 executives options to purchase 20,000 shares each- Option exercise price: $5

Option granted on 1 Jan 20x2, vests on 1 Jan 20x5 [VESTING PERIOD]

Binomial fair pricing: $3 [measured reliably = no change after grant date]

Event Dr Cr1styear Staff CostCapital Reserve ESO(3 x 5 x 20,000 x 1/3)

100k100k

2nd yearEx price reducedto $4

Staff CostCapital Reserve ESO(3 x 5 x 20,000 x 2/3) + (0.2 x 100,000 x) 100k prev recognized

Option value before repricing: $1.60Option value after repricing: $1.80

110k110k

3rd year Staff CostCapital Reserve ESO(3 x 5 x 20,000 x 3/3) + (0.2 x 100,000 x2/2) 210k prev recognized

110k110k

Illustration 10 Entity/Counter-party doesnt choose NOT to meetcondition, but experiencefailure to meet condition (i.e. GDP fail to meet 5%)

- Cancellation No impact, continue to recognize same exp over vesting periodIllustration 11 Entity CHOOSES to cancel/settle option during vesting

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Cancellation/settlementacceleration of vesting period.I.e. option recognized prospectively as vested over shorter accelerated period.

- Firm grant top 5 executives options to purchase 20,000 shares- Option exercise price: $5- Shares granted on 1 Jan 20x2, vest on 1 Jan 20x5- Black scholes fair pricing of option value: $3- ON Dec 20x3. Firm cancels stock option and pays each executive 50kEvent Dr Cr1styear Staff Cost

Capital Reserve ESO(3 x 5 x 20,000 x 1/3)

100k100k

2nd yearStock optioncancelled

Staff CostCapital Reserve ESO(3 x 5 x 20,000 x 2/2) -100k

Option prospectively (accelerate) recognized asvested over 2 yr

200k200k

3rd yearCompensationfrom firm

Capital reserve (5 x 50k)Cash

250k250k

Illustration 12- Counterparty choose NOT to meet non-vesting conditionCancellationaccelerated vesting

- Firm grants CFO to participate in plan where CFO obtains share options- CFO needs to save 10% of monthly salary of $10,000 for 3 year period- CFO may use accumulated savings to exercise options at end of 3 years-

Estimated exp of share-based payment arrangement = 3,600 per year for 3 yrsEvent Dr Cr

20x1Dec 31

Staff CostCashSalary in arrears (10% x 120k)(CFOs salary for 12 months)

Staff costsCapital Reserve ESO

*Keep CFO 10% salary, end of 3 years may use amtto exercise option

120k

3.6k

108k12k

3.6k

20x2Apr 1(After 3months)

CFO pulls outof thisprogramme

Takes refund

Staff CostCashSalary in arrears (10% x 30k)(CFOs salary for 3 months)

Salary in Arrears (extinguish liability)Cash

Staff CostsCapital Reserve - ESO

(Accelerated recognition upon cancellation)

30k

15k

7.2k

27k3k

15k

7.2k

Illustration 13 Unable to estimate reliably FV of equity [IMPT!]

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- Use intrinsic value (diff btw fair value of shares and exercisable price)- Measure intrinsic value every period from start date to final settlement

ExampleFirm give CEO option to purchase 1,000,000 shares at 0.30 per share

Options granted on 1 Mar 20x1, will vest on 1 Jan 20x4 [vest over 3 years]- New startup, FV of options cant measure reliably (no liquidity, volatility data)- Firm measures stock option at intrinsic value

Date Share price Intrinsic value (share price ex value)

1 Mar 20x1 0.30

31 Dec 20x1 0.42 0.42-0.3 = 0.12

31 Dec 20x2 0.45 0.45-0.3 = 0.15

31 Dec 20x3 0.50 0.5 0.3 = 0.2

20X4 Post-Vesting 0.6 0.6 0.3 = 0.3

20x5 Post-Vesting 0.8 0.8 0.3 = 0.5

Every period need to re-measure intrinsic value as fair value not obtainableEvent Dr CrGrant date No journal entries, have not vested

B/S End dateRecord @ 20x1intrinsic

Staff CostCapital Reserve ESO(0.12 x 1,000,000 x 1/3)

