Certified Equity Professional Institute

Transcription

1 Exam Overview Webinars Certified Equity Professional Institute Level 2 Exam Overview Webinar Accounting Certified Equity Professional Institute The information presented herein is of a general nature and has been simplified for presentation to a large audience. It is not a complete discussion of all aspects the laws, rules, regulations, standards, and principles that govern equity compensation plans. The contents are neither designed nor intended to be relied upon, and should not be considered, as legal, tax or accounting advice. Your specific situation may involve circumstances that cause the laws, rules, regulations, standards and principles described herein to apply differently. You should consult your own advisors before deciding what, if any, course of action to take in your own particular situation.

2 Accounting Overview 20% of the Exam Definitions and Concepts ASC 718 Staff Accounting Bulletin 107 ASC 260 Tax accounting IFRS 2-2-

3 Grants to Employees Fair Value Options option-pricing model Black-Scholes Lattice model Suboptimal exercise factor Likelihood that employees will terminate and be forced to exercise the option sooner than they would otherwise Restricted Stock/Units FMV If dividends are paid on the stock but not paid on the grant, FMV discounted Performance awards Non-market conditions FMV Market conditions generally Monte Carlo simulation -3-

4 Grants to Employees Private company option valuations Private companies must also estimate volatility Peer companies Index not often used Private companies may not have sufficient history to estimate expected life Simplified method under SAB 107 Only permissible for plain vanilla options Sometimes permissible for public companies (especially if recently public) Average of vesting period and contractual term. Example: Option with 4-year graded vesting and a 10-year term Average vesting period for 4-year graded vesting schedule: (1 x 25%) + (2 x 25%) + (3 x 25%) + (4 x 25%) = 2.5 years Expected Life = (2.5 years + 10 years) / 2 = 6.25 years -4-

5 Grants to Employees Equity awards Settled in stock Measurement date generally = grant date Fair value calculated at grant and not adjusted Liability awards Required cash settlements Cash-settled SARs, sash-settled RSUs, or phantom stock Cash- or stock-settled If employee choice or outside company control (if probable) If company decides, only if pattern of paying cash instead of shares Measurement date = settlement date (exercise, payout, expiration) Fair value recalculated each reporting period until settlement date -5-

6 Grants to Employees Grant date for equity awards Grant date cannot occur until all required approvals have been obtained Including shareholder approval of plan, if required No expense is recognized until all required approvals have been obtained Grants must be expected to be communicated within a relatively short period of time after approved, for approval date to be considered grant date Otherwise, mutual understanding of the terms does not exist -6-

7 ASC 718 Expense Attribution Expense is recorded over requisite service period Typically the vesting schedule ASC 718 defines three types of service periods: Explicit Expressly stated under the terms of the award Example: Vests over 4 years in equal, annual installments Implicit Inferred based on vesting requirements Example: Vests upon completion of a sales target, which is expected in 18 months Derived Calculated using an option pricing model Example: Can only be exercised if stock price doubles after grant date Can be more than one type and can change -7-

8 ASC 718 Expense Attribution If service period is non-substantive, expense is recorded immediately Applies when: Vesting is accelerated (or continued) upon retirement, and Award recipient is eligible to retire Where awards provide for accelerated vesting upon retirement If award recipient is eligible to retire at grant, all expense is recognized immediately Otherwise, recognize expense over the shorter of: Vesting Period Period in which award recipient will become eligible to retire -8-

9 Accounting Straight-line vs. accelerated attribution Example: Grant vests in three equal, annual installments, $120,000 total FV Straight-Line Attribution Expense per year Year 1 Year 2 Year 3 Total Straight-line attribution: $ 40,000 $ 40,000 $ 40,000 $ 120,000 Accelerated Attribution Expense per year Year 1 Year 2 Year 3 Total First vesting tranche: $ 40,000 $ 40,000 Second vesting tranche: $ 20,000 $ 20,000 $ 40,000 Third vesting tranche: $ 13,333 $ 13,333 $ 13,334 $ 40,000 Total for the award: $ 73,333 $ 33,333 $ 13,334 $ 120,000-9-

