Narrowing Your Options! April 29, 2004

Transcription

1 Narrowing Your Options! April 29, 2004

2 Presenters Jim Kroeker Deloitte Audit Partner, Accounting Services Group John Sarno Deloitte Manager, Accounting Standards & Communications Group Bo Davis Deloitte Manager, Accounting Services Group Matt Kelpy Deloitte Senior Manager, Accounting Services Group Copyright 2004 Deloitte Development LLC. All rights reserved. 1

3 Setting the Stage Presented by Jim Kroeker

4 Overview Current Environment History of SFAS 123 ED on Share-Based Payment Copyright 2004 Deloitte Development LLC. All rights reserved. 3

5 History of SFAS 123 Issued October 1995, and highly controversial Allowed companies option of intrinsic or fair value accounting Required pro forma disclosure of fair value accounting in companies financial statements if companies applied intrinsic value accounting Up until a couple years ago, only 2 public companies followed SFAS 123 Now ~500 adopted fair value expensing Copyright 2004 Deloitte Development LLC. All rights reserved. 4

6 Exposure Draft on Share-Based Payment Effective dates and transition methods Measurement Disclosure requirements Recognition Modifications Income tax accounting Questions and answers Copyright 2004 Deloitte Development LLC. All rights reserved. 5

7 Effective Dates and Transition Methods, Measurement & Disclosure Requirements Presented by John Sarno

8 Effective Dates and Transition Effective dates Public companies fiscal years beginning after December 15, 2004 Nonpublic companies Nonpublic companies that previously used fair value accounting for recognition or pro forma disclosure purposes December 15, 2004 (does not include companies who adopted pro forma disclosure requirements of SFAS 123 using the minimum value method) All other nonpublic companies fiscal years beginning after December 15, 2005 Copyright 2004 Deloitte Development LLC. All rights reserved. 7

9 Effective Dates and Transition (cont) Transition methods Public companies required to use the modified prospective method for transition Record compensation cost for new and modified awards Record compensation cost for unvested portion of previously issued and outstanding awards Nonpublic companies Nonpublic companies that previously used fair value accounting for recognition or pro forma disclosure purposes would be required to use the modified prospective method for transition All other nonpublic companies required to use the prospective method for transition Copyright 2004 Deloitte Development LLC. All rights reserved. 8

10 Effective Dates and Transition (cont) Transition methods (cont) Liability awards Examples of liability awards are awards settled in cash or other assets (e.g., cash settled stock appreciation right (SAR)) Awards reclassified as liabilities accounted for as a change in accounting principle (cumulative effect) Awards previously recorded at intrinsic value adjusted to fair value as a change in accounting principle (cumulative effect) Copyright 2004 Deloitte Development LLC. All rights reserved. 9

11 Effective Dates and Transition (cont) Liability awards example 1 Facts Assume award re-characterized as a liability award under the proposed standard Amount previously recorded in additional paid in capital (APIC) = $100 Fair value of the liability award on the date of initial adoption (January 1, 2005) = $120 Fair value of the liability award on December 31, 2005 = $110 Copyright 2004 Deloitte Development LLC. All rights reserved. 10

12 Effective Dates and Transition (cont) Liability awards example 1 (cont) Step 1: Company would reclassify any amounts currently in APIC to a share-based liability Dr. APIC 100 Cr. Share-based liability 100 Step 2: Company would fair value the award on the date of adoption; excess recorded as cumulative effect adjustment Dr. Cumulative effect adjustment 20 Cr. Share-based liability 20 Step 3: Mark the liability to fair value each reporting period Dr. Share-based liability 10 Cr. Compensation cost 10 Copyright 2004 Deloitte Development LLC. All rights reserved. 11

