Source: http://streeterwyatt.com/2015/06/19/accounting-for-equity-awards-a-non-technical-overview-of-selected-key-issues/
Timestamp: 2019-04-21 06:11:06+00:00

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On June 8, 2015, the Financial Accounting Standards Board issued an exposure draft to make some helpful changes to the accounting for compensatory stock options. The most significant would allow awards to continue classification as equity so long as net withholding is less than or equal to the applicable maximum withholding rates rather than minimum withholding rates. Also, equity repurchase rights triggered by a voluntary termination would not cause an award to be classified as liability awards. Other important changes include a change for the accounting for taxes. To make it easier to put these changes in context, we include the accounting article to our executive compensation treatise (“Executive Compensation for Emerging Growth Companies, Thomson Reuters, 2015) with highlights in red below to indicate the changes (please excuse the occasional edit codes that Thomson Reuters embeds into the raw text).
6.1 Introduction. ►Note: FASB has changed the cataloging format for its standards. What was previously known as FAS 123R is now Topic 718. In general, the following chapter uses the original citations to FAS 123R. Generally Accepted Accounting Principles (“GAAP”) in the United States are determined by the Financial Accounting Standards Board (“FASB”), a private professional organization dedicated to the establishment of standards for the fair presentation of financial results in an entity’s financial statements.1 In December 2004, FASB issued ►Financial Accounting Statement 123 (revised), Share Based Payment, (“FAS”) which requires companies to recognize compensation cost on their financial statements in connection with various compensatory equity awards. Awards covered by ►FAS 123R include options, direct shares (including fully vested stock, restricted stock and restricted stock units (“RSUs”) and stock appreciation rights (“SARs”).
►It should be noted that it is likely at some point in the future much of GAAP will converge into standards promulgated by the International Accounting Standards Board (“IASB”).2 IASB has issued its own rule regarding share-based payments in International Financial Reporting Standard (“IFRS”) 2. While IFRS 2 and ►FAS 123R are substantially similar, there are differences that will likely apply to US companies once the convergence is complete.
►See ►§6:45 for a discussion of the rules regarding a change in status from employee to non-employee.
►Also, with respect to consolidated companies, only members of the parent company’s board are treated as employees for purposes of ►FAS 123R, except that a member of a consolidated subsidiary’s board is an employee if the members of the subsidiary board are appointed by the non-controlling shareholders of the parent company or by another member of the consolidated group,3 and further, the controlling shareholder must be precluded from voting for the director.4 This treatment applies only with respect to the consolidated financial statements. If the director is not treated as an employee for consolidated financial statement purposes, the consolidated financial statements will treat awards to that director as awards to a non-employee. However, if that director is elected by the subsidiary’s shareholders, the award will be accounted for as an employee award under ►FAS 123R in the separate statements of the subsidiary.
►►FAS 123R requires companies to value equity-based awards and then “recognize” the cost, typically as an expense or offset to income, as the services are provided.1 As discussed below, the compensation cost typically is recognized as a debit to compensation expense and a corresponding credit to a liability account if the award is subject to liability award treatment (see §6:32) or as an addition to equity (typically addition to paid-in-capital) if equity treatment is available. Because liability treatment involves continuing re-measurement of the award and adjustment of the amount to be recognized, companies generally have a strong preference to avoid liability award treatment.
►The measurement of equity compensation awards subject to ►FAS 123R depends on the fair value of the equity instruments the employer is required to deliver once the employee has satisfied all conditions for the award.1 For awards that qualify for equity treatment (as opposed to liability treatment) the fair value is based on the underlying share price and other factors at the date of grant. For awards subject to liability treatment, the measurement date is the settlement date (the date of exercise, payment etc.).2 Prior to that time, the awards are measured and re-measured at the end of each reporting period.
►For restricted stock, RSUs and similar awards, fair valuation is typically simply the fair value of the underlying stock. Valuation of options and similar rights, such as SARs, is much more complex however. Typically an option permits an employee to purchase the underlying stock at a fixed price equal to the fair value of the underlying stock at grant. Under Accounting Principles Board Opinion APB 25 (“APB 25”), one of the predecessors to ►FAS 123R, typically no compensation expense was incurred because at grant there was deemed to be no compensation element. This is because APB 25 relied on an “intrinsic value” concept rather than ►FAS 123R’s fair value concept–intrinsic value being the difference between the fair value of the stock at measurement (usually the grant date) over the exercise price. Thus under APB 25 and assuming all other conditions for fixed accounting under APB 25 were met, there was no compensation cost recognized if the award required an exercise price exactly equal to the grant date value of the stock to be received. However, FASB concluded there is tangible value to the practical right to purchase stock only when it increases in value with no corresponding obligation to purchase the stock if, for example, the fair value of the stock falls below the exercise price. The award of such a unique right has real and perceived value which is determined under ►FAS 123R and expensed over the vesting period.3 The fair valuation methodology for options is discussed starting at §6:18.
►Also, vesting expectations can influence the pricing models used in valuing options and SARs. In closed-form models such as the Black-Scholes model, an expected term is developed based on assumptions about the option and exercise patterns. The expected term is influenced by the exercise period, and while it cannot be longer than the contractual term, it also cannot be shorter than the vesting term.3 Also, typical lattice models will reflect exercise behavior influenced by vesting.
It should be noted that on June 8, 2015 FASB issued an exposure draft that would permit the employer to forego the expense and uncertainty of estimating forfeitures by electing to account for forfeitures as they occur. The election must be made on a company basis as opposed to a grant by grant basis. Once the rules become effective, the choice of the company—to elect the new permissible treatment or continue estimating—will establish the company’s policy. Any later attempt to change to the other would be treated as a change in accounting principle which requires an assessment of preferability, and the change would have to be reflected retrospectively.
►Certain elements in addition to vesting are not taken into account in determining fair value: reload options and contingent features.1 Reload options typically provide that as an option is exercised, an additional option grant will be made based upon the number of shares exercised. The reload feature does not affect the fair value determination of the original option. Rather, when the reload grant occurs, its value will be determined under ►FAS 123R valuation principles at that time. Also, contingent features that require the return of the equity for less than fair value are not taken into account in determining the grant date fair value. Instead, the contingent feature shall be taken into account when the contingency occurs. Typically such contingencies are referred to as clawbacks, pursuant to which the equity must be returned for cost if, for example, an employee violates a non-compete, or it is later determined that the award was based on accounting results that are subsequently restated.
►Certain exceptions apply, especially for private companies. Private companies generally are companies other than those that have or are controlled by companies that have publicly traded equity securities or have filed a registration statement to publicly trade equity securities.1 Companies that only have publicly traded debt are private companies for purposes of ►FAS 123R.
