Accounting Oddities Tracey Berthcsi, CEP, Brandywine Realty Trust Julie Kenia, CEP, Stock & Option Solutions Steve Laskowski, CEP, Prudential Elizabeth Stoudt, CEP, Aon
Agenda Modifications Non-employee Accounting Unexpected Volatility Swings Q&A -2-
Brandywine Realty Trust At Brandywine, 'Best of Class' is our mission and the focus in all that we do. It is our goal in developing, building and managing the nation's most remarkable Class-A office and mixed use properties. We continuously support and give back to the communities in which we live and work. Our mission influences a corporate culture that fosters the potential for excellence in every employee. Location Market Cap Total Employees 384 Employees Receiving Equity Stock Options Radnor, PA $2.80 B RSUs 23% Performance RSUs 4% 0% (have not been awarded since 2011) -3-
Current Equity Awards Time Vested Restricted Share Rights Award-1/3 of Award 3 Year Cliff Vest with Retirement Provision for Officers (VP and above) Restricted Performance Share Units (RPSU s)-2/3 of Award 3 Year Performance Based Vest with Retirement Provision for Officers (VP and above) Retirement Eligible is defined as separation from service from the Company and its Subsidiaries after attaining age (57) and completing at least (15) years. Expense Recognized from date of grant through Retirement Eligibility date -4-
Prudential Financial, Inc. For nearly 140 years, Prudential Financial, Inc., has helped individual and institutional customers grow and protect their wealth. Today, we are one of the world's largest financial services institutions with operations in the United States, Asia, Europe, and Latin America. We also have one of the most recognized and trusted brand symbols: The Rock, an icon of strength, stability, expertise, and innovation. We strive to create long-term value for our stakeholders through strong business fundamentals, consistent with our mission, guided by our vision, and directed by our company's core values. We are committed to keeping our promises and to doing business the right way. Location Market Cap Newark, NJ $34 B Total Employees 49,000 Employees Receiving Equity Stock Options 160 RSUs 3,000 Performance RSUs 160 ESPP 11,000 12,000
MODIFICATION ACCOUNTING -6-
What is Modification Accounting? 718-20-35-3: A modification of the terms or conditions of an equity award shall be treated as an exchange of the original award for a new award. -7-
List of Modifications ESPP with reset, rollover, or allows increases (within offering period) Extension to posttermination exercise window Acceleration of vesting (exec terms) Modify to allow vesting after termination Resetting of performance targets Employee status changes (employee to non or vice versa) Option exchange / repricing Spin Offs Mergers Addition of retirement eligibility provisions Equity to liability, or liability to equity change -8-
Accounting for Vesting Modifications Before After Modification Probable Probable Probable to Probable Type I (ASC 718-20-55-111) FV of original award Other Modification measure incremental expense (new award) Improbable Probable to Improbable Type II (ASC 718-20-55-113) FV of original award Update forfeiture estimate Other Modification measure incremental expense (new award) Improbable Improbable to Probable Type III (ASC 718-20-55-116) FV of modified award only Other Modification included in FV of modified award Improbable to Improbable Type IV (ASC 718-20-55-118) FV of modified award only Other modification included in FV of modified award No expense impact - improbable -9-
Steps to Modification Accounting Terms Data Type(s) Data Load/Book / Notify Gather terms of modification Severance / term agreement Original grant agreements If multiple dates involved, get legal s input on modification date Vested vs. unvested, outstanding, award type Type I Probable to Probable e.g., Vested, extension to exercise period Before/After Type III Improbable to Probable e.g., Unvested, acceleration Options gather B/S inputs Volatility Expected Term If Type III determine expense already taken for unvested options/units Load into system Book expense Notify other depts (tax, etc.) Document Memos are actually important here Explain terms, inputs used, etc. -10-
Type I vs. Type III Type I Usually vested shares Can be unvested too, with reprice, etc. Keep Original Expense continue to book Before/After Fair Value If After > Before = incremental expense Incremental for vested book immediately Incremental for unvested book over remaining service period Can never result in less expense Type III Always unvested Reverse original expense for unvested shares Calculate new fair value, no before/after If acceleration book immediately Can result in less expense -11-
