Acct 592 SOLUTION Prof. Teresa Gordon

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1 Homework A, Problem 1a - Stock Appreciation Rights (paid in cash) Publicly-traded company Stone Inc. offered stock appreciation rights (S) to its president, Richard Rock, on the appreciation of 100,000 shares of Stone Inc. common stock. The S were granted on December 31, 2014 when the stock was selling for $30 per share. Mr. Rock will receive all price appreciation from the date of the grant until the date of exercise in the form of cash. The earliest possible exercise date was identified as January 1, 2017, and, if not exercised, the S will expire on July 1, The relevant market prices for Stone Co. stock are given in the table below along with the fair value estimates for the S. Assume that Mr. Rock exercised all of his S on March 1, Stone s marginal tax rate is 30%. Mr. Rock holds 51% of the voting shares and is not expected to retire until a. Prepare all necessary entries on Stone Inc. s books assuming that Stone Inc. is a public company with stock trading on the New York Stock Exchange. LIABILITY AWARD - REMEASURED THROUGH EXERCISE Estimated Shares % Earned 12/31/2014 $ $ ,000 $600,000 0% $0 No journal entry Estimated Shares % Earned 12/31/2015 $ $ ,000 $825,000 50% $412,500 Previously recognized = $0 expense $412,500 12/31/2015 expense 412,500 Share-based compensation liability 412,500 Deferred tax asset 30% 123,750 Deferred tax benefit (I/S) 123,750 % Earned 12/30/2016 $ $ ,000 $350, % $350,000 Previously recognized = $412,500 expense ($62,500) 12/30/2016 expense - 62,500 Share-based compensation liability 62,500 - Deferred tax asset 30% - 18,750 Deferred tax benefit (I/S) 18,750 - % Earned 12/30/2017 $ $ ,000 $630, % $630,000 Previously recognized = $350,000 expense $280,000 12/30/2017 expense 280,000 - Share-based compensation liability - 280,000 Deferred tax asset 30% 84,000 - Deferred tax benefit (I/S) - 84,000 HW A - Spring 2011 w ASC.xlsx HW A1-a

2 = INTRINSIC VALUE 3/1/2018 $ Base price Intrinsic value 9.00 % Earned $ 100,000 $900, % $900,000 $ Previously recognized = $630,000 $ expense $270,000 3/1/2018 expense 270,000 - Share-based compensation liability - 270,000 Deferred tax asset 30% 81,000 - Deferred tax benefit (I/S) - 81,000 3/1/2018 Shares-based compensation liability $900,000 Cash $ 9.00 intrinsic value = fair vale at exercise $900,000 Pay contractual amount at difference between mkt value and base price Current taxes payable $ 270,000 Current tax expense $ 270,000 To recognize benefit from tax deduction Deferred tax benefit (I/S) $270,000 Deferred tax asset 30% $270,000 To zero out the deferred tax asset (no further amounts can be deductible) THIS METHOD IS BASED ON ASC (FAS123R, para. A131) TRUE ASC dr=cr? Tax deduction is based on intrinsic value at settlement: $ 9.00 Tax rate 30% Value of tax deduction (per share) $ 2.70 Options exercised 100,000 Reduction in income taxes currently payable = $ 270,000 Share-based compensation liability 12/31/ ,500 (412,500) 12/30/ ,500 - (350,000) 12/30/ ,000 (630,000) 3/1/ ,000 (900,000) 3/1/ , Deferred Tax Asset 12/31/ , ,750 12/30/ , ,000 12/30/ , ,000 3/1/ , ,000 3/1/ ,000 - HW A - Spring 2011 w ASC.xlsx HW A1-a

3 Homework A, Problem 1b - Stock appreciation rights (paid in stock) Publicly-traded company EQUITY AWARD Stone Inc. offered stock appreciation rights (S) to its president, Richard Rock, on the appreciation of 100,000 shares of Stone Inc. common stock. The S were granted on December 31, 2014 when the stock was selling for $30 per share. Mr. Rock will receive all price appreciation from the date of the grant until the date of exercise in the form of stock. The earliest possible exercise date was identified as January 1, 2017, and, if not exercised, the S will expire on July 1, The relevant market prices for Stone Co. stock are given in the table below along with the fair value estimates for the S. Assume that Mr. Rock exercised all of his S on March 1, Stone s marginal tax rate is 30%. Mr. Rock holds 51% of the voting shares and is not expected to retire until Prepare all necessary entries on Stone Inc. s books assuming that the appreciation earned by Mr. Rock cannot be paid in cash. Instead, he will receive shares of Stone Inc. common stock with a value equal to the appreciation from grant date to exercise date. Par value is $1 Difference: will receive stock (no cash) valued at difference between market price at exercise & base price Fair Value Estimated of Shares 12/31/2014 $ $ ,000 $600,000 0% $0 No journal entry Fair Value Estimated of Shares 12/31/2015 $ $ ,000 $600,000 50% $300,000 Previously recognized = $0 expense = $300,000 12/31/2015 expense 300,000 APIC - stock appreciation rights 300,000 Deferred tax asset 30% 90,000 Deferred tax benefit (I/S) 90,000 Fair Value of 12/30/2016 $ $ ,000 $600, % $600,000 Previously recognized = $300,000 expense = $300,000 12/30/2016 expense 300,000 - APIC - stock appreciation rights - 300,000 Deferred tax asset 30% 90,000 - Deferred tax benefit (I/S) - 90,000 HW A - Spring 2011 w ASC.xlsx HW A1-b (2011)