►FASB believes it is possible to derive a fair value of an option in nearly all circumstances but in those “rare circumstances,” for example, if an option contains such extra-ordinary complexity that such is not the case, any company (including a public company) may use a modified form of the APB 25 rules that preceded ►FAS 123R.1 That is, rather than measuring compensation by reference to a grant date fair value, compensation can be recognized by reference to its intrinsic value, which, as noted above, is the difference between the value of the underlying stock and the option exercise price. This intrinsic value is re-measured every period and compensation is adjusted based on the re-measured amount. Thus, this alternative is comparable to variable accounting under APB 25–a rule that was much detested because of its unpredictable effect on the income statement.
►Also, private companies with liability awards (awards that do not qualify for equity treatment–see §§6:32 et seq.) may choose to have those awards valued on an intrinsic basis rather than the ►FAS 123R fair value basis.1 This choice might make sense in a variety of circumstances, including that, while companies are private there typically is little importance attached to GAAP accounting financial statements–other measures are typically more important such as cash flow, revenue growth etc. Given the complexity of option calculation, under circumstances such as this, the intrinsic value alternative may make sense.
►►FAS 123R generally covers all types of share based awards including employee stock purchase plans (“ESPPs”) subject to ►I.R.C. §423. See ►Chapter 2.
►►FAS 123 provides limited guidance on the accounting for ESPPs.1 For a standard plan with a discount equal to 15% of the lower of the fair market value of the stock at the beginning or end of the purchase period, ►FAS 123R basically concludes there are two components of value: 15% of the beginning purchase period price and an option fair value (see §§6:18 et seq.) equal to 85% of the value of an option to purchase the stock at the end of a purchase period. These two values combined constitute the fair value of the ESPP.
►For more complicated valuations reference must be made to earlier guidance under the previous rule, ►FAS 123.2 Most specifically, many ESPPs that pre-date ►FAS 123R provided for as many as four purchase periods within a 24 month offering period. If the stock price continues to increase, participants in the second, third and fourth purchase periods can still take advantage of the opening price in the first period. This ongoing complexity adds a third element of value to be considered.
►Certain ESPPs are deemed non-compensatory and thus do not require expense recognition, though most companies have assessed that the limited nature of such ESPPs make them too unattractive to warrant the effort and expense to maintain.3 The most important limit is that the discount at which the employees may purchase the shares generally cannot exceed 5% of the actual purchase price (larger discounts need to be justified as genuine costs of raising significant amounts of capital in a public offering if they are to avoid ►FAS 123R recognition). This limitation is not only small in comparison to the maximum 15% allowable under ►I.R.C. §423 but it does not permit the discount to be based on the fair market value at the start or end of the purchase period, whichever is lower, as permitted by ►I.R.C. &s;§423. A discount greater than 5% is permissible if available to all holders of the same equity class regardless whether such higher costs are consistent with the per sharing costs of raising capital. This alternative is rarely attractive.
►Other requirements regarding non-compensatory ESPPs are that all employees be eligible after meeting limited employment qualifications and that employees must enroll no later than 31 days after the price has been fixed.
►In an interesting though not particularly significant wrinkle, if an ESPP provides for a fixed discount (for example, 10%) from the purchase date price only, the award is classified as a liability under ►FAS 150.4 Thus, from the date of grant until purchase the discount and any withholdings show as liabilities on the balance sheet and not as credits to equity. This is because the award will result in a fixed monetary value known at grant with a variable number of shares. See §§6:32 and 6:43 with regard to liability awards. For example, assume an employee elects to have $1,000 withheld for six months with a 10% discount based on the purchase price. Regardless of what happens to the stock price, the employee will purchase $1,111 in value of the stock. Thus, if the stock price is $10 per share, the purchase price will be $9, with a total purchase of $111.11 shares (a value of $1,111). If the stock price is $20, the purchase price will be $18, with a total purchase of $55.55 shares (also a $1,111 value). At purchase a total of $111 must be expensed.
►As noted, share-based awards are generally valued by a fair value method and that value is generally expensed over the vesting period. See §6:25 for rules for determining the date as of when the fair value is determined, and §6:26 for determining the period over which the fair value is expensed.
►It should be noted that while the total compensation cost is generally determined by reference to the value of the equity awarded to the service provider, ►FAS 123R does provide that the value of the goods and services received by the company can be used to determine compensation cost if such measure is more reliably determinable on the basis of such values in share based transactions with non-employees.1 Thus, for example, if a company pays an outside vender X number of shares for services that the vendor provides for a determinable amount of cash to other customers, this value might be a better measurement if those exact same services can be specifically associated with shares provided to an employee. This circumstance would seem exceedingly rare however, and accordingly, the vast majority of ►FAS 123R cost calculations focus on the value of equity paid to employees.
►Observable market prices of identical or similar instruments “in active markets” should be used if available. Thus, awards of stock subject only to vesting should be based on the market price as of the measurement date.
►If observable prices are not available, fair value should be determined (a) based on the exchange value between willing buyers and sellers;2(b) based on established economic principles of modern corporate finance;3 and (c) taking into all substantive characteristics of the instrument4 except those specifically excluded and discussed in §6:8, such as vesting conditions and reload features.
►Determining the fair value of options and similar awards is particularly challenging. As noted, the fair value of share awards such as fully vested stock, stock subject to vesting (commonly referred to as restricted stock) or stock deliverable in the future, typically reflects the value of the underlying stock, either by reference to observable prices in active <?I01AR61 ?>markets or acceptable fair market valuation standards. Option fair value determination is more complex. While the value of the underlying stock is certainly an important component of option fair value, what in fact is being measured is the value of owning a right, not an obligation: (1) to purchase for a price which is typically, though not always, both fixed and known; (2) shares of stock whose number potentially may increase or decrease based on events that are unknown at the time of grant (such as length of employment, satisfaction or non-satisfaction of performance conditions, market performance of the stock); (3) over a period of time that is typically limited, but that also may decreased based on such factors as (again) length of employment.
►To the extent there are observable market prices for options with same or similar terms, such prices should be used. It is exceedingly rare however to find such similar instruments. While vesting is disregarded in valuing underlying stock, vesting is important in determining the expected term of or exercise patterns of an option. Thus, the price an investor might pay for a tradeable option in a company’s stock is not particularly relevant in pricing an employee option in that company’s stock because many terms, including the expected term influenced by vesting, are dissimilar.
►As noted, valuing an option requires that a variety of unknown factors be taken into account. This is not a novel concept–any valuation of an asset to be held over time takes into account assumptions regarding unknown events. Both the purchaser and seller of stock traded on a public market take into account both objective and subjective assessments of future events such as product value in a changing market, barriers to competition, assessment of management effectiveness, ability to deal with debt obligations to identify just a few. The same is true of private company stock valuations that not only take into account the past (revenues and earnings) and the present (current assets) but also the future (what is the rate at which earnings should be capitalized; what is the future value of company intellectual property and goodwill; what is the value of comparable companies–a value influenced as well by future expectations).