Type I Extension of Grace Period Continue to book original fair value Before/After Fair Value = Incremental expense (or not!) Options only RSUs no grace period, before/after = same! -12-
Option Modification Extension of Grace Period Before 3 months to Exercise Exercise Price: $2 Market Value: $5 Expected Term: 0.25 years Volatility: 40% (for.25 years) Interest Rate:.30% (for.25 years) Fair Value: $3.00 After 3 years to Exercise Exercise Price: $2 Market Value: $5 Expected Term: 3.00 years You could argue for less, but no one does Volatility: 60% (for 3 years) Interest Rate: 1.00% (for 3 years) Fair Value: $3.35 Incremental Fair Value: $0.35-13-
Type III Acceleration of Unvested Shares Reverse original expense for UNVESTED options/units Calculate and book new fair value Options if they remain outstanding / exercisable, new fair value impacts tax accounting and diluted EPS -14-
Acceleration of Vesting Disability, Death or Retirement Restricted Stock: Vesting for all Restricted Shares shall occur provided that Grantee is an employee of the Company and as of such Vesting Date Grantee shall be entitled to the delivery of Shares with respect to such Restricted Share RPSU s: the Grantee shall be eligible to receive Shares (if any) under the Program as if the Measurement Period ended on last day of the month in which termination or death occurred and as though the Grantee had remained employed by the Employer through such date. -15-
ESPP Modifications Plan features that trigger modifications Allowing increases in contributions within an offering period If you have multiple purchase periods, most common to allow change for subsequent purchases within the same offering Resets and Rollovers Think of it as an option repricing Changes to plan mid-offering Increasing a share limit Any other broad changes to terms Must calculate pre and post modification expense to determine incremental charge ESPPs are complicated because you must also consider the impact on the number of shares to be purchased -16-
Typical ESPP Modifications Increase in ESPP Contributions Calculate the fair value for the additional shares that can be purchased with the increased contribution amounts Continue to expense original estimated shares to be purchased True Up at purchase is complicated Original Contributions at Beginning of Offering Contributions 5,000 Increase in Contribution During Offering $ $ 1,000 Shares 500 100 Fair Value $ 1.50 $ 0.25 Expense $ 750.00 $ 25.00 Resets/Rollovers Calculate the before/after fair value - incremental Continue to expense original expense -17-
Performance Award Modifications Changing the goals Still must consider 4 types of modifications Determine probable or improbable both pre and post-modification Do you even have modification expense? Ex. Type I modification for performance (non-market) conditions that doesn t impact number of awards to vest What if original target is met but new target is not met? If the award was expected to vest even without the modification at the time of modification (Type I or II), you will recognize expense on the original award. What about market condition awards? Can t assume probable or improbable based on perceived stock price performance Must calculate pre and post-modification expense, typically with a Monte Carlo simulation model -18-
Options and Antidilution Provisions What if antidilution provision is missing or is discretionary? 2 for 1 stock split example Pre-Modification Exercise Price: $50 Number of Options: 100 Pre-Split FMV: $100 Post-Split Expected FMV: $50 Expected Term: 4.00 years Volatility: 25% Interest Rate: 1.00% Dividend Yield: 2.00% Fair Value: $8.38 Post-Modification Exercise Price: $25 Number of Options: 200 Post-Split FMV: $50 Expected Term: 4.00 years Volatility: 25% Interest Rate: 1.00% Dividend Yield 2.00% Fair Value: $22.87 Incremental Expense: ($22.87 x 200) - ($8.38 x 100) = $3,735-19-
Common Modification Accounting Mistakes Miscategorizing type of modification Type I vs. Type III Get the documents! Assuming pre-modification fair value is the grant date fair value Using incorrect expected term Reversing all expense, not just unvested Assuming that it is/isn t a modification Get the documents! Change to consultant language around service in grant agreement -20-
NON-EMPLOYEE ACCOUNTING -21-
Accounting For Non-employee Grants Non-employee Grants Accounting Formerly EITF 96-18 now ASC Topic 505-50 Final measurement at vest date, not grant date as with employee options Expected term generally is remaining contractual term Exceptions to this rule Re-estimate fair value each quarter until final vest date Black/Scholes or option-pricing model for options Market value for RSUs/RSAs Choice of accelerated or straight-line amortization EITF 96-18 required accelerated attribution, but FAS123(R) removed this requirement Generally preferred to use same attribution method in use as for employee grants Most companies use straight-line attribution -22-