10 Accounting Accelerated attribution Why use? IFRS 2 requires for options/awards with graded vesting Performance or market based vesting conditions attached to grants -10-

11 ASC 718 Forfeitures General Rule No expense is recorded for shares that are forfeited Shares that cancel before they are earned Previously recorded expense for forfeited shares can be reversed Expense for vested shares is not reversed (even if they expire unexercised) Applies To Options, SARs, awards with: Service-based vesting conditions (time) Performance-based vesting conditions Where performance conditions are not related to stock price Note: Under no circumstances is expense ever reversed for an option that has vested. Expense is still recognized for vested options that expire unexercised, even if the options are underwater at expiration. -11-

12 ASC 718 Forfeitures If vesting is contingent on service conditions Forfeitures can be accounted for as they occur, with no estimation Company records full fair value of grant. Expense reversed as forfeitures occur. Expected number of forfeitures can be estimated at grant and expense recorded only for awards that are expected to vest Expense attribution is adjusted only if expectations change or actual outcome differs from expectations If forfeiture rate estimate changes, true up in period in which estimate changes Awards with fair value of $300,000 vesting in three annual increments. The company applies an annual estimated forfeiture rate of 2%. Total Estimated Fair Value: $288,160 First vest tranche: $98,000 ($100,000 x 98%) Second vest tranche: $96,040 ($100,000 x 98% x 98%) Third vest tranche: $94,120 ($100,000 x 98% x 98% x 98%) Accelerated Attribution Straight-Line Attribution Year 1 Year 2 Year 3 Year 1 Year 2 Year 3 Total First vest tranche $98,000 $98,000 $98,000 Second vest tranche $48,020 $48,020 $96,040 $96,040 Third vest tranche $31,373 $31,373 $31,374 $94,120 $94,120 Total: $177,393 $79,393 $31,374 $98,000 $96,040 $94,120 $288,

13 ASC 718 Forfeitures If vesting is contingent on performance conditions Expected number of forfeitures estimated at grant and expense recorded only for awards that are expected to vest Expense attribution is adjusted only if expectations change or actual outcome differs from expectations If forfeiture rate estimate changes, true up in period in which estimate changes -13-

14 ASC 718 Forfeitures Adjustment to Estimate Adjustments to expense as a result of a change in forfeiture estimate (or increase/decrease in expected payout of a non-market performance award) is recorded on a cumulative basis in period that change occurs Example: Award for $90,000 worth of stock vesting in full at end of three-year period. Initial estimate of forfeitures is 5% per year, but at the end of year two, the estimate is adjusted to 3% per year. How much expense is recorded in the second year of the service period? Year 1 Total expense = $77,164 ($90,000 x.95 x.95 x.95) Expense recorded in year 1 = $25,722 Year 2 New total expense = $82,141 ($90,000 x.97 x.97 x.97) Total expense at end of year 2 = $54,760 ($82,141 x 2/3) Expense recorded in year 2 = $29,038 ($54,760 - $25,722) -14-

15 ASC 718 Forfeitures - Exception to General Rule Options, SARs, awards with market-based vesting conditions Related to value of corporate stock Absolute value of stock Rise in stock price Comparative value of stock Shareholder return Fair value is calculated using sophisticated option-pricing model Takes into account likelihood of reaching price target Expense is not reversed if the forfeiture is due to failure to achieve market condition Expense is reversed if forfeiture due to termination (failure to meet service condition) -15-

16 ASC 718 Transactional Issues Stock-for-stock, net exercises Do not impact accounting treatment Can tender shares (even those acquired during the current transaction) to cover cost without generating additional cost This applies under both ASC 718 and IFRS 2 Share withholding ASC 718: If stock used to pay taxes, withholding must be limited to maximum individual tax rate in the applicable jurisdiction to avoid liability treatment This is new beginning with first accounting period after December IFRS 2: Shares tendered back to the company to cover tax withholding must be limited to the minimally required tax withholding. If not, shares withheld to cover taxes get liability treatment. -16-