►In theory, an option valuation isolates certain aspects of future behavior, though the means of isolating such value can differ. The value of the underlying stock is essentially a given input. Option valuation is an attempt to value certain other elements in reference to that input, such as, how long the right will last, what can be expected to happen to the value of the stock over that period of time, when the exercise price is tendered, and today’s present value of that exercise price. ►FAS 123R generally requires that at the time of valuation (which as discussed in this chapter) can vary depending on whether the award is an equity or liability award, when the award is granted, when it is modified, etc., the fair value assumptions be based on expectations at that time based on information available at that time.2 Changes in information and expectations generally do not affect the original valuation, though if a later valuation is required because for example, certain modifications occur or because the award is a liability award, updated information and expectations as of the time of the revaluation must be taken into account.
►6. volatility of the underlying stock over the expected term.
►The first two variables should be readily determinable (even though a valuation might be required to determine the value of the underlying stock for a private company).
►Note that while the SEC permits safe harbor type expected terms for plain vanilla options of reporting companies, such relief is unavailable for options granted after December 31, 2007, unless the reporting company has insufficient historical data to reasonably estimate the expected term.3 The expiration of the safe harbor for most companies is based on the thought that over time legitimate expectations about behavior patterns could emerge, of course solving one of the more complex elements of the Black Scholes model, an observation that seems to have come to fruition.
It should be noted that on June 8, 2015 FASB issued an exposure draft that would permit private employers (not otherwise subject to SAB 107) to use the plain vanilla safe harbor for determining expected term.
►Stock volatility also has a significant effect on valuation. Stock volatility is basically a measure of the amount a stock price can be expected to fluctuate over the expected term.4 Growth oriented companies typically have significantly more volatility than mature companies principally because there is more perceived data about where a mature company can go in the future as predicted by where it has been over long periods of time. The Black-Scholes value of a stock with greater volatility over the expected term will often be more affected by that volatility because at some time during the expected term a substantial spike in the value of the stock can be expected to occur, increasing the likelihood of exercise during that spike.
►►FAS 123R requires that option pricing models use a time value of money rate equal to the implied yield available at the date of valuation from the United States Treasury zero-coupon yield.1 The implied yield must be computed over the expected term if a Black-Scholes type model is used (if a lattice model is used the term is the option contractual term). The higher the interest rate assumption, the higher the option value due in part to the shrinking true value of the exercise price over the expected term but also due to assumed equity premiums of the stock above the risk free rate.
►Implicit in the value of a share of stock is an allocation of that value to expected dividends. Option holders do not receive dividends and therefore, expected dividend value over the expected term should decrease the fair value of the option itself. The higher the expected dividend, the lower the option value under an option pricing model. Thus, for the typical emerging company, the dividend adjustment is likely to be small because typically dividends are not expected.
►The volatility value, itself a complex determination, is zero for zero volatility and rises with increases in assumed volatility. PwC indicates that the typical formula, when applied to the example above, would yield increases in the option value of $11.52, $23.17 and $32.59 for assumed volatilities of 20%, 50% and 80% respectively. Thus for a company with 50% volatility, the option value is about 46% of the underlying value of the stock at grant.
►Finally, if the option is in the money at that time of grant, the in the money value–intrinsic value–is a third theoretical component of the value of the option as measured by the Black-Scholes model. While in the money option grants are particularly rare under ►I.R.C. &s;§409 (See ►Chapter 2), this component affects an option’s value, for example, when an option is modified or when it is revalued because it is liability award.
►As noted, ►FAS 123R indicates that lattice models are preferable, though, closed-form models such as the Black-Scholes model are acceptable. Lattice models start with inputs similar to those used in a Black-Scholes model: underlying stock value, exercise price, volatility, interest rate and dividend yield. The significant difference is the term–lattice models utilize the entire contractual term.1 While a great deal of individual mathematical calculations must be made to price an option with a lattice model, the model is not a formula but an averaging the present value of a reasonably expected range of cash flows influenced by exercise behavior and contractual terms. The theoretical benefit of a lattice model is that it can be expanded to include virtually all outcomes for such behavior and contractual terms. The basic lattice model starts with the original stock price and then assumes formula increases and decreases over set intervals during the contractual term until a stock value tree is built out at the end of the contractual term.
►Then, having arrived at Time 1, the first anniversary of the grant, the tree moves to Time 2, the second anniversary, assuming upward or downward movements from each of the previous two Time 1 outcomes. This process is repeated until Time 6, the six-year anniversary of the grant. Time 6 thus represents different possible and reasonable outcomes of the value of the stock price at the expiration of the option (obviously the stock value could fall to zero or rise to any number above $724, but under the circumstances and the formula applied, the range derived by the formulas should be a reasonably acceptable range projecting forward from the grant date). The outcomes at the far right are significant numbers–they represent reasonable outcomes of the value of the stock, and when reduced by the exercise price of $100, equal various potential values of the option at its expiration. This is because the day an option expires it is exactly worth the intrinsic value (the excess, if any, of the stock’s fair value over the exercise price), at that time.
►Getting to the year six numbers is the entire point of the first tree and is the starting place for a second tree which, taking the Time 6 value minus the option exercise price, works backward in time to derive the option value at the date of grant. So, notice the far right numbers in the following tree are just the far right number in the preceding tree minus the $100 exercise price, but not below zero.
►Note that the bottom three boxes to the right are zeroes because the fair value of the stock at those boxes is less than the option exercise price.
►However, there is more to it. For example, taking the top two values, they are theoretically the result of either an increase or a decrease from the derived value in Time 5, less the exercise price and adjusted for present value. If one simply averages the $624 and $297, the result is $460. The discounted value of that amount at Time 5, assuming a 3% discount rate is approximately $447, a number somewhat higher than $424 value in the top box of Time 5. This skew looks like a probability skew. For example, if the top box at Time 6 had only a one in three chance of occurring and the second box had a two in three chance of occurring, the value of the box in Time 5 would be approximately $624 + 297 + 297/3, or $406.
►This process is computed for each box in the preceding time node until an option value of $36 is derived as of the date of grant. That is the ►FAS 123R value upon which cost recognition is based.
6:25. When is fair value determined?
►The determination of the valuation of a share-based award that is an equity award is determined on the award’s grant date. The grant date is the date on which the employee and employer “reach a mutual understanding of the key terms and conditions” of the award.1 Notwithstanding the foregoing, the grant date does not occur until all approvals are obtained (including necessary shareholder approval unless such approval is perfunctory, such as when the board approving the change constitutes a majority of the shareholders). Also, the grant date generally does not occur until the company is obligated to issue the award and the employee actually begins to be affected by changes in the stock price.
►Awards subject to liability treatment are measured and then re-measured at the end of each reporting period until the award is settled.2 Generally, the re-measured cost is recognized proportionately over the vesting period and after the vesting period the changes in fair value are recognized in the period in which they occur. See §6:43.
►[An important distinction is necessary here. It is often the case that a grant is made on one date, for example November 1, 2009, but that the vesting period, assume monthly vesting over 48 months, begins as of an earlier date, which is as<?I04AEBM ?>sumed to be August 1, 2009. This might occur when an employee is hired on August 1, 2009 but the compensation committee does not meet until just prior to November 1, 2009.
