ACCT 3230 – Corporate Financial Reporting II
Share-Based Compensation
? Background and terminology
? Restricted Stock
? Stock Options
? Stock Appreciation Rights
Share-Based Compensation: Background and terminology
A form. of employee compensation plan under which employees receive shares of stock or options to acquire shares of stock, once certain conditions (such as a vesting period) are met.
The types of share-based compensation we will cover are:
? Restricted Stock Awards (RSAs) – Also called “Performance” Stock Awards if tied to a specific performance goal.
? Restricted Stock Units (RSUs) – Also called “Performance” Stock Units if tied to a specific performance goal.
? Employee Stock Options (ESOs)
? Stock Appreciation Rights (SARs)
CEO Equity Compensation – S&P 1500 by Type
Share-based compensation is used for a number of reasons:
- Incentive alignment: employees who add value to the company add value to their compensation (this is more relevant for upper management).
- Capital constraints: newer firms with fewer resources can pay their employees well (via the appreciation of the firm’s equity price) without expending cash or other assets.
- Employee retention: employees must complete a vesting period to earn their share-based compensation period, incentivizing them to stay with the firm.
Example (From Microsoft’s proxy statements in 2016 and 2019):
Share-based compensation terms:
Grant date: The date at which an employer and an employee reach a mutual understanding on the key terms and conditions of a share-based payment award.
Vesting date: Date that a share-based compensation plan is exercisable by an employee.
Vesting period: Period from the grant date to the vesting date. Typically, the vesting period would align with the requisite service period.
Requisite service period: The period or periods during which an employee is required to provide service in exchange for an award under a share-based payment arrangement. (We will assume that the requisite service period is equal to the vesting period in this class.)
Restricted stock: Shares of stock in a share-based compensation plan that cannot be awarded until the employee has satisfied vesting (or other) requirements.
Stock option: A call option that gives the employee the right, but not the obligation, to purchase shares from the firm upon payment of a specified amount (the strike price).
Exercise (strike) price: The amount that must be paid for a share of common stock upon exercise of an option or warrant.
Stock appreciation rights: Rights to a cash payment equal to the difference between the stock price at the exercise date and a specified price.
Accounting treatment
Share-based compensation plans result in compensation expense for the firm, typically measured as the fair value of the securities at the grant date. Subsequent changes to fair value are irrelevant for measuring compensation expense. The expense is recognized proportionally over the requisite service (vesting) period.
Restricted Stock Awards (RSAs): Shares of stock issued to the employee at the grant date. The Common Stock account is credited for the par value (if the firm’s equity has one) and the PIC account is credited for the remaining total fair value of the shares; the Unearned Compensation account (contra-equity account) is debited for the total fair value.
Entry required at the Grant date:
Unearned Compensation (B-XS/E) xxx (fair value of restricted stock)
Common Stock (B-S/E) yyy (par value of restricted stock)
Paid-in Capital – Common Stock (B-S/E) zzz (PLUG: fair value – par value)
Entry required each year of the vesting period:
Compensation Expense (I-E) xxx/vesting period
Unearned Compensation (B-XS/E) xxx/vesting period
Entry required when restricted stock is awarded to employee (at the end of the vesting period):
No entry – the common stock was already issued at the grant date
Accounting treatment for share-based compensation, continued…
Restricted Stock Units (RSUs): Shares an employee has the right to receive after the vesting period is completed, but are not issued at the grant date. Therefore, the shares are not recorded until the restricted stock is awarded.
Entry required at the Grant date:
No entry – the common stock has not been issued yet.
Entry required each year of the vesting period:
Compensation Expense (I-E) aaa/vest. per. (fair value/vesting period)
Paid-in Capital—Restricted Stock (B-S/E) aaa/vest. per.
Entry required when restricted stock is awarded to employee (at the end of the vesting period):
Paid-in Capital—R/S (B-S/E) aaa (grant date fair value of R/S)
Common Stock (B-S/E) bbb (par value of R/S)
Paid-in Capital – Common Stock (B-S/E) ccc (PLUG: fair value – par value)
Note: While there is no entry required at the grant date for restricted stock units, the fair value used to measure compensation expense is still measured as of the grant date.
Accounting treatment for share-based compensation, continued…
Stock Options: Shares of stock an employee is entitled to purchase at the exercise/strike price upon completing the vesting period. Fair values are measured using an option pricing model (e.g., the Black-Scholes model). Note: New shares are not issued at the grant date, so the accounting treatment looks similar to RSUs.
Entry required at the Grant date:
No entry – the common stock (underlying the options) has not been issued yet.
Entry required each year of the vesting period:
Compensation Expense (I-E) aaa/vest. per. (fair value/vesting period)
Paid-in Capital—Stock Options (B-S/E) aaa/vest. per.