40k40k

B/S End dateRecord @ 20x2intrinsic

Staff CostCapital Reserve ESO(0.15 x 1,000,000 x 2/3) 40k

60k60k

B/S End date

Record @ 20x3intrinsic

Staff Cost

Capital Reserve ESO(0.2 x 1,000,000 x 3/3) 100k

100k

100k

Post-Vestingperiod 20x4Still recordchange inintrinsic

Exercise: 200koptionsShare price: 0.6Intrinsic =0.3

Staff CostCapital Reserve ESO(0.3 x 1,000,000 (40k+60k+100k))

Recordincrease in option value for ALL option first

Cash (0.3 x 200,000) ex price of 0.30 per shareCapital reserve (0.2 x 300kupdatedoption value)Share capital (Current price 0.6 x 200k)

100k

60k60k

100k

120k

Post-Vestingperiod 20x5Still recordchange inintrinsic

Exercises: 800koptionsShare price: 0.6Intrinsic =0.5

Staff CostCapital Reserve ESO(0.5 0.3) x 800k

Record increase in option value for ALL option first

Cash (0.3 x 800,000) ex price at 0.30 per shareCapital reserve (80% x 300k + 160k value)Share capital (Current price 0.8 x 800k)

160k

240k400k

160k

640k

Note total staff cost over years = 460k

*If intrinsic value drop, reverse staff cost and share based payment, as over accountedIllustration 14 Employee share purchase plan (held in trust)

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Firm offers all 120 employees opportunity to participate in share purchase planEmployees entitled to buy 10,000 shares at 20% disc from market price on 30 Jun 20x6All shares boughtheld in trust for five years and all dividends paid also held in trust

- 100 employees accept the plan and 1,000,000 shares were purchased frommarket at $4 each (20% discount from quoted price of $5)

- Shares are vested when purchased but cant be sold for five yearso Accounting for transfer restriction, fair value of restricted share = $4.40

Since fair value restricted share = $4.40Purchase price = $4Then value of equity instrument option granted = (4.40-4) x 1,000,000 = 400k

To recognize this instrument immediately, given NO vesting period(only held in trust which diminishes the equity instrument value)

Dr Cr

Staff CostCapital Reserve

400k400k

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Cash settled Share based payment transaction [Liability]Need to adjust for # of expected ESO in each period, till end of vestingNeed to re-measure/adjust for options fair value change even after vesting tillsettlement/expiry Change in FV recognized as Staff Cost (P&L)

Employee entitled to cash in future based on increase in share price over time Advantages - No dilution to share capital base

- Pay diff in cash, employee dont have to pay $ to exercise option

Illustration 15 Share appreciation rights (SAR), rewards cash settled- Firm grants CEO 1mil SAR, condition to remain in firm for next 3 years- Initial share price @ Jan 20x1: $5

Year Given Market Price of Shares Fair value of Share Appreciation Rights

Dec 20x1 $5.50 $0.9

Dec 20x2 $5.80 $1.50Dec 20x3 $6 $2.1

Dec 20x4 $7 $2.5

Dec 20x5 $8

*Since we know FV of liability, we do not needto use intrinsic value Still as this is liability = need to re-measure fair value of liability at each period

Event Dr CrGrant Date (20x1 Jan) No journal entries recorded, not vested yet

20x1 DecS Price = 5.50Fair value of rights = 0.90

Staff CostLiability(0.9 x 1,000,000 x 1/3)

300k300k

20x2 Dec

S Price = 5.80Fair value of rights = 1.50

Staff Cost

Liability(1.5 x 1,000,000 x 2/3) 300k

700k

700k

20x3 DecS Price = 6.00Fair value of rights = 2.10

Staff CostLiability(2.1 x 1,000,000 x 3/3) 1m

1.1m1.1m

20x4 DecTotal Liability = 2.1mFair value of rights = 2.50S. price = 7

RECORD EXERCISEExercise: 400k rightsRemaining rights = 600k

Liability (2.1m - residual 0.6m rights@2.5)Staff cost

Cash (S. price $7 initial $5) x 400k

Or separate the entriesStaff Cost (2.5-2.1) x 600k

LiabilityRe-measurement for those not redeemed yet

Liability (2.1m cap reserve x 40%)Staff Cost (2.1 intrinsic $2 actual)Cash [(7-5) x 400k]