►The requisite service period may be explicit, implicit or derived.4 While an award may have one or more of the foregoing, only one type of service period may apply for purposes of ►FAS 123R. An explicit service period is one expressly stated in the terms of the award, such as four year monthly vesting.5 An implicit service period is not expressly stated but may be inferred from the terms of the award and other facts and circumstances.6 Thus, if an award is based on completion of a product and it is probable the product will be completed in 18 months, the requisite service period is the implied service period of 18 months. A performance award will typically have an implied service period but recognition will not begin until it becomes probable the vesting requirements will eventually be met, as discussed below.
►►FAS 123R requires that the value of an award be recognized over the requisite service period.1 For an award subject to cliff vesting (all or nothing depending on length of employment), the portion of the grant date fair value that vests on the cliff date must be fully recognized by the reporting date that includes the cliff vesting date. For any reporting dates prior to the cliff vesting date a portion of that value must be recognized on a straight line, or strictly pro rata, basis.2 For example, as of the January 1, 2009 date of grant, assume 1,000 shares are expected to vest on the December 31, 2011 cliff vesting date. Assume the award qualifies for equity (as opposed to liability) award treatment and that the grant date fair value is $10 per share, or $10,000 total value. Assuming the expected vesting assumption remains unchanged as of December 31, 2011, the entire $10,000 must be recognized as of the reporting period ending December 31, 2011. This is accomplished by recognizing $3,333 (one third) in each of the reporting years ending December 31, 2009, 2010 and 2011.
►Consider the same example discussed above except that the option vests in three equal annual installments. If the company elects, it may recognize the $10,000 total cost exactly as it does for cliff vesting: $3,333 recognized each year under the assumption there is one award which vests in full on December 31, 2011. (However, the expense recognized as of each period must be at least equal to the portion that has already vested–thus, if 50% vests in year one and 25% vests in each of years 2 and 3, 50% of the award must be recognized at the end of year 1 and 25% by the end of year 2).
►This method results in a front loaded expensing of options. It was essentially required by the FASB in ►FAS 123R Exposure draft, though the final version of ►FAS 123R also permits the use of the single award straightline concept above.
►As noted, an award subject to performance vesting is not recognized until the performance criteria are “probable” which means likely to occur pursuant to ►FAS 5, Accounting for Contingencies.1 Often, probability is not achieved until the event has occurred, such as when a required IPO or liquidity event occurs. Also, if the event requires a specified return to investors, the award is not a performance based <?I01K4J7 ?>award but is a market based award.2 This distinction can be very significant because cost will be recognized by the end of a time-based vesting period (if any) even if the investor return is never achieved and thus the award never vests.
►Assume that an employer grants options with an exercise price equal to the fair value of the stock on January 1, 2009. Further assume there are 1,000 employees and that all grants will vest at the rate of 100 shares for each 5% increase in market share. Also, the company estimates a 3% forfeiture rate and as of the date of grant the company believes it is probable that a 5% increase in market share is probable but does not believe any greater increase is probable. The fair value of the options is $20 per share at grant.
►As a variation of the previous example, the award provides <?I008YKT ?>that 100 shares per employee vest if certain sales targets are met in each year. Unearned awards do not carry over from year to year and as of the date of grant, management believes it probable that all awards will be earned. In this instance, there will again be three separate awards. Each will be valued at the $20 grant fair value because at the grant date all material terms are known, and each has its own distinct service inception date and requisite service period over which the cost will be recognized because only service and performance during that period will be counted for purposes of that portion of the total award.7 Ignoring the effect of forfeitures, the compensation cost recognized in each year is $2,000,000–the value of 100 option shares in each year for the 1,000 employees.
►►FAS 123R provides an example similar to the following.4 On January 1, 2009 the company grants an option for 200,000 shares to an executive. The option vests if either the price of the company’s stock reaches a certain level for at least 30 consecutive days or the executive remains employed for five years. The company must derive a service period for the market condition and use that or five years, whichever is shorter.5 Thus, if the derived market service period is three years, the grant date option value must be spread over the first three years. If the market condition is satisfied before three years have elapsed, all unrecognized cost must be immediately recognized. If the executive terminates employment before the market condition is met, but after the three-year derived service period, the previously recognized expense is not reversed under any circumstance, even if the executive terminates prior to the five year service requirement and thus never vests.
►If, however, the executive must meet both the market condition and the five year service condition, the requisite service period is the longer of the five year explicit period and the three year derived period and recognition will not commence until it is probable both conditions will be satisfied. If the executive terminates prior to the end of five years without meeting the market condition, any previously recognized cost will be reversed. If the executive is still employed at the end of five years, no cost previously recognized is reversed.
►Share-based awards subject to ►FAS 123R are either subject to equity or liability award treatment. Although most of ►FAS 123R applies to both, there is one significant difference–equity awards are valued as of the grant date and that value does not change, unless there is a modification, while li<?I05YSR1 ?>ability awards are measured and re-measured as of each reporting date until the award is actually settled.1 This is one of the most important distinctions to be made in designing an equity compensation award. The result of ending up with liability treatment is similar to the undesirable variable accounting treatment under previous APB 25, in that it involves unpredictable changes to the amount of compensation recognized while the award is outstanding.
It should be noted that on June 8, 2015 FASB issued an exposure draft that would base the classification of an award with repurchase features as equity of liability on the basis of probability, not whether or not the employee or the employer can control the event. The most obvious example is a repurchase right on voluntary termination. Under the current rules, such a repurchase right would trigger liability treatment. Under the current rules, such a provision would permit the award to be classified as equity unless the voluntary termination were deemed probable by the company.
►An award that is based on a factor, in addition to the company’s stock price, that is not a service, performance or market condition is subject to liability treatment. For example, an award that vests based on a country GNP or who wins the Super Bowl is subject to liability treatment. However, awards that otherwise qualify as equity awards are not liability awards simply because those awards have a fixed exercise price denominated in the currency of a foreign operation or in which the employee’s pay is denominated.
►As for withholding taxes, to continue as an equity award and avoid liability treatment for shares subject to net settlement, the award’s terms must limit the withholding settlement to no more than the minimum state and federal withholding taxes (including FICA and other employment taxes1) and the company does not, as a matter of practice, withhold amounts in excess of the statutory minimums.
However, it should be noted that on June 8, 2015, the FASB issued an exposure draft that would liberalize the current withholding rules to permit equity treatment so long as the withholding settlement does not exceed the maximum rate in a particular jurisdiction. The proposed rule would also require that any cash paid by the employer to the taxing authorities to pay the withholding obligation on a net settlement should be reflected in the cash flow statement as a financing activity.
6:42. Liability awards– Rewards of LLC, subsidiary-based interests, etc.