13 Effective Dates and Transition (cont) Liability awards example 2 Facts Assume liability award was previously recorded at intrinsic value and now needs to be recorded at fair value under proposed standard Intrinsic value of liability award currently recorded in financial statements = $120 Fair value of liability award on date of initial adoption (January 1, 2005) = $150 Fair value of liability award on December 31, 2005 = $175 Copyright 2004 Deloitte Development LLC. All rights reserved. 12

14 Effective Dates and Transition (cont) Liability awards example 2 (cont) Step 1: Adjust liability award to fair value on date of adoption Dr. Change in accounting principle 30 Cr. Share-based liability 30 Step 2: Mark the liability to fair value each reporting period Dr. Compensation cost 25 Cr. Share-based liability 25 Copyright 2004 Deloitte Development LLC. All rights reserved. 13

15 Effective Dates and Transition (cont) Prior adoption of fair value accounting No transition exceptions, even for those who adopted fair value accounting under SFAS 148 Retroactive restatement will not be permitted under the transition provisions of proposed standard Companies could retroactively adopt fair value accounting under SFAS 148 prior to adoption of the proposed standard Achieves comparability of compensation cost reported in the financial statements Copyright 2004 Deloitte Development LLC. All rights reserved. 14

16 Effective Dates and Transition (cont) Prior adoption of SFAS 123 example Facts Assume a company issued an at-the-money sharebased award in calendar year 2002 with grant-date fair value of $20 and four year vesting requirement In 2003, the company adopts fair value accounting under prospective transition provisions of SFAS 148 In 2005, the company adopts the provisions of proposed standard Copyright 2004 Deloitte Development LLC. All rights reserved. 15

17 Effective Dates and Transition (cont) Prior adoption example (cont) Result In 2002, the company records no compensation cost as award accounted for at intrinsic value under APB 25 In 2003 and 2004, the company records no compensation cost as the award was a previously issued award and the company adopted fair value accounting prospectively In 2005, the company records $5 of compensation cost only for the unvested portion of the award under the modified prospective method Copyright 2004 Deloitte Development LLC. All rights reserved. 16

18 Measurement Measurement principle = grant date fair value Valuation models Regardless of model used, the proposed standard requires the use of certain inputs to determine fair value Preference for lattice model (i.e., binomial type model), as opposed to a closed form model (i.e., Black-Scholes model) Copyright 2004 Deloitte Development LLC. All rights reserved. 17

19 Measurement (cont) Valuation models (cont) Lattice model Affords companies ability to vary expected term of award depending on employees exercise and post-vesting termination behaviors Allows companies ability to incorporate different volatility percentages or dividend rates over term of award Copyright 2004 Deloitte Development LLC. All rights reserved. 18

20 Measurement (cont) Nonpublic companies Minimum value method eliminated must estimate volatility Make a one time policy decision (fair value vs. intrinsic value remeasured at each reporting date) Employee share purchase plan exemption removed Eliminates current SFAS 123 exemption for plans with no look-back and maximum 5% discount Noncompensatory only if terms are same as those available to all shareholders of same class of equity Copyright 2004 Deloitte Development LLC. All rights reserved. 19

21 Disclosure Requirements Similar to required disclosures for companies who had adopted SFAS 123 Additional disclosures required Intrinsic value of options exercised Compensation cost capitalized Amount of unrecognized compensation cost Other Copyright 2004 Deloitte Development LLC. All rights reserved. 20

22 Recognition of Compensation Cost & Modifications Presented by Bo Davis

23 Recognition of Compensation Cost General concepts Total compensation cost recognized based on the number of instruments that eventually vest Awards vest when employee s right to award is not contingent on performance of additional services Compensation cost recognized over requisite service period Compensation cost cannot reverse if vested award expires unexercised Copyright 2004 Deloitte Development LLC. All rights reserved. 22

24 Recognition of Compensation Cost (cont) Impact of service conditions, performance conditions and market conditions on recognition Recognition for award with performance condition based on best estimate of outcome of performance condition Example $100 of NI = 100 options vest, 60% probability $200 of NI = 200 options vest, 20% probability $300 of NI = 300 options vest, 20% probability Record compensation for 100 options (most probable outcome) Copyright 2004 Deloitte Development LLC. All rights reserved. 23