Entry required when stock options are exercised:
Cash (B-A) strike price (total)
Paid-in Capital—Stock Options (B-S/E) aaa (grant date fair value of S/O)
Common Stock (B-S/E) bbb (par value of stock issued)
Paid-in Capital – Common Stock (B-S/E) ccc (PLUG: fair value – par value)
What happens if stock options expire unexercised?:
Note: The company will NOT reverse the compensation expense recorded in previous periods. Instead, the company will move the PIC amount into an “expired” options account:
Paid-in Capital—Stock Options (B-S/E) ddd (Grant date fair value of expiring options)
Paid-in Capital—Expired Options (B-S/E) ddd
Accounting treatment for share-based compensation, continued…
Stock Appreciation Rights (SARs): A form. of share-based compensation where appreciation of the stock price results in a liability for the firm. Appreciation above a specified price is paid in cash to vested employees when the rights are exercised. Compensation expense in a given period is based on total appreciation as of that period and is recognized proportionally over the vesting period.
Entry required at the Grant date:
No entry required if the specified price is equal to the market price (usually true)Entry required each year of the vesting period:
Compensation Expense (I-E) xxx*
SAR Liability (B-L) xxx
* xxx = (total appreciation * proportion of vesting period elapsed) – previously recognized compensation expense
Entry required when the SAR is exercised:
SAR Liability (B-L) yyy
Cash (B-A) yyy
Accounting for Forfeitures of Stock-Based Comp
Employees must remain with the firm throughout the vesting period in order to earn their share-based compensation. Those that do not meet the vesting requirements will forfeit their compensation.
There are two acceptable methods of accounting for forfeitures:
1) Estimating forfeitures and recording only the percentage of shares/options/rights expected to vest. A change in estimate in a later period requires the cumulative effect of the change to be recorded in that period.
2) Recording forfeitures as they are incurred (i.e., when the employee leaves). At this point, all journal entries related to the forfeited compensation are reversed, including compensation expense, paid-in capital, and any shares issued at the grant date (via restricted stock awards).
Restricted stock (awards and units) example
Firm A grants 1,000 shares of $1 par restricted stock to its employees January 1st , 2020. The market price of the restricted stock on the grant date is $10. The vesting period is 3 years – the shares will be awarded January 1st, 2023. Firm A uses estimates to account for forfeitures. They originally estimate 10% of the shares will be forfeited, but revised the estimate to 15% on December 31 st, 2021. Prepare all journal entries assuming these are restricted stock awards, then repeat the question assuming they are restricted stock units instead.
Restricted Stock Awards
? Jan 1, 2020 – Record the grant of the RSAs.
Unearned Compensation (B-XS/E) 9,000 (1,000 * $10 * 90%)
Common Stock (B-S/E) 900 (1,000 * $1 * 90%)
Paid-In Capital-C/S (B-S/E) 8,100
? Dec 31, 2020 – Record compensation expense for year 1.
Compensation Expense (I-E) 3,000 (9,000 / 3)
Unearned Compensation (B-XS/E) 3,000
? Dec 31, 2021 – Compensation expense for year 2 – would be the same as year 1, but we have a change in estimate. Our total compensation expense as of year 2 is 85% * 1,000 * $10 * 2/3 = $5,667. We already recognized 3,000 in year 1, so the difference will be used in our entry.
Compensation Expense (I-E) 2,667 (5,667 – 3,000)
Unearned Compensation (B-XS/E) 2,667
We also need to back out shares recorded at the grant date that we now assume will be forfeited. We need to back out 90% - 85% = 5% of shares of common stock recorded.
Common Stock (B-S/E) 50 (1,000 * $1 * 5%)
PIC-C/S (B-S/E) 450 [PLUG]
Unearned Compensation (B-XS/E) 500 (1,000 * $10 * 5%)
Restricted stock example, continued…
? Dec 31, 2022 – Compensation expense for year 3 – we adjusted for the cumulative effect of the change in estimate in year 2 and did not have a subsequent change in estimate, so year 3 compensation expense can be calculated straight line.
Compensation Expense (I-E) 2,833 (8,500 / 3)
Unearned Compensation (B-XS/E) 2,833
Note: The sum of our compensation expense from all three years totals $8,500, and our unearned compensation balance is 0.
? Jan 1, 2023 – No entry required.
Restricted Stock Units – Record journal entries assuming units instead of awards:
? Jan 1, 2020 – No entry for RSUs because no new stock has been issued.
? Dec 31, 2020 – Record compensation expense for year 1.
Compensation Expense (I-E) 3,000 (9,000 / 3)
PIC – Restricted Stock (B-S/E) 3,000
? Dec 31, 2021 – Unlike the RSA example, we do not need a second entry on this day to back out previously recorded shares because we have not recorded any share issuances thus far. Our total compensation expense is the same as above.
Compensation Expense (I-E) 2,667 (5,667 – 3,000)
PIC – Restricted Stock (B-S/E) 2,667
? Dec 31, 2022 – Compensation expense for year 3 is calculated straight line.
Compensation Expense (I-E) 2,833 (8,500 / 3)
PIC – Restricted Stock (B-S/E) 2,833
Note: The sum of our compensation expense from all three years totals $8,500, which is the ending balance in our PIC – Restricted Stock account.
? Jan 1, 2023 – Record the issuance of shares for employees who completed the vesting period.
PIC—Restricted Stock (B-S/E) 8,500 (1,000 * $10 * 85%)
Common Stock (B-S/E) 850