►The critical analysis focuses on whether the awards in substance are equity awards accounted for as such under ►FAS 123R or more similar to performance or profit sharing arrangements subject to liability treatment. Characteristics indicative of equity treatment are voting and dividend rights similar to those enjoyed by other shareholders. The interest should also constitute equity for corporate law purposes and retain a residual interest in net assets. On the other hand, liability treatment would be indicated by few if any assets underlying the interests, significant subordination of the interests and liquidation or repayment provisions that limit downside or provide for cash payment. If equity is indicated the SEC rejects valuation based strictly on liquidation that ignores the upside potential.
►As noted, ►FAS 123R requires the re-measurement of compensation expense for a liability at each reporting date. Assume a cash-settled SAR is granted on January 1, 2009 and has a six year contractual term but vests on a 100% cliff basis three years after grant. The option has a $100 strike <?I01XD08 ?>price, which is the fair value of the underlying stock at the date of grant. Assume that the grant date fair value of the option, as determined under an appropriate pricing model under ►FAS 123R is $36. Assume that as of December 31, 2009 the fair value of the option is $33.1 In this instance, disregarding the effect of a forfeiture, the cost recognized for 2009 is $11–one third of the reporting date value as opposed to the grant date value.
►Assume that the value of the option at December 31, 2010 has increased to $45.2 For 2006, the cumulative cost to be recognized through the end of the second year is two thirds of the $45. This means $45 minus the expense recognized in 2009 is recognized in 2010: $30-11=$19. Assume at the end of year 2011, the value of the option is $40. The cost recognized in 2011 is the full $40 minus the $30 expensed in 2009 and 2010, or $10.
►At this point, the difference between equity and liability award treatment is that $40 has been recognized as a liability award over the three years of the requisite service period and the amount has varied as follows, based on a number of factors, most significantly a change in the value of the underlying stock: $11 in 2009, $19 in 2010 and $10 in 2001. Also, the grant date fair value is not particularly relevant–value is computed on the reporting date. If the SAR were instead settleable in stock and otherwise eligible for equity treatment, the total expense in this instance would have been $36 and the annual expense would have been $12 based on the grant date fair value. Also, this cost would not have changed regardless of the change in the underlying value of the stock.
►An unexpected and unwelcome example can occur in the event of an equity restructuring such as a stock split or a stock dividend. In the event of such a transaction it is often necessary to adjust the number of shares and/or the exercise price to retain the economic value of an option. However, if such equitable adjustment for anti-dilution is not expressly required by the terms of the option, the accounting firms have taken the position that under ►FAS 123R any such adjustment is a modification of the award. ►FAS 123R permits the amendment of a plan or award to add antidilution features without causing the amendment to be a modification only if the amendment is made before actual restructuring is contemplated. This is a point shat should be reviewed carefully in every plan.
►Alternatively, the company could spread the entire remaining $5,000 over each of the three remaining years ($1,667 each year). If employees quit in 2012 or 2013, compensation cost is adjusted so that only the original grant date value is expensed.
►Often an employee quits working as an employee but continues in non-employee service that counts for vesting purposes. As noted, awards for non-employees are not measured until the vesting date and accordingly, the award is re-measured and expensed similar to a liability award until then.1 If an employee ceases employment, continues in non-employee service and the original terms of the award permit such service to count for vesting purposes, at that point the option’s value is re-measured. The percent of that value represented by the remaining term of the service period is recognized over the remaining term.2 For example, assume an option is granted and that its ►FAS 123R grant date fair value is $100. The option vests on a cliff basis after four years. The option holder quits employment after year three but agrees to continue as a consultant. The option’s original terms permit consulting service to count for vesting purposes. The ►FAS 123R re-measured fair value of the award at termination is $300 (given the option itself has only one year to run, this suggests a dramatic increase in the value of the underlying stock). Assume the amount of cost recognized in the three years before termination is $75. Assuming the option holder continues in consulting service through year four, the amount of cost recognized in year four is the one-quarter of the remaining service period multiplied by $300, or $75. Thus, the total recognized cost of the award is $150.
►If, however, the original award does not permit such service to count for vesting purposes, and is in effect modified to permit consulting service to count for vesting purposes, the award is treated as modified and thus the total value of the re-valued award, minus previously recognized cost, is recognized over the remaining service period. In this case, the amount to be recognized in the one vesting year remaining is $225 ($300 minus the $75 previously recognized). The total amount recognized is thus $300.
►If the acquirer is required to replace target shares, either because of the terms of the acquisition agreement or the target awards themselves, or because of state law, then all or part of the fair value of the replacement award is accounted for as payment of the purchase price to acquire the target. If the acquirer is not required to replace the awards, the entire fair value of the replacement awards is accounted for as ►FAS 123R compensation cost on the acquirer’s post-acquisition financial statements.
►From the amount determined above, an amount is allocated to the purchase price by multiplying the ►FAS 123R value of the awards expected to vest by the requisite service completed before the acquisition divided by the greater of the total service period and the target company requisite service period. The total service period is the pre-acquisition completed service and the post-acquisition requisite service period under ►FAS 123R.
►The remaining amount is recognized as post-acquisition compensation cost.
►There are many other important topics addressed by ►FAS 123R though they are generally more technical matters that go beyond the concerns typically involved in designing executive compensation arrangements.
In general, the current rules require the computation of a “windfall” which is the excess of tax benefits over compensation costs. The windfall is then added as an equity item under additional paid-in capital. In addition, the windfall is classified as a financing activity on the cash flow statement.
However, on June 8, 2015, FASB issued an exposure draft to eliminate the windfall pool and require the windfall to be reflected on the income statement without having to delay recognition until it actually reduces taxes. The cash flow statement treatment would be changed to reflect the windfall as an operating activity. The change would be prospective with respect to the new income treatment, retrospective with respect to the cash flow statement change and require a cumulative change adjustment to opening retained earnings in the year of adoption with respect to the elimination of the delay in recognition treatment. Of course, these rules are subject to change pending the adoption of a final rule. The changes, if adopted would likely increase income statement variability from year to year and because of the manner in which the treasury stock method address earnings per share calculations, will provide additional dilution of the EPS result.
►►(a) A description of the share-based payment arrangement(s), including the general terms of awards under the arrangement(s), such as the requisite service period(s) and any other substantive conditions (including those related to vesting), the maximum contractual term of equity (or liability) share options or similar instruments, and the number of shares authorized for awards of equity share options or other equity instruments. An entity shall disclose the method it uses for measuring compensation cost from share-based payment arrangements with employees.
►The number and weighted-average exercise prices (or conversion ratios) for each of the following groups of share options (or share units): (a) those outstanding at the beginning of the year, (b) those outstanding at the end of the year, (c) those exercisable or convertible at the end of the year, and those granted, (e) exercised or converted, (f) forfeited, or (g) expired during the year.
►(c) The number and weighted-average grant-date fair value (or calculated value for a nonpublic entity that uses that method or intrinsic value for awards measured pursuant to paragraphs 24 and 25 of [►FAS 123R]) of equity instruments not specified in paragraph A240(b)(1) (for example, shares of nonvested stock), for each of the following groups of equity instruments: (a) those nonvested at the beginning of the year, (b) those nonvested at the end of the year, and those (c) granted, (d) vested, or (e) forfeited during the year.
