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
Paid in Capital Stock Options $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
Paid in Capital Stock Options $110,000
To record Compensation for 2002Compensation Expense $110,000
Paid in Capital Stock Options $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
Recently