Record over-provision of staff cost & exercise

600k200k

240k

840k

800k

240k

40k800k

20x5 DecRemaining liab =1.5mS. price = 8Exercise: Last 600k rights

Liability (extinguish rest of liability)Staff cost ($3 actual $2.5 intrinsic) x 600k

Cash (S. price $8 initial $5) x 600kRecord over-provision of staff cost & exercise

1.5m300k

1.8m

Staff cost over the years = 0.3m + 0.7m + 1.1m + 0.2m + 0.3m = 2.6m

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Share based payment transactions with cash alternatives IMPTArrangement provides either entity or counterparty with choice whether to settletransaction in cash or issuing equity instruments

Depends on whether entity/counterparty has right to choose

Counterpartyright tochoose

SPLITACCOUNTING

If got debtcomponent(liability)

==> revalueat eachreporting enddate!

If counter party has choice of settlement Entity has in fact just issued compound financial instrument with 2components:Debt(i.e. counterparty right to demand cash payment)Equity(counterparty right to demand settlement in equity)

A. Requires split accounting, fair value of debt to determine firstTransactionw partiesnotemployees

Entity should measure FV of goods/services acquiredand measure FV of debt componentfirst.

Residual to equity(FV of goods FV of debt) = FV of equity

Transactionw employees

Entity measure fair value of debt component firstthen fair value of equity; taking into accountcounterparty must forfeit right to receive cash in orderto receive equity instrument

B. On settlement dateCounterpartydemandssettlement inequity

Entity transfer liability to equity, as considerationfor equity instrument issued

Counterpartydemandssettlement incash

Entity treat payment as full settlement ofliability, any equity component previouslyrecognized REMAINS within equity

Entity hasright tochoose

NO SPLITACCOUNTING

Entity hasPresentobligation tosettle in cash

Present obligation to settle in cash ONLY if:- Settlement in equity instrument no commercial

substance (i.e. cant issue more shares, maxed out)- Past policy/practice of settlement in cash- Generally settle in cash if requested

Account as cash-settled SBPTNoobligation tosettle in cash

Transaction account as equity settled share basedpayment

ON SETTLEMENT DATE

Settle in cash Cash payment acc for as share repurchase

Settle by issuingequity instrument

- no further accounting requiredExcess payment recognize as expenses

Illustration 17 - Counterparty has right to choose [Transaction w employee]

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Firm grants CEO right to choose either: (Grant only if she serve 2 years) - Vesting- 1.2m shares OR- 1m phantom shares with right to receive cash payment equal to 1mil shares

If choose share alternative (1.2m): Shares must be held for two years after vesting date

Date Market price of shares

Changes in share prices will affect Liabilitygiven it cash paid based on share pricegivenif phantom share alternative chosen

20x1, Jan 1 $5 per share20x1, Dec 31 $5.40 per share

20x2, Dec 31 $6 per share

COMPOUND INSTRUMENT1. Determine FV of debt alternative first: 1,000,000 x Current mkt price ($5) = $5mil2. Fair value of share alternative

Based on option pricing model, taken into account post-vesting 2 year restrictionFair value of each share = $4.50 on grant dateHence FV of share alternative is (1.2m share as proxy) is $5,400,000 (1.2m x 4.50)

3. CEO must forfeit right to receive either one to receive other:Residual fair value of equity component in compound instrument = (5.4m 5m) = 400k

Apply:(a)Equity settled SBPT treatmentto equity portion (i.e. FV of equity instrument stays)(b)Debt settled SBPT treatmentto debt portionEvent Dr CrGrant date No Journal entries

20x131 Dec

Staff CostLiability (1m x 5.40 x 1 x 0.5)

Recording debt portion using cash settled SBPT

Staff Cost

Capital Reserve (400k unchanged x 1 x 0.5)Record equity portion using equity settled SBPT

Entries CombinedStaff Cost

Liability (price of 5.40 x 1m phantom x )Capital reserve (equity component 400k x )

2.7m

0.2m

2.9m

2.7m

0.2m

2.7m200k

20x231 Dec

Staff CostLiability (1m x 6 x 1 x 1) 2.7m

Staff CostCapital Reserve (400k unchangedx 1 x 1) 0.2m

Entries CombinedStaff Cost

Liability (price of 6 x 1m phantom x 1) 2.7mCapital reserve (equity component 400k x )