►(i) The weighted-average grant-date fair value (or calculated value for a nonpublic entity that uses that method or intrinsic value for awards measured at that value pursuant to paragraphs 24 and 25 of [►FAS 123R]) of equity options or other equity instruments granted during the year.
►(ii) The total intrinsic value of options exercised (or share units converted), share-based liabilities paid, and the total fair value of shares vested during the year.
►(i) The number, weighted-average exercise price (or conversion ratio), aggregate intrinsic value, and weighted-average remaining contractual term of options (or share units) outstanding.
►(ii) The number, weighted-average exercise price (or conversion ratio), aggregate intrinsic value (except for nonpublic entities), and weighted-average remaining contractual term of options (or share units) currently exercisable (or convertible).
►(i) A description of the method used during the year to estimate the fair value (or calculated value) of awards under share-based payment arrangements.
►(ii) A description of the significant assumptions used during the year to estimate the fair value (or calculated value) of share-based compensation awards, including (if applicable): (a) Expected term of share options and similar instruments, including a discussion of the method used to incorporate the contractual term of the instruments and employees’ expected exercise and post-vesting employment termination behavior into the fair value (or calculated value) of the instrument. (b) Expected volatility of the entity’s shares and the method used to estimate it. An entity that uses a method that employs different volatilities during the contractual term shall disclose the range of expected volatilities used and the weighted- expected volatility. A nonpublic entity that uses the calculated value method should disclose the reasons why it is not practicable for it to estimate the expected volatility of its share price, the appropriate industry sector index that it has selected, the reasons for selecting that particular index, and how it has calculated historical volatility using that index. (c) Expected dividends. An entity that uses a method that <?I09S48Z ?>employs different dividend rates during the contractual term shall disclose the range of expected dividends used and the weighted-average expected dividends. (d) Risk-free rate(s). An entity that uses a method that employs different risk-free rates shall disclose the range of risk-free rates used.
►(g) Discount for post-vesting restrictions and the method for estimating it.
►(h) An entity that grants equity or liability instruments under multiple share-based payment arrangements with employees shall provide the information specified in paragraphs A240(a)-(e) separately for different types of awards to the extent that the differences in the characteristics of the awards make separate disclosure important to an understanding of the entity’s use of share-based compensation. For example, separate disclosure of weighted-average exercise prices (or conversion ratios) at the end of the year for options (or share units) with a fixed exercise price (or conversion ratio) and those with an indexed exercise price (or conversion ratio) could be important. It also could be important to segregate the number of options (or share units) not yet exercisable into those that will become exercisable (or convertible) based solely on fulfilling a service condition and those for which a performance condition must be met for the options (share units) to become exercisable (convertible). It could be equally important to provide separate disclosures for awards that are classified as equity and those classified as liabilities.
►(i) Total compensation cost for share-based payment arrangements (a) recognized in income as well as the total recognized tax benefit related thereto and (b) the total compensation cost capitalized as part of the cost of an asset.
►(ii) A description of significant modifications, including the terms of the modifications, the number of employees affected, and the total incremental compensation cost resulting from the modifications.
►(j) As of the latest balance sheet date presented, the total compensation cost related to nonvested awards not yet recognized and the weighted-average period over which it is expected to be recognized.
►(k) If not separately disclosed elsewhere, the amount of cash received from exercise of share options and similar instruments granted under share-based payment arrangements and the tax benefit realized from stock options exercised during the annual period.
►(l) If not separately disclosed elsewhere, the amount of cash used to settle equity instruments granted under share-based payment arrangements.
►(m) A description of the entity’s policy, if any, for issuing shares upon share option exercise (or share unit conversion), including the source of those shares (that is, new shares or treasury shares). If as a result of its policy, an entity expects to repurchase shares in the following annual period, the entity shall disclose an estimate of the amount (or a range, if more appropriate) of shares to be repurchased during that period.
►See SEC “Concept Release on Allowing U.S. Issuers to Prepare Financial Statements in Accordance with International Financial Reporting Standards” (available at sec.gov) (8/13/2007; corrected 9/13/2007).
►Financial Accounting Standards Board Statement 123R, Share-based Payment, paragraph 1 (Dec. 2004) [hereinafter FAS 123R].
►FAS 123R, paragraph 4. Employee stock ownership plans are commonly known as ESOPs, which are generally a unique type of tax-qualified retirement plan subject to ►I.R.C. &ss;§§401 et seq. While stock options are sometimes referred to as ESOPs because of the acronym for employee stock option plans, such option plans are covered by ►FAS 123R, whereas ESOPs are not. ESOPS are accounted for under American Institute of Certified Public Accounting (“AICPA”) Statement of Position (“SOP”) 93-6, Employers’ Accounting for Employee Stock Ownership Plans. SOP 93-6 is beyond the scope of this volume and is not discussed herein.
►FAS 123R, supra at §6:2, note 1, Appendix E, Glossary, definition of Employee. Appendix E, specifically cites the principles of ►I.R.S. Rev. Rul. 87-41, 1987-1 C. B. 296.
►Financial Accounting Standards Board Emerging Issues Task Force Issue 00-23, “Issues Related to Accounting For Stock Compensation Under APB 25 and FASB Interpretation 44,” Issue 40(a) [hereinafater EITF 00-23].
►FAS 123R, supra at §6:2, note 1, Appendix E, definition of Employee.
►►Grant Thornton, Share-based Payment, FASB Statement 123R and Related Guidance, p. 5 (2008) [hereinafter Grant Thornton].
►Ernst & Young, Financial Reporting Developments, Share Based Payment–FASB Statement No. 123 (revised 2004), p. 52-7 (2005) [hereinafter Ernst & Young].
►FAS 123R, supra at §6:2, note 1, Appendix A, paragraph A-76; PricewaterhouseCoopers, Guide to Accounting for Stock Based Compensation, p. 6 (2007) [hereinafter PwC].
►Ernst & Young, supra at note 2.
►FAS 123R, supra at §6:2, note 1, paragraph 11.
►FAS 123R, supra at §6:2, note 1, paragraph 11. The awards in the case should be accounted for as derivatives pursuant to the guidance in FASB EITF 02-8.
►FAS 123R, supra at §6:2, note 1, paragraph 5.
►FAS 123R, supra at §6:2, note 1, Appendix A, Illustration 4(a), paragraphs 86&ndash;-93.
►FAS 123R, supra at §6:2, note 1, paragraph 16.
►FAS 123R, supra at §6:2, note 1, paragraph 36.
►FAS 123R, supra at §6:2, note 1, paragraph 22.
►FAS 123R, supra at §6:2, note 1, paragraph 15.
►FAS 123R, supra at §6:2, note 1, paragraph 21.