25 Recognition of Compensation Cost (cont) Market conditions For awards with a market condition, compensation cost recognized if service condition achieved, but market condition not satisfied Proposed standard uses market condition instead of target stock or specific amount of intrinsic value Result: Some awards previously considered to have performance condition may now be considered to have a market condition Copyright 2004 Deloitte Development LLC. All rights reserved. 24

26 Recognition of Compensation Cost (cont) Major differences from SFAS 123 Forfeitures No longer allowed to recognize compensation cost for entire award and recognize forfeitures as they occur Awards with graded vesting No longer allowed to straight-line compensation cost for awards with graded vesting Follow FIN 28 model, which results in accelerated compensation cost recognition Copyright 2004 Deloitte Development LLC. All rights reserved. 25

27 Recognition of Compensation Cost (cont) Awards with graded vesting example Grant 1,000 options with fair value of $10 ($10,000) Options vest ratably over the 4 year service period SFAS 123 allowed recognition of $2,500 per year Recognize as follows (FIN 28 model) Award Year 1 Year 2 Year 3 Year 4 Tranche 1 2,500 Tranche 2 1,250 1,250 Tranche Tranche ,208 2,708 1, Copyright 2004 Deloitte Development LLC. All rights reserved. 26

28 Recognition of Compensation Cost (cont) Liability awards companies must recognize compensation cost based on fair value (not intrinsic value) Nonpublic companies can recognize compensation cost based on either fair value or variable intrinsic value Copyright 2004 Deloitte Development LLC. All rights reserved. 27

29 Modifications Modification accounting similar to SFAS 123 Modifications include Extending life of award Adjusting exercise price of award Adjusting performance conditions of award Changing award s classification A modification that increases the fair value of the award results in incremental compensation Copyright 2004 Deloitte Development LLC. All rights reserved. 28

30 Modifications (cont) Incremental compensation equals excess of fair value of modified award over fair value of original award immediately before modification Total recognized compensation cost equals total of: Portion of grant date fair value vested or is expected to vest Incremental cost resulting from the modification Copyright 2004 Deloitte Development LLC. All rights reserved. 29

31 Modifications (cont) Modification example (vested options) 1/1/X1 100 options granted at the money, $30 exercise price; $15 fair value 1/1/X4 options are vested but the stock price has declined to $20; company resets or reprices the option to $20 Fair value of modified option at 1/1/X4 $12 Less: fair value of original option at 1/1/X4 <9> Additional compensation cost $ 3 Copyright 2004 Deloitte Development LLC. All rights reserved. 30

32 Modifications (cont) Modification example (cont) $1,500 = compensation cost already recognized during the vesting period ($15x100) $300 = additional compensation cost ($3x100) $1,800 = total The modified options immediately vested, so additional compensation cost immediately recognized ($300) Copyright 2004 Deloitte Development LLC. All rights reserved. 31

33 Modifications (cont) Cash settlement of vested awards If at fair value, settlement accounted for as repurchase of outstanding equity instrument Cash payment exceeding fair value is additional compensation cost No adjustment to original compensation cost Copyright 2004 Deloitte Development LLC. All rights reserved. 32

34 Modifications (cont) Modification of nonvested awards Accounting same as vested options, except recognize the unrecognized compensation cost from original options plus incremental compensation cost for modified options over remaining vesting period of modified options Copyright 2004 Deloitte Development LLC. All rights reserved. 33

35 Modifications (cont) Cash settlement of nonvested awards Same as vested, except that the settlement immediately vests options Results in immediate recognition of remaining unrecognized compensation Copyright 2004 Deloitte Development LLC. All rights reserved. 34