3.3m

0.2m

3.5m

3.3m

0.2m

3.3m200k

If choosecashsettlement

LiabilityCash

Equity (cap reserve) remains, may be transferred to RE

6m6m

If chooseequitysettlement

LiabilityCapital reserveShare capital (!.2m shares)

6m400k

6.4m

If options nt exercised; at each period, remeasure ONLY liability portion till expiry/settleTREASURY SHARES

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- Treasury shares not considered as assets- Presented as contra-equity, and deduction from equity in balance sheet- Transactions involving treasury shares never give rise to any profit or

loss, excess goes to Equity- See: Seminar 22, Question 2, NEJ 32-240

Example of Treasury shares purchase

Event Dr Cr

Buyback 100kshares @ $2 each

Equity Treasury SharesCash

200k200k

Sale of treasuryshares @ $3 each

CashEquity Treasury SharesEquity

300k200k100k

Use of Treasury Shares for Employee Share Schemes

- Entity grants employees rights to equity instruments of entity- Entity either chooses or is required to buy instruments (i.e. treasury

shares) from another party- Accounted for as Equity settled SBPT

Two Transactions:1. Equity settled SBPT2. Share buyback

Accounting For Deferred Tax: Treasury shares for ESO

Hence noting the timingdifference fordeductions;

This leads to aTEMPORARY

DIFFERENCE

Amount of Temp DifferenceAccounting Base (CA) = Nil, given this impactequity portion of B/STax Base (TB): Amount IRAS permits as deduction in future periods

CA TB DTD TR DTA

NIL 100 100 20% 20

NIL 120 120 20% 24

See Illustration 18 below for Treasury Share deferred tax example.

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ILLUSTRATION 18: Treasury shares for ESO and Deferred TaxRCL approved plan to grant 10,000 ESOs to each 13 employees

- Strike price: $3- Options granted on 1 Jan 2006

o Vesting conditional upon employee working till 31 Dec 2008o After 3 years vesting, employee has until 31 Mar 2009 to exercise

Year Blackscholes fair pricing SGX Market price

2006 Jan 1.5 Keep this constant for equity SBPT 3

2006 Dec 1.6 3.3

2007 Dec 1.85 3.6

2008 Dec 1.9 4

Date Attrition: Expect one employee to leave each year,

Dec 2006 Total estimated remaining after vesting: 10

Dec 2007 Total estimated remaining after vesting: 10

Dec 2008 Actual remaining: 11 employees

RCL to transfer treasury shares to employees under ESOS, take advantage of tax deduction

Tax: 20%:RCL Share buyback 110,000 shares at $4 on 31 Dec, all 11 employees exercised option

IRAS: Deduction: Diff btw cost in acquiring shares & amt paid by employee

Date CA TB (Note: exercise amt is $3) DTD DTD X TR = DTA Change

20x6 NIL [3.3-3) x 10 x 1,000 x 1/3 10,000 2,000 +2,000

20x7 NIL (3.6-3) x 10 x 1,000 x 2/3 40,000 8,000 +6,000

20x8 NIL (4-3) x 11 x 1,000 x 3/3 110,000 22,000 +14,000

Non-cash settled, stick with original fair pricing for option when grantedEvent Dr Cr

20x6 Dec

Record staff cost

Temp diff, claimdeductible in future

Staff Cost

Capital Reserve ESO(10 x 10,000 x 1.5 x 1/3)

Deferred Tax AssetTax Expense

50k

2k

50k

2k

20x7 DecRecord staff cost

Temp diff, deductiblein future

Staff CostCapital Reserve ESO(10 x 10,000 x 1.5 x 2/3) -50k

Deferred Tax AssetTax Expense

50k

6k

50k

6k

2008 Dec

Record staff cost

Share buyback

Temp diff, claimdeductible in future

Staff Cost

Capital Reserve ESO(11 x 10,000 x 1.5 x 3/3) -100k

Equity - Treasury Shares ($4 x 110,000)Cash

Deferred Tax AssetTax Expense

65k

440k

14k

65k

440k

14k

2009, Mar 31

Empty DTA

Cash (110,000 x $3)what employees paid to exerciseCapital reserve ESO Empty the cap reserve

Equity -Treasury Shares you provided T-sharesEquity Capital revenue gain on disposal of T-Shares

Tax ExpenseDeferred Tax Asset (Empty DTA on closing)