17 ASC 718 Modifications What is a modification? Changes not required under the original terms of the grant Repricings / option exchanges Acceleration of vesting Unlikely to result in additional expense if NOT in connection with termination of employment (shortens expected term) Extension of post-termination grace period Addition of new exercise method Also unlikely to result in additional expense Cancellation and regrant Type I modification No reversal of prior expense Continue to recognize remaining expense (if not yet fully vested) Additional, incremental expense calculated and accrued over new/remaining service period -17-

18 ASC 718 Compensatory ESPP Accounted for in same manner as a stock option Fair value can include up to three components Discount at offering begin date Value of look-back: Proportionate value of at-the-money call option granted on enrollment date Value of additional shares: Proportionate value of at-the-money put option granted on enrollment date Expense is attributed over service period offering period Fair value of each purchase period is computed separately Forfeitures Expense reversed for terminations Expense is not reversed for voluntary withdrawals and reductions in contribution % -18-

19 ASC 718 Accounting for Tax Benefits Reconciles expense recognized for a grant to the tax benefit realized For non-qualified arrangements, assume future benefit Reduce tax expense DTA (deferred tax asset) is recorded DTA = FV multiplied by company s corporate tax rate Recorded as expense is recognized Once actual tax deduction is realized, DTA is reversed Compare actual tax benefit to estimated tax benefit (DTA) If tax benefit exceeds expense, record difference as excess tax benefit If tax benefit is less than expense, record additional tax expense (deficiency or shortfall) Actual DTA = Positive = Excess / windfall Actual DTA = Negative = Deficiency / shortfall -19-

20 ASC 718 Accounting for Tax Benefits Qualified Arrangements (ISOs and ESPPs) No reduction in tax expense assumed at grant No automatic corporate tax deduction Even if history suggests pattern of disqualifying dispositions DTA is not recorded Upon actual disqualifying disposition: Reduce tax expense based on lesser of tax deduction or expense recognized for the arrangement Increase paid-in-capital if deduction exceeds expense -20-

21 ASC 260 Earnings Per Share Basic earnings per share Net earnings / common stock Diluted earnings per share Net earnings / (common stock + common equivalents) Issued Stock (stock owned by shareholders) Unissued Stock Employee stock options/ RSUs / RSAs Warrants Convertible preferred stock -21-

22 ASC 260 Earnings Per Share Basic and Diluted EPS Common stock in denominator is increased by shares issued pursuant to employee stock transactions (exercises/issuances) Weighted for period outstanding Diluted EPS Common equivalents in denominator calculated using Treasury Stock Method Assumed vest/exercise/issuance Newly issued shares would increase denominator Hypothetical proceeds used to repurchase shares at average FMV, lessening impact of exercise Exercise cost /price Average Unamortized Expense (excluding forfeitures) -22-

23 ASC 260 Treasury Stock Method Hypothetical assumed proceeds Two sources Exercise cost Total option price of shares exercised / released Unamortized expense Portion of compensation expense not yet recognized Considered part of the exercise proceeds Average unamortized expense over the period Computed without respect to estimated forfeitures Used to buy back shares -23-

24 ASC 260 Treasury Stock Method Anti-Dilutive Options Option increases, rather than decreases, earnings per share Underwater or out-of-the-money options are examples of anti-dilutive options Buyback shares exceed option shares Excluded from Diluted EPS Even in-the-money options can be anti-dilutive Unamortized expense can cause shares repurchased to exceed options outstanding Other important thing to know Restricted stock is treated as a common equivalent until vested Just like a stock option with a price of $0-24-

25 Educational Courses to Assist In Exam Preparation NASPP NCEO Although the CEP Institute makes this information available to candidates, we do not endorse educational programs. The candidate must determine whether the program is suitable for his/her needs. -25-