Accounting For Non-employee Grants Many systems do not support accounting for non-employee grants Many companies use a spreadsheet to calculate Spreadsheets are error-prone and sometimes incorrectly designed When implementing a system, calculations will often not match Impact on Tax Accounting Diluted EPS -23-
Non-Employee Accounting Excel Functions EOM() Allows you to set the fair value date to the last date of the month End of quarter =EOMONTH(fair value date,mod(12-month(fair value date),3)) Yearfrac() Difference between two dates Doesn t work for remaining contractual term when expire date is in the past Lookup for intersection of two values in a table VLOOKUP(fair value date, 'Interest Rate'!A:L, MATCH(Interest Rate Term),'Interest Rate'!$1:$1,0)) -24-
Table Lookup Interest Rate Term (1, 2, 3, etc.) Look up 5 years as of June 6, 2013 Use for interest rates, volatility -25-
Index /Match will change your life Actual quote! Throw out Vlookup Use only Index / Match instead Advantages of index match Faster Reduces file size RIGHT to LEFT lookups! Not broken if/when you INSERT a column! Quick demo: http://storage.pardot.com/14822/116424/vlookup_022615.mp4-26-
Common Non-employee Accounting Mistakes Not realizing that s/he is a non-employee Doesn t apply to outside directors Scientific Advisory Boards Consultants Not using remaining contractual term Not locking down expense at VEST DATE Continuing to mark-to-market well past vest date Not realizing impact on diluted EPS/tax accounting Timing of notification of change from employee to nonemployee -27-
Change in Status Accounting Employee to Non-Employee Use same approach as non-employee accounting Add Effective Date prorate expense for period of non-employee Non-Employee to Employee Stop non-employee accounting Determine fair value as of change in status date, continue with employee accounting -28-
UNEXPECTED VOLATILITY SWINGS -29-
Unexpected Volatility Swings What does the accounting guidance say? Assumptions used to estimate the fair value of equity and liability instruments granted to employees should be determined in a consistent manner from period to period The valuation technique an entity selects to estimate fair value for a particular type of instrument also should be used consistently and should not be changed unless a different valuation technique is expected to produce a better estimate of fair value. (ASC 718) The staff would not expect that a company would frequently switch between valuation techniques or models, particularly in circumstances where there was no significant variation in the form of share-based payments being valued. (SAB 107) -30-
Changing Volatility Methodology Excluding periods of time The staff believes that if Company B disregards a period of historical volatility, it should be prepared to support its conclusion that its historical share price during that previous period is not relevant to estimating expected volatility due to one or more discrete and specific historical events and that similar events are not expected to occur during the expected term of the share option. The staff believes these situations would be rare. (SAB 107) For example, in computing historical volatility, an entity might disregard an identifiable period of time in which its share price was extraordinarily volatile because of a failed takeover bid if a similar event is not expected to recur during the expected or contractual term. If an entity s share price was extremely volatile for an identifiable period of time, for instance, due to a general market decline, that entity might place less weight on its volatility during that period of time because of possible mean reversion. (ASC 718) -31-
Changing Volatility Methodology New types of awards (options versus market-based performance awards) Historical volatility Significant acquisition, spin-off, or other corporate transaction Implied volatility Change in volume or open interest Change in maturities available -32-
Contact Info Tracey Berthcsi, CEP Senior Compensation & Benefits Manger 555 East Lancaster Avenue, Suite 100 Radnor, PA 19087 Bus: (610) 832-4970 E-mail: tracey.berthcsi@bdnreit.com Julie Kenia, CEP Senior Equity Compensation Consultant 910 Campisi Way, Suite 2E Campbell, CA 95008 USA Bus: (408) 979-8700 E-mail: jkenia@sos-team.com Steve Laskowski, CEP Director, Financial Reporting 100 Mulberry Street, Gateway 3 Newark, NJ 07102 Bus: (973) 802-8635 E-mail: steven.laskowski@prudential.com Elizabeth Stoudt, CEP Director 1650 Market Street Philadelphia, PA 19103 Bus: (908) 380-0144 E-Mail: estoudt@radford.com -33-