330k165k

22k

440k55k

22k

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DEFERRED TAX FOR STAFF COST DEDUCTIONSA. If IRAS accord staff cost deductions when its incurred (no temp diff)

Date Dr Cr

2008Jan 1

No entry as havent vest

Dec 31 Staff CostLiability

Tax payableTax expense (20% x 20,000)

20k

4k

20k

4k

2009Dec 31

LiabilityStaff Cost (4.5k x 10,000 x 1) 20k

Cash

Tax payableTax expense (20% x 25k)

20k25k

5k

45k

5k

B. If IRAS accord tax deductions based on staff costs related to SARs onlywhen paid to employees (Cash Basis)

Date Events2008Jan 2

Precision entered into agreement to give 1,000 share appreciation rights(SARs) to each 100 senior employees

Each SAR entitles employee cash payment equal to PELs share price onexercise date in excess of exercise price of $20

SAR vests conditionally upon employee working for PEL until 31 Dec2010Employee has until 31 Dec 2011 to exercise SAR after vesting period

2008Dec

Total expected to leave PEL: 2Exp Remaining: 98

2009Dec

Total expected to leave PEL: 7Exp Remaining: 93

2010Dec

End of vesting periodTotal actual remaining: 8840 employees exercised their SARs on 31 Dec 2010None of remaining SARs were exercised in 2011

201131 Dec

Share price = $19

TAX ISSUEStaff costs incurred in relation to SARs was deductible for tax purpose only when paidto employees

Tax rate = 20%, may assume probable PEL sufficient taxable profit for utilization of DTA.

Year Fair value of SAR Share price

31/12/08 $3 $2031/12/09 $4 $22

31/12/10 $5 $24

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Tax for Liabilities [Staff cost exp]CA: Liability account arising from staff costTB: Carry Amt Future deductible (only when paid to employee ~ cash basis)

Year CA TB DTD (CA-TB) DTA(Temp diff x TR)

Change

31/12/08 98k 0 98k 19,600 19,60031/12/09 248k 0 248k 49,600 30,000

31/12/10 248+192-200= 240k

0 240k 48,000 (1,600)

Date Dr Cr

Year 1Record staffcost throughvesting

Staff CostLiability(3 x 98 x 1,000 x 1/3)

Deferred Tax Asset

Tax Expense (Principle 2, underlying)

98,000

19,600

98,000

19,600

Year 2Record staffcost throughvesting

Staff CostLiability(4 x 93 x 1,000 x 2/3) 98k

Deferred Tax AssetTax Expense

150,000

30,000

150,000

30,000

Year 3Last vesting

40 exercised48 remaining*FV of SAR = 5Record 160kpaid to staff

Account forDeferred tax

*Deductiblesgiven as cashis paid, as 40employeesexercised

Staff CostLiability

(5 x 88 x 1,000 x 3/3) 248k

Liability (440k remaining 48 x 1,000 x 5*)Staff costdiff placed hereCash (S. price $24 - $20) x 40 x 1,000

Tax expenseDeferred Tax Asset

Tax payable (cash given of 160k x 20%)Tax expenseGiven deductibles accorded when cash given

Analytical CheckP&L staff cost: (192k-40k) x 20% = 30,400Tax accounted for: 32,000 1,600 = 30,400

192,000

200,000

1,600

32,000

192,000

40,000160,000

1,600

32,000

2011Dec 31

Liability (remaining extinguished)Staff Cost

Tax expense (240k x 20%)Deferred Tax Asset empty DTA

240,000

48,000

240,000

48,000

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INT FRS 111: Group Share-Based Payment Transactions

Accounting for share based payment transactions involves:- Entity buying shares of another entity to satisfy obligation to employee- Two or more entities in same group

Entityreceiving the goods/services shall measure

Nature of Award Own EquityInstruments

Cash or other assets(including another groupentitys equity instrument)

Entitys Obligation toSettle?

Yes Equity-Settled Cash-Settled

No Equity-Settled Equity-settled

Entity settling SBPT when another entity receives goods/services shall recognizetransaction as an equity-settledSBPT only if its settled in entitys own instruments.