►FAS 123R, supra at §6:2, note 1, paragraph 17, 21. Note that ►FAS 123R provides yet a different meaning to the term restricted stock. As discussed in ►Chapter 2 from a tax perspective, restricted stock generally refers to stock which is issued subject to the issuer’s right to repurchase the stock at cost if certain performances conditions are not met. Also, as discussed in ►Chapter 3 with respect to ►SEC Rule 144, restricted stock refers to stock which is issued, but not pursuant to a registration statement. ►FAS 123R provides its own definition as it provides in footnote <?I04FIQ6 ?>11 that notwithstanding the tax definition, the term “restricted share” in ►FAS 123R refers to a fully vested outstanding share whose sale is contractually or governmentally prohibited for a specified period of time. For purposes of this text, restricted share or restricted stock is intended to be consistent with the tax usage of the term unless otherwise indicated.
►FAS 123R, supra at §6:2, note 1, paragraph 43.
►FAS 123R, supra at §6:2, note 1, paragraph 45.
►SEC Staff Accounting Bulletin 107, ►17 C.F.R. &s;§211, subpart B Topic 14, D.2., Question 3 (March 29, 2005) [hereinafter SAB 107].
►FAS 123R, supra at §6:2, note 1, paragraphs 39, 47.
►FAS 123R, supra at §6:2, note 1, Appendix E, Glossary, definition of market condition.
►FAS 123R, supra at §6:2, note 1, paragraph 19.
►FAS 123R, supra at §6:2, note 1, paragraphs 26 and 27.
►FAS 123R, supra at §6:2, note 1, Appendix E, Glossary, definition of nonpublic entity.
►FAS 123R, supra at §6:2, note 1, paragraph 23. Private companies may also use the simplified safe harbor in SAB 107 to determine expected term, §6:20, note 3.
►FAS 123R, supra at §6:2, note 1, paragraph 24.
►FAS 123R, supra at §6:2, note 1, paragraph 38.
►FAS 123R, supra at §6:2, note 1, Appendix A, paragraphs A211&ndash;-219.
►FASB Technical Bulletin, 97-1, Accounting under Statement 123 for Certain Employee Stock Purchase Plans with a Look-Back Option (December 1997).
►FAS 123R, supra at §6:2, note 1, paragraph 12.
►See infra §6:36, note 1; also see Grant Thornton, supra at §6:5, note 1, p. 25.
►FAS 123R, supra at §6:2, note 1, paragraph 7.
►FAS 123R, supra at §6:2, note 1, Appendix A.
►FAS 123R, supra at §6:2, note 1, Appendix A, paragraph A8.
►For example, ►FAS 123R, supra at §6:2, note 1, paragraph 6, indicates that the transfer of shares in exchange for a non-recourse note will be accounted for consistent with the substance of the transaction. Thus, although the transaction is structured as a purchase with apparent little compensation value because the payment is made with a note in which there is no personal recourse against the employee, it will be accounted for and valued according to its substance–i.e., as an option.
►FAS 123R, supra at §6:2, note 1, Appendix A, paragraph A.
►►FAS 123R, supra at §6:2, note 1, Appendix A, paragraph A13. Appendix A also refers to a Monte Carlo simulation technique, which could also be described as a variation of a lattice model.
►See e.g., PwC, supra at §6:5, note 3, p. 215.
►►FAS 123R, supra at §6:2, note 1, Appendix A, paragraph A16.
►See Ernst & Young, supra at §6:5, note 2, p. 57-7.
►PwC, supra at §6:5, note 3, p. 210.
►SAB 107, supra at §6:10, as amended by SEC Staff Accounting Bulletin 110 (December 21, 2007). FASB permits private companies to use the expected term for safe harbor. Grant Thornton, supra at §6:5, note 1.
►FAS 123R, supra at §6:2, note 1, Appendix E, definition of volatility.
►FAS 123R, supra at §6:2, note 1, Appendix A, paragraph A25.
►FAS 123R, supra at §6:2, note 1, Appendix A, paragraph 36. Such an exercise reduction provision could cause an option to fail to satisfy the option exception for ►I.R.C. &s;§409A because of a below market exercise price. See ►Chapter 2.
►PwC, supra at §6:5, note 3, p. 212 and 213.
►Ernst & Young, supra at &s;§6:5, note 2, Appendix E.
►PwC, supra at &s;§6:5, note 3, p. 215 (2007).
►Ernst & Young, supra at &s;§6:5, note 2, p. E-1 provides a formula, though not necessarily the formula used in the PwC formula. The Ernst & Young formula provides upward movements at each time node derived by the following formula, u=esvt where s is annualized volatility and t is the time period between nodes (expressed as one year = 1.0). For downward movements at each time node the formula is d=1/u.
►This might suggest that, contrary to the statement in §6:21 above that an increase in the risk tree rate increases the option value, a higher risk free rate decreases the option value of the option as the tree moves to the left (for example, PV = future value/1 x interest rate). However, either through probabilities below or the use of the risk-free rate in building the stock value of the first tree, the overall effect of an increase in the interest rate is to increase the option value.
►As noted supra in note 3, the Ernst & Young formula referenced above (which is not the formula PwC has used in building the tree which actually appears above) does not build into its formula for the first tree <?I03Y7BI ?>(building the stock value) an increase in the stock price based on rising interest rates. Thus, Ernst & Young provides a formula in working back through the second tree that weighs the probability in favor of the higher number, thus accomplishing a similar result.
►FAS 123R, supra at §6:2, note 1, Appendix A, paragraph A41.
►FAS 123R, supra at §6:2, note 1, Appendix E, definition of grant date.
►Grant Thornton, supra at §6:5, note 1, p. 59.
►FAS 123R, supra at §6:2, note 1, Appendix E, definition of service inception date.
►FAS 123R, supra at §6:2, note 1, paragraph 41.
►FAS 123R, supra at §6:2, note 1, Appendix A, paragraph A79.
►FAS 123R, supra at §6:2, note 1, Appendix E, Glossary, definition of explicit service period.
►FAS 123R, supra at §6:2, note 1, Appendix E, Glossary, definition of implicit service period.
►FAS 123R, supra at §6:2, note 1, Appendix E, Glossary, definition of derived service period.
►FAS 123R, supra at §6:2, note 1, Appendix A, paragraph A60.
►FAS 123R, supra at §6:2, note 1, paragraph 44.
►FAS 123R, supra at §6:2, note 1, paragraph 39.
►FAS 123R, supra at §6:2, note 1, paragraph 39. See also Grant Thornton, FAS 123R, supra at §6:5, note 1, p. 67.
►FAS 123R, supra at §6:2, note 1, Appendix A, Illustration 4(a), paragraph 86.
►Grant Thornton, supra at §6:5, note 1, p. 69.
►Ernst & Young, supra at §6:5, note 2, p. 34&ndash;-35.
►FAS 123R, supra at §6:2, note 1, Appendix A, Illustration 5(a), paragraph 105. See also Grant Thornton, Share-based Payment, FASB Statement 123R and Related Guidance, p. 69 (2008).
►FAS 123R, supra at §6:2, note 1, Appendix A, Illustration 5(a), paragraphs A105&ndash;-108.
