Chapter 19-1 - ACG 3141 Chapter 19 Share Based Compensation...

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Unformatted text preview: ACG 3141: Chapter 19 Share Based Compensation and Earnings per Share Part 1 (Class 24) 1 Topics Go over Class 23 homework Share Based Compensation Explain and implement the accounting for stock award plans. Explain and implement the accounting for stock options. Explain and implement the accounting for stock appreciation rights. Explain and implement the accounting for stock purchase plans. Distinguish between a simple and a complex capital structure. Describe what is meant by the weighted average number of common shares. Differentiate the effect on EPS of the sale of new shares, a stock dividend or stock split, and the reacquisition of shares. Describe how preferred dividends affect the calculation of EPS 2 Basic Earnings per Share Learning Objectives Explain and implement the accounting for stock award plans. 3 Stock Award Plans – Restricted Stock Restricted stock award plans usually are Restricted tied to continued employment of the person receiving the award. person The The compensation associated with a share of restricted stock is the market price at the grant date of an unrestricted share of the same stock. The amount is accrued as compensation The expense over the service period for which participants receive the shares. participants 4 Restricted Stock On January 1, 2006, Matrix, Inc. awarded 10,000 On shares of its $2 par value common stock to its CEO. The shares will be forfeited if the CEO leaves within the next five years. On January 1, the common stock of Matrix is selling for $62 per share. Matrix No entry is required on January 1, 2006, but total No compensation is calculated at the date of grant as follows: compensation Number of × Shares issuable Fair value per share Total = Compensation 10,000 × $62.00 = $620,000 5 Restricted Stock The total compensation of $620,000 will be The recognized over the service period of 5 years. recognized $620,000 ÷ 5 = $124,000 per year On December 31, 2006, through 2010, we will On prepare the following journal entry: prepare GENERAL JOURNAL Date Description Debit Credit Dec 31 Compensation expense 124,000 Paid-in capital - restricted stock 124,000 6 Restricted Stock On December 31, 2010, the restrictions are On lifted, and the following entry will be made: lifted, GENERAL JOURNAL Date Description Debit Credit Dec 31 Paid-in capital - restricted stock Common stock (10,000 x $2) Paid-in capital in excess of par 620,000 20,000 600,000 7 Restricted Stock Instead, assume that the executive leaves in 2008, before Instead, becoming vested in the restricted shares. By 12/31/2007, the company would have accrued $228,000 ($124,000 x 2 years). company When the stock is forfeited, the entries originally accruing the When compensation expense must be reversed. This will be one of the very few situations in which you will credit an expense account. account. GENERAL JOURNAL Date Description Debit Credit 12/31/07 Paid-in capital - restricted stock 228,000 228,000 Compensation Expense reverse 2 years x $124,000 8 Stock Option Plans In most cases, employees are not awarded In not shares of stock. Rather they are given an option to buy shares at some time in the future. the Options are usually granted 1. for a specified number of shares, 2. at a specified price, 3. during a specified period of time. 9 Learning Objectives Explain and implement the accounting for stock options. 10 Expense – The Great Debate Historically, options have been measured at Historically, their intrinsic value – the simple difference between the market price of the shares and the option price at which they can be acquired. If the market and exercise price are equal on the date of grant, no compensation expense is recognized even if the options provide executives with substantial income. substantial 11 Expense – The Great Debate Critics to current practice have identified three Critics objections. objections. 1. Options with no intrinsic value at issue have Options zero fair value and should not give rise to not expense recognition. expense 1. It is impossible to measure the fair value of It compensation on the date of grant. compensation 1. Current practices have unacceptable economic Current consequences. consequences. 12 Recognizing Fair Value of Options Effective for fiscal years beginning after June 15, 2005, companies now are required to estimate the fair value of stock options on the grant date. SFAS 123 (revised) requires the use of an SFAS option pricing model that deals with the: option 1. Exercise price of the option. Exercise 2. Expected term of the option. 3. Current market price of the stock. 4. Expected dividends. 5. Expected risk-free rate of return. 6. Expected volatility of the stock. 