- Otherwise recognize as cash-settled SBPTScenario 1: Subsidiary employees granted rights to Subsidiarys equityinstrument by either Subsidiary/Parent

Subsidiary:Obligation: YesOwn Instrument: Yes

- Equity SettledParentObligation: Yes??Own Instrument: No

- Cash SettledConsolidated:Equitysettled

Scenario 2A: ILLUSTRATION A1Parent grants right to its own equity instrument to subsidiary employee

Subsidiary

Obligation: NoOwn Instrument: No

- Equity Settled- Capital contri

ParentObligation: YesOwn Instrument: Yes

- Equity SettledConsolidated:Equity Settled

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Scenario 2B: ILLUSTRATION A2Subsidiary grant rights to its parents equity instruments to its employees

Subsidiary:

Obligation: YesOwn Instrument: No

- Cash SettledParent:

- No EntryConsolidated:Equity Settled

Scenario 3: Involving cash-settled SBPTWhen parent obliged to pay cash to supplier/employees of subsidiary linked to:

(a)Price of Subsidiary equity or (b) price of Parent equity

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Illustration A1: Parent grants right to its instruments direct to subsidiary staffINT FRS 111: ESOPto be accounted for as equity settledfor all books.

- P approve plan that grants top 5 executives of Subsidiary ESO to purchase 200kshares each

- Exercise price: $5 per share- Options granted on 1 Jan 20x1, vested on 31 Dec 20x3- Fair value of each option is $1.50

Event Dr Cr

S Books Staff Cost (1,500,000 /3)Capital Reserve Contribution from P

500k500k

P Books Investment in S (1,500,000 /3)Capital Reserve ESOP

500k500k

Group F/SConsolidated

adjustments

Capital reserveInvestment in S

500k500k

As a result, in group statement: Staff cost increase by 500k, Capital reserve ESOP increase by 500k.

- Effect similar to case where company issue own equity instrument to ownemployees (I.e. subsidiary employee as parents employee)

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Illustration A2: Subsidiary grants rights to parents equity instrument to its staffINT FRS 111:Require subsidiary to account it as cash settledRequire accounting ofequity settled in consolidated statements No accounting entries in parents book

- Subsidiary approve plan to grant top 5 executive right to purchase 200k each ofparents share

- Exercise price: $5- Option granted on 1 Jan 20x1, vest on 31 Dec 20x2- ALL employees exercised option in Dec 20x3 when share price is at 6.40

Share Market Price Fair value of Option

1 Jan 20x1 $5 $1 (For equity based payment, this dont change)

31 Dec 20x1 $5.90 $1.20

31 Dec 20x2 $6.20 $130

Event Dr Cr

31 Dec 20x1 - VESTINGS Books Staff Cost (1.20 x 5 x 200k) x ~ liability reval

Liability600k

600kGrpStatement

LiabilityStaff Cost

(Reverse cash settled entry by subsidiary)

Staff cost ($1 constant option value x 200k x 5) X Capital reserve ESOP

(To record ESOP as equity settled)

600k

500k

600k

500k

31 Dec 20x2 - VESTING

S Books Staff Cost (1.30 x 5 x 200k) x 2/2 600kLiability

Liability revaluation less prior recognition

700k700k

GrpStatement

For beg20x2

LiabilityStaff cost

Reverse cash settled entry by subsidiary

Staff Cost ($1 constant value x 200k x 5) X 1 500k

Capital Reserve ESOP

LiabilityBeginning Retained ProfitBeginning Capital reserve ESOP

(Consolidation adjustments for20x1!)

700k

500K

600k

700k

500k

100k500k

31 Dec 20x3 REDEMPTION DATES Books Staff Cost (1.30 x 5 x 200k) x 2/2 600k

Liability (all liability emptied, all exercised)Cash (actual 6.40 initial share 5) x 5 x 200k

Additional cost incurred as shares went up by 100k

0.1m1.3m

1.4m

Group Treasury Shares 100k

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statement

For beg20x3

Staff cost(Reverse cash settled recognized by subsidiary)

Treasury shares (700k + 600k)Staff Cost

Beginning capital reserve (500k + 500k)(Consolidation adjustments for20x1, 20x2, 20x3)

Capital Reserve ESOPStaff Cost

Treasury shares(Record exercise of ESOP and cancellation of treasuryshares)

1.3m

1m0.4m

100k

0.3m

1m

1.4m

Note: In subsequent years no future consolidation adjustments required,group incurred 1.4m in staff compensation, amount charged to groupbeginning RE.