►FAS 123R, supra at §6:2, note 1, Appendix A, paragraph A69, Illustration 6, paragraph A113.
►FAS 123R, supra at §6:2, note 1, Appendix A, paragraph A67.
►FAS 123R, supra at §6:2, note 1, paragraph A68.
►FASB Staff Position (FSP) ►FAS 123R-6 “Techical Corrections of FASB Statement No. 123(R)” (10/20/2007), paragraphs 8&ndash;-10.
►FAS 123R, supra at §6:2, note 1, Appendix A, paragraph 19.
►FAS 123R, supra at §6:2, note 1, Appendix A, paragraph 19. This is because the value of the market condition is already taken into account in determining the reduced fair value of the award.
►FAS 123R supra at §6:2, note 1, Appendix A, paragraph 72.
►FAS 123R, supra at §6:2, note 1, Appendix A, paragraphs A61 and A74.
►Compare FAS 123R Financial Accounting Standards Board Statement 123R, paragraph 16 with paragraph 36.
►FAS 123R, supra at §6:2, note 1, paragraph 32.
►FAS 123R, supra at §6:2, note 1, paragraph 34.
►FAS 123R, supra at §6:2, note 1, paragraph 31. Liability treatment typically is not required if the repurchase is simply to accomplish a forfeiture on an early exercised option in the event of failure to meet the vesting event. See PricewaterhouseCoopers (“PwC”), Guide to Accounting for Stock Based Compensation, p. 49 (2007).
►FAS 123R, supra at §6:2, note 1, footnote 16.
►Grant Thornton, supra at §6:5, note 1, p. 13 (2008).
►FASB Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of both liabilities and Equity (5/15/2003) [herinafter FAS 150].
►FAS 123R, supra at §6:2, note 1, paragraph 29.
►FASB Staff Position (FSP) ►FAS 150-3, Effective Date, Disclosures and Transition for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests under FASB Statements No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity (11/7/2003).
►FAS 150, supra at §6:36, note 1, paragraph 12. See also Grant Thornton, supra at §6:5, note 1, p. 10 (2008). The last example is interesting. Typically a put is the holder’s right to redeem shares thus creating a potential company obligation. A liability award can be created in this instance if the obligation can be settled by a number of shares that changes inversely with the change in value of the shares–if the stock price increases, the number of share required decreases and vice versa.
►FAS 150, supra at §6:36, note 1, paragraph 11.
►FAS 123R, supra at §6:2, note 1; PwC, supra at §6:5, note 3, p. 44.
►Grant Thornton, supra at §6:5, note 1, p. 10.
►Grant Thornton, supra at §6:5, note 1, p. 11.
►FAS 123R, supra at §6:2, note 1, paragraph 35; PwC, supra at §6:5, note 3, p. 48.
►See Grant Thornton, supra at §6:5, note 1, p. 12; PwC, supra at §6:5, note 3, p. 47 (2007).
►Grant Thornton, supra at §6:5, note 1, p. 17.
►Grant Thornton, supra at §6:5, note 1, p. 17, describing 2006 AICPA National Conference on SEC & PCAOB Development.
►EITF 00&ndash;-23, supra at §6:13, note 3, Issue 40(a).
►ASR 268, EITF Topic D-98, “Classification and Measurement of Redeemable Securities,” and SEC Staff Accounting Bulletin Topic 14.E. See Grant Thornton, supra at §6:5, note 1, p. 17 (2008). PwC, supra at §6:5, note 3, p. 50 and Ernst & Young, supra at §6:5, note 2, pp. 55&ndash;-14.
►The $33 is selected to make a point that can become important in many aspects of option valuation under ►FAS 123R. Refer back to the discussion at §6:22 regarding the three theoretical components of option value. Two are time-based–minimum value and volatility value, The third is intrinsic value. Consider that nothing has changed with respect to the option except that its contractual term has decreased. The exercise price remains the same of course and the underlying stock price is assumed to be the same. Under the Black-Scholes model there is likely to be little or no change to the expected term when preparing a December 31, 2009 ►FAS 123R valuation as compared to the January 1, 2009 grant date valuation. However, as the date gets closer to the ultimate option expiration date, the value of the option approaches the intrinsic value of the option and essentially the value of the option attributable to time based assumptions wears away. Of course, if the underlying stock price increases, the option value will increase, but that is a function of the increase in the intrinsic value even if it offsets the wearing away of the time based value as time goes on.
►Again, consistent with the note above, this dramatic increase is likely attributable to an increase in the underlying share value, absent a change in assumptions. The closer the date gets to the option expiration date, the less the value is influenced by time value assumptions.
►Grant Thornton, supra at §6:5, note 1, p. 19.
►As suggested above, the value of an option or SAR is less affected by time assumptions the closer the valuation date is to the option expiration date. At expiration the option or SAR is exactly equal to its intrinsic value.
►FAS 123R, supra at §6:2, note 1, Appendix A, paragraph 133.
►FAS 123R, supra at §6:2, note 1, paragraph 51.
►FAS 123R, supra at §6:2, note 1, Appendix A, Illustrations 13(c) and (d), paragraphs 166&ndash;-169.
►FAS 123R, supra at §6:2, note 1, Appendix A, Illustrations 13(a) and (b), paragraphs 162&ndash;-165.
►See Grant Thornton, supra at §6:5, note 1, p. 77, for a discussion of the deliberations of the FASB Statement 123R Resource Group at its May 26, 2005 meeting.
►See FAS 123R, supra at §6:2, note 1, p. 5.
►FASB Statement No. 141R, Business Combinations (December, 2007).
►Id.; FASB Interpretation 44 “Accounting for Certain Transactions involvong Stock Compensation–an Interpretation of APB Opinion No. 25” (March, 2000); EITF Issue 00-23, and EITF Issue 99-12, Determination of Measurement Date for the Market Price of Acquirer Securities Issued in a Purchase Business Combination.
►FASB Emerging Issues Task Force, Issue 99&ndash;-12, last discussed January 19&ndash;-20, 2000.
►Grant Thornton, supra at §6:5, note 1, p. 82.
►FASB Interpretation 44, paragraph 85 (March, 2000).
►FAS 123R, supra at §6:2, note 1, paragraphs 58&ndash;-63. See Grant Thornton, supra at §6:5, note 1, p. 5; Ernst & Young, supra at §6:5, note 2, p. 52&ndash;-7; and PwC. supra §6:5, note 3, p. 6 for guidance regarding tax treatment of awards.
►FAS 123R, supra at §6:2, note 1, paragraphs 64 and 65.
►In some circumstances, an entity may need to disclose information beyond that listed in this paragraph to achieve the disclosure objectives.
►An entity that uses the intrinsic value method pursuant to paragraphs 24 and 25 of [►FAS 123R] is not required to disclose the following information for awards accounted for under that method.
►FASB Statement 128, Earnings per Share (February, 1997). See FAS 123R, supra at §6:2, note 1, paragraph 66.

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