13 Stock Option Plans On January 1, 2006, Matrix, Inc. grants options to On purchase 100,000 shares of the company’s $1 par value common stock to four key executives. The options may be exercised during the next 10 years, but not before December 31, 2010. The exercise and market price of the stock on January 1 is $57 per share. The fair value of the options, estimated using an options pricing model is $5 per option. is 14 Stock Option Plans January 1, 2006: Calculate total January compensation expense. compensation Shares per executive 100,000 Number of executives 4 Total shares 400,000 Compensation per share $ 5 Total compensation $ 2,000,000 $2,000,000 ÷ 5 years (2006 through 2010) = $400,000. years 15 Stock Option Plans - Inception The following entry will be made on The December 31, 2006 through 2010, the service period. service GENERAL JOURNAL Date Description Debit Credit Dec 31 Compensation expense Paid-in capital - stock options 400,000 400,000 16 Stock Option Plans – Exercise On May 2, 2011, two executives exercise their On options when the market price of the stock is $92 per share. 200,000 shares × $57 per share = $11,400,000 200,000 GENERAL JOURNAL Date Description Debit Credit May 2 Cash 11,400,000 Paid-in capital - stock options 1,000,000 Common stock ($1 par) 200,000 Paid in capital in excess of par 12,200,000 17 Stock Option Plans – Options Unexercised If no options were exercised during the 10-year exercise period, the following entry would be made when the options expire: would GENERAL JOURNAL Date Description Debit Credit Dec 31 Paid-in capital - stock options 2,000,000 Paid-in capital - expired options 2,000,000 18 Stock Option Plans – Estimated Forfeitures In many cases, the right to receive a stock option is subject to In vesting. Thus, there is the possibility that employees included in the grant will leave the company prior to vesting and forfeit their options. The amount of compensation expense to be recorded for stock options is adjusted down to reflect anticipated forfeitures. This is done by decreasing the estimated fair value. forfeitures. Assume that when Matrix granted stock options to its executives, it Assume had a historic forfeiture rate of 5%. had In our example, Matrix granted 4 options to 100,000 employees at a In fair value of $5 per share. Total compensation expense to be recognized over the five-year vesting period is $2 million ($5 x 4 x 100,000). 5% of this amount (100,000) is estimated to be forfeited. Thus, the total compensation expense to be recognized is $1,900,000. Thus, Matrix’s annual compensation expense will be $380,000 (1,900,000 ÷ 5). 5). 19 Stock Options – Changes in Forfeiture Expectations What if the estimated forfeitures changes during the vesting period? The company adjusts the cumulative amount of compensation expense recorded to date in the year the estimate changes. Assume that, during 2009 (the fourth year), Matrix revises its estimate of forfeitures from 5% to 10%. The new estimate of total compensation would be $1,800,000 ($2 million x 90%) rather than the existing estimate of $1,900,000 ($2 million x 95%). The actual amount of compensation expense recorded during 2006 – 2008 was $1,140,000 (1,900,000 ÷ 5 x 3). The amount of compensation expense that should have been recorded given the new estimate is $1,080,000 (1,800,000 ÷ 5 x 3). The difference in these amounts ($60,000) will decrease compensation expense in 2008. Compensation expense for 2008 would be $360,000 (1,800,000 ÷ 5). However, the $60,000 difference between the new estimate and the old will be deducted from 2008 compensation expense so that 2008 compensation expense will be $300,000. 2009 compensation expense will be $360,000 (1,800,000 ÷ 5). 20 Stock Options – Changes in Forfeiture Expectations Total Compensation Expense (revised expectations) 1,800,000 2006 Compensation Expense 380,000 2007 Compensation Expense 380,000 2008 Compensation Expense 380,000 (these are based on initial expectations of 1,900,000 ÷5) 2009 Compensation Expense 300,000 (based on new expectations of 1,800,000 ÷ 5, less cumulative difference between what was recorded under the old expectation and the new) 2010 Compensation Expense 360,000 (1,800,000 ÷ 5) Total Compensation Expense Recorded 1,800,000 21 Stock Options – Changes in Forfeiture Expectations Note that the cumulative change is made retrospectively by decreasing compensation expense in the year of change. This differs from accounting for similar items (compare to change in estimate for fixed assets). This change affects only forfeitures. If, say, the fair value of the options themselves change over the vesting period (i.e., the market value of the stock increases or decreases), there will be no change to the accounting. Why? The accounting is driven by the inception date. The value at inception is the basis for the total compensation expense. As a result, in a declining market, companies could be showing compensation expense for options that have become worthless. To alleviate this problem, companies turn to Performance Stock Option Plans. 