NO accounting entries required in parents book

Disclosure Page 953

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EXTRA

Miscellaneous: Company act amendments (2005)

The reform of the share buyback regime Enabling of redemption of preference shares The introduction of the concept of treasury shares allow a company to

hold re-purchased shares in treasury instead of cancelling themo Though treasury shares has no voting/dividend rights

Miscellaneous: IRAS Tax Circular- Companies able to use treasury shares to fulfill ESO/Share awards- Firms that grants ESOs/Share awards through treasury shares accorded

a tax deduction- Given equity-based remuneration that are effected through treasury

shares involve companies incurring actual outlay in buying back own

shares Outlay given tax deduction- For purpose of allowing deductions for treasury shares under ESO

o Tax treatment not aligned w accounting treatment under FRS102o Amount of deduction is based on amount firm actually incurred

(i.e. diff btw cost to firm of acquiring treasury shares transferred toemployee and amount paid by employee for treasury shares)

Miscellaneous: Hagopian and boring professors with accountants

Why ESO should beexpensed (FASB)

Why ESO should not be expensed (Hagopian)

Share price dilution ESO Is a gain sharing instrumentHas no accounting costs unless and until there isgain to be shared

Cost of gain sharing instrument must be located onbooks of party that reap gain, shareholders reapthe gain (in higher share price) hence cost of ESOborne by shareholders (i.e. share price dilution)

Cost to shareholders already properly accountedfor under the treasury stock method of accounting

as a transfer of value from shareholders toemployee option holders

ESO Is a transferrableoption, has tangible valueonce vested is a paymentfor employee service andshould be expensed

Neither granting nor vesting ESO meet standardaccounting definition of expense

Granting of ESO is not opportunity cost either.

ESO is diff from transferable stock option with acall premium

Hard to value ESO, due to liquidity and otherissues

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Miscellaneous: More boring professors arguing w Hagopian

Why ESO should be expensed (Bodie, Kaplan, Mrton)

1. Fallacy that stock options do not represent real costa. Transfer of value do not have to involve transfers of cashb. Issuing stock options to employees incurs a sacrifice of cash opp cost

which needs to be accounted for.c. Seen as cash forgone by issuing options to employees rather than

selling to investors opportunity costd. Options use to offset cash company conserves by paying employees

lesspart of remuneration package

2. Fallacy: Cost of employee stock options cannot be estimateda. Claim that employee stock options are private contrat, illiquid

instruments that cant be sold, swapped or pledged, hence hard tovalue

b.

True that instrument lack of liquidity will reduce value to holder, butholder liquidity loss makes no diff to what it costs issuer to createinstrument. Hence issuer should record!

c. May use blackscholes model or variant of it to value, esp with currentfinancial technology Though less precise than cash payouts/sharegrants but financial statements should be as representative as possible

3. Fallacy: Stock option cost are already adequately discloseda. Fallacy that cost of option grants in footnotes to financial statements,

investors/analysts may adjust income statements for cost of optionsand will have necessary data available in footnotes

b. But, relegating such item of major economic significance as employeeoption grants in footnotes would systematically distort reports

c. Esp when database and programmes calculate profitability ratiosbased on numbers in companies audited P&L/B/S. affectcomparability, need for more faithful presentation

d. Also, auditors and executives place lesser emphasis on footnotes thanmain figures, hence might miss out this significant item.

4. Fallacy: Expensing stock options will hurt young businessa. Irony to point 3, as it current disclosure in footnotes is adequate for

communicating economics of stock option grants, then moving costfrom footnote to main balance sheet, income statement figures willhave no market effect

What will expensing involve?1. Benefits accrue to firm from issuing stock options occur in future periods2. Use a straight line amortization formula that will reduce management

error/bias despite some loss of accuracy. i.e. Option that vests over period3. Besides reporting issue of options as expenses in income statement, option

grant should appear on balance sheet. Cost of options recognize in B/S attime of grant as paid in capital

4. Firm to revise income number they have reported should employees forfeitoption and leave company

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Extra Questions in Seminar

Answer:A

Careful for exams!!Must check if FV can be measured:If can be reliably measured, dont use intrinsic value even ifshare prices for each period providedIf cant be reliably measured, use intrinsic value but must re-measure every period

Answer:A