36 Modifications (cont) Modifications of vesting conditions Vesting requirements based on service conditions, performance conditions, or a combination Generally, compensation cost for equity awards not recorded for less than grant date fair value, unless award fails to vest Copyright 2004 Deloitte Development LLC. All rights reserved. 35

37 Modifications (cont) Modifications of vesting conditions Awards expected to vest under original terms, recognize compensation cost if either Awards vest under modified requirements Awards would have vested under original requirements Awards NOT expected to vest under original requirements, recognize compensation only if modified award vests No compensation cost for awards that do not vest Copyright 2004 Deloitte Development LLC. All rights reserved. 36

38 Modifications (cont) Modifications that change award s classification Compensation cost for equity awards not recorded for less than grant date fair value unless award fails to vest Normally, compensation cost for liability awards ultimately recorded at intrinsic value when settled However, modifications can change these general rules Copyright 2004 Deloitte Development LLC. All rights reserved. 37

39 Modifications (cont) Equity-to-liability modification Compensation cost for equity awards not recorded for less than the grant-date fair value unless award fails to vest Ultimate compensation cost will equal the greater of (a) grant-date value of original award or (b) fair value of modified liability award when settled Anti-abuse provision companies could modify underwater equity awards to make them a liability and recognize only compensation cost for fair value when settled Copyright 2004 Deloitte Development LLC. All rights reserved. 38

40 Modifications (cont) Liability-to-equity modification Account for the award as if it had been classified as equity from the grant date Except when modification date fair value is greater than grant date fair value Copyright 2004 Deloitte Development LLC. All rights reserved. 39

41 Tax Provisions: Changes and Challenges Presented by Matt Kelpy

42 Income Tax Accounting Two-event approach to income tax accounting Grant of option represents compensation event At vesting, the equity instrument is issued thus representing a financing activity Tax benefit deficiencies are recorded to the income statement (debit to expense) Excess tax benefits recorded as an adjustment to APIC (credit to equity) Copyright 2004 Deloitte Development LLC. All rights reserved. 41

43 Income Tax Accounting Income Taxes An example Company issues options that vest over 3 years with a fair value of $60 on the date of grant and an exercise price of $30. The company s effective tax rate is 40% Years 1-3 (each year) Dr. Deferred tax asset 8 Cr. Tax benefit 8 Copyright 2004 Deloitte Development LLC. All rights reserved. 42

44 Income Tax Accounting Income Taxes An example (con t) On the date of exercise the company s common stock is worth $130. The tax deduction is equal to the share price on the date of exercise less the exercise price ($100 = $130 - $30). Dr. Income tax receivable 40 Cr. APIC 16 Cr. Deferred tax asset 24 Copyright 2004 Deloitte Development LLC. All rights reserved. 43

45 Income Tax Accounting Income Taxes An example (con t) Alternatively, on the date of exercise the company s common stock is worth $60 Dr. Income tax receivable 12 Dr. Tax expense 12 Cr. Deferred tax asset 24 Copyright 2004 Deloitte Development LLC. All rights reserved. 44

46 Income Tax Accounting Income Taxes An example (con t) Should the option expire un-exercised the Company would be required to reverse the previously recognized tax benefit through the statement of operations Dr. Tax expense 24 Cr. Deferred tax asset 24 Copyright 2004 Deloitte Development LLC. All rights reserved. 45

47 Q&A

48 Deloitte Resources For the Record Exposed! Fair Value Accounting for Share-Based Payments Heads Up Narrowing Your Options! Fair Value Accounting for Share-Based Payments Copyright 2004 Deloitte Development LLC. All rights reserved. 47

49 Continuing Professional Education Deloitte personnel requiring CPE credits for attending this web conference, please your name, office, responsibility center and social security number to Natalie Saviano. No CPE credit is available for playback. Clients will be sent a CPE certificate from their Deloitte representative that should be processed according to their office procedures. Copyright 2004 Deloitte Development LLC. All rights reserved. 48

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