4 Fair Value of 12/30/2017 $ $ ,000 $600, % $600,000 Previously recognized = $600,000 expense = $0 12/30/2017 No adjustment needed - measured at fair value at grant date and 100% earned Fair Value of 3/1/2018 $ $ ,000 $600, % $600,000 Base price $ Previously recognized = $600,000 Intrinsic value $ 9.00 expense = $0 3/1/2018 No adjustment needed - measured at fair value at grant date and 100% earned Actual value earned = 100,000 $ ,000 Expected value earned= 600,000 Excess tax deduction 300,000 Tax rate 30% Excess tax benefit to owners equity 90,000 shares common Number of shares to be issued= 900,000 equals 23,077 $ shares issued (ignoring partial shares) 23,077 $1 par value= $ 23, Additional pd in capital CS $ 576, ,000 TRUE Debit Credit 3/1/2018 APIC - stock appreciation rights $600,000 Common stock 23,077 APIC - common stock 576,923 Remove deferred tax asset: Deferred tax benefit (I/S) 180,000 Deferred tax asset 180,000 Record actual tax deduction & excess benefit Current income taxes payable 270,000 Current tax benefit (I/S) 180,000 APIC - excess tax benefit 90,000 APIC - Stock Appreciation Rights 12/31/ ,000 (300,000) 12/30/ ,000 (600,000) 3/1/ , Deferred Tax Asset 12/31/ ,000-90,000 12/30/ , ,000 12/30/ ,000 - HW A - Spring 2011 w ASC.xlsx HW A1-b (2011)

5 Notes for Research Question Solutions 2.a This question was based on An award specifies that vesting will occur after four years of continuous employee service OR when a new product currently under development is officially launched. The employer estimates that it is probable that the product will be launched by the end of the third year of the award. Explicit = 4 years (required length of employment) Implicit = 3 years = Implied service period since performance condition will be met then (probably) Shorter period will be used since these are "OR" conditions, longer would be used for "AND" conditions Therefore, the requisite service period (the period over which we recognize compensation expense) for this set of facts is 3 years Measurement date for equity awards is the grant date ( & 30-6 and the measurement date for liability awards is the settlement date ( ). I didn't mention cash settlement so I intended for these examples to be equity awards but researching the issue both ways makes for a thorough approach. HW A - Spring 2011 w ASC.xlsx Research

6 2b This question was based on Case A but I added a service condition An award is negotiated with a company s CEO relating to 200,000 options with an exercise price of $20 each. The award is structured so that 40,000 options will vest or be forfeit in each of the next 5 years depending on whether performance targets related to the company s market share are achieved. A five year plan establishes the targets at the inception of the plan. Forfeiture of the options in a particular year will not affect the outcome for any other tranche of 40,000 options. If the CEO does not remain employed by the company, any unvested options at the termination date will be forfeit. Explicit service period = 5 years See also paragraphs cited below not in implementation guidance Each tranche has a different service period, ranging from one to five years. The measurement date is the grant date because the performance targets are set at the beginning Note that this is a performance condition (not a market condition because market condition refers to the STOCK PRICE not the market share of a company's products.) So this example has a "or" condition between the service condition and the performance condition. Note that this is a performance condition (not a market condition because market condition refers to the STOCK PRICE not the market share of a company's products.) In addition, MY scenario has a "AND" condition between a service condition and the performance condition. In other words, you have to work through the vesting date AND meet the market share targets. Therefore, we use the LONGER of the two conditions for each tranche. Examples ASC and Case A & C - grant date at beginnning of tranche 1 for all tranches Tranche 1 Tranche 2 Tranche 3 Tranche 4 Tranche 5 However Case A would have 5 1-year service periods like the next chart Without the service condition, the would look like this: Example ASC & Case B - grant date at beginning of each separate tranche Tranche 1 Tranche 2 Tranche 3 Tranche 4 Tranche 5 Example in 55-95: the measurement date would be at the beginning of each one-year requisite service period because the performance objective is not set until the beginning date of each tranche Examples in & 55-96: the measurement date is at the beginning of Tranche 1 for ALL tranches because the performance objectives are known at that point in time Examples in and 55-96: the GRANT date is at the beginning of Tranche 1 for ALL tranches. HW A - Spring 2011 w ASC.xlsx Research