22 Performance Stock Option Plans In some cases, option plans are structured so In that the number of options received and/or the exercise price per share may be based on the occurrence of some future event. occurrence For example, assume on 1/1/06 employees may For receive options to purchase 10 million $1 par common shares at $35 per share after 12/31/09 BUT only if the company’s sales increase by 10% by 12/31/2009. The fair value of the options is determined to be $8 per share. options 23 Performance Stock Option Plans In 2006, all options are expected to vest because the sales target is expected to be met. Thus, the total compensation expense is estimated at $80 million (10 million x $8 per share). In each year of the 4 year vesting period, the company will record compensation expense of $20 million. Assume that in 2008 (after 2 years), the company estimates that it is not probable that the options will vest because the sales target will not be met. The new estimate of compensation will be 0 (0 options expected to vest x $8 per option = $0 compensation expense. In 2008, the company would reverse the 2 years of compensation expense recorded in 2006 and 2007 Debit PIC Stock Options 40 million Credit Compensation Expense 40 million (2 years x 20 million recorded). Because the likelihood of meeting a performance measure also drives the compensation expense (not simply the fair value of the option), when the expectation of meeting the measure changes, compensation expense is adjusted. 24 Learning Objectives Explain and implement the accounting for stock appreciation rights. 25 Stock Appreciation Rights The recipient is awarded the share appreciation which is The share the amount by which the market price on the exercise date exceeds the option price. date Note that SARs do not require the employee to pony up Note any cash to purchase shares. They are compensated for their efforts in increasing the market value of the company’s stock. company’s $$$ 26 Stock Appreciation Rights Stock Appreciation Rights Payable in Shares are Stock part of Equity part Fair Value Approach: The fair value of the SARs is The estimated at the date of grant and accrued to expense over the service period. over Paid-in capital – SAR Plan is credited 27 Stock Appreciation Rights Stock Appreciation Rights Payable in Cash Stock (Liability) (Liability) The compensation, and related liability, The is estimated each period and continually adjusted to reflect changes in the market price of stock until the compensation is finally paid. compensation Liability – SAR plan is credited 28 SAR Example (Illustration 19-3, p. 962) At January 1, 2006, Universal Communications issued SARs that, upon exercise, entitle key executives to receive compensation equal in value to the excess of the market price at exercise over the share price at the date of grant. The SARs vest at the end of 2009 (cannot be exercised until then) and expire at the end of 2013. The fair value of the SARs, estimated by an appropriate option pricing model, is $8 per SAR at January 1, 2006. The fair value reestimated at December 31, 2006, 2007, 2008, and 2009 is $8.40, $8, $6, and $4.30 29 SAR payable in Stock - Equity Calculate total compensation expense: $ 8 estimated fair value x 10 million SARs granted $80 million The total compensation is allocated to expense over the four-year service (vesting) period: 20062009 is $20 million ($80 million ÷ 4). 30 SAR Payable in Cash - Liability If cash is to be paid, the company must accrue a liability. General liability accounting rules apply. That means that the amount of the liability is adjusted to value each year (and compensation expense will be likewise adjusted). At grant on 1/1/06, the SARs were worth $8 At 12/31/06, $8.4 At 12/31/07 - $8 At 12/31/08 - $6 At 12/31/08 - $4.3 31 SAR Payable in Cash - Liability 32 Learning Objectives Explain and implement the accounting for stock purchase plans. 33 Employee Share Purchase Plans Broad-based plans offer stock options to all Broad-based employees rather than a select few. employees No compensation involved if . . . 1. All employees meeting employment qualifications All participate. participate. 1. Equal offers of stock to all eligible employees. 1. Exercise period is reasonable. 1. Only modest discount from the market price is available (no Only greater than 5%). greater Purchases made under non-compensatory plans are Purchases treated as regular stock issuances. treated 34 Employee Share Purchase Plans If a plan becomes compensatory because one of the four non-compensatory requirements are not met, the discount element will be compensation expense to the employer. For example, assume that the plan offers a 15% discount on share price to employees. Normally stock sells for $1,000. The entry would be: Cash Compensation Expense Common Stock 850 (discounted price) 150 (discount) 1,000 35 Learning Objectives Distinguish between a simple and a complex capital structure. 36 Earnings Per Share (EPS) Of the myriad facts and figures generated by Of accountants, the single accounting number that is reported most frequently in the media and receives by far the most attention by investors and creditors is earnings per share. earnings The main purpose of the complex and often arbitrary The EPS rules are meant to lead to greater comparability. EPS Note that EPS refers only to common stock!!! 37 Basic Earnings Per Share *Current period’s cumulative preferred stock Simple Capital dividends (whether or not declared) and Structure (Basic EPS) noncumulative preferred stock dividends (only if declared). (only Net income (after tax) – Preferred dividends* Weighted average outstanding common stock Number of shares outstanding × Number of months outstanding ÷ 12 Weighted average shares outstanding 38 Two Types of Earnings Per Share Basic Earnings per Share: The company has a “simple” capital structure. That is, in addition to its common stock, the company has no securities that have the potential to dilute (i.e., decrease) Earnings per Share. Diluted Earnings per Share: The company has a “complex” capital structure. That is, in addition to its common stock, the company has securities that have the potential to dilute (i.e., decrease) Earnings per Share. 39 Learning Objectives Describe what is meant by the weighted average number of common shares. 40 Issuance of New Shares Compute the weighted average number of shares of common stock outstanding. shares Date 1/1 4/1 10/1 Description Balance Issued Issued No. of Shares 100,000 50,000 10,000 41 Issuance of New Shares Compute the weighted average number of shares of common stock outstanding. shares 100,000 x 12/12 (shares outstanding from 1/1) +50,000 × 9/12 (shares issued on 3/1) +50,000 +10,000 × 3/12 (shares issued on 10/1 +10,000 3/12 = 140,000 weighted average shares outstanding 140,000 42 Learning Objectives Differentiate the effect on EPS of the sale of new shares, a stock dividend or stock split, and the reacquisition of shares. 43 Stock Dividends and Stock Splits Common shares issued as part of stock Common dividends and stock splits are treated retroactively as subdivisions of the shares already outstanding at the date of the split or dividend. or 44 Stock Dividends and Stock Splits Compute the weighted average number of shares of common stock outstanding. of Date 1/1 4/1 5/1 Description No. of Shares Balance 100,000 Issued 50,000 Stock dividend(100%) 150,000 45 Stock Dividends and Stock Splits Compute the weighted average number of shares of common stock outstanding. shares (Jan 1 shares 100,000 + 100,000 dividend) x 12/12 = (Jan (April 1 shares 50,000 + 50,000 dividend) x 9/12 = (April Weighted average shares 200,000 200,000 75,000 275,000 Why? Comparing apples to applies (making beginning and Why? ending balances comparable) ending 46 Stock Dividends and Stock Splits Retroactive treatment: New shares issued this period? Yes Stock dividend or split is Stock applied retroactively in proportion to the number of shares outstanding at the time of the dividend or split. of No Stock dividend or split Stock is treated as outstanding from the beginning of the period. beginning 47 Reacquired Shares The weighted average number of shares is The reduced by the number of reacquired shares, time-weighted for the fraction of the year they were not outstanding. not 48 Reacquired Shares Compute the weighted average number of shares of common stock outstanding. shares Date 1/1 4/1 5/1 Description Balance Issued Repurchased shares No. of Shares 100,000 50,000 12,000 49 Reacquired Shares Compute the weighted average number of shares of common stock outstanding. shares January 1 shares 100,000 x 12/12 = January 100,000 Shares issued 4/1 50,000 x 9/12 = Shares Shares repurchased 5/1 (12,000 x 8/12)= Weighted Average Shares 100,000 37,500 ( 8,000) 129,000 Note that there are other ways to do these calculations. 50 Learning Objectives Describe how preferred dividends affect the calculation of EPS 51 Earnings Available to Common Shareholders Net income Less: Current period’s cumulative preferred stock dividends (whether or not declared) Less: Noncumulative preferred stock dividends (only if declared). Net income available to common shareholders 52 Earnings Per Share A company had 200,000 shares of $50 par value common stock, 10,000 shares of 5%, $20 par value cumulative preferred stock, and 30,000 shares of 5%, $10 par value noncumulative preferred stock outstanding during the year. Net income after taxes was $1,500,000. No dividends were declared during the year. EPS would be a. $7.50 a. b. $7.43 b. c. $7.45 c. d. $7.38 d. 53 Earnings Per Share A company had 200,000 shares of $50 par value common stock, 10,000 shares of 5%, $20 par value cumulative preferred stock, and 30,000 shares of 5%, $10 par value noncumulative preferred stock outstanding during the year. Net income after taxes was $1,500,000. No dividends were declared during the year. EPS would be a. $7.50 a. $1,500,000 – (10,000 × 5% × $20 par) b. $7.43 b. 200,000 shares c. $7.45 c. Since dividends were not declared, only Since not d. $7.38 d. the cumulative preferred stock dividends cumulative are subtracted. are 54 Next Time The effect of dilutive securities on earnings per share. Dilutive securities are any security that can decrease Earnings per Share Convertible preferred stock Convertible debt Options and Warrants This gets very complicated. Read carefully and work through the examples in the text. 55 ...
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This note was uploaded on 10/28/2009 for the course ACG 3141 taught by Professor Graybeal during the Spring '08 term at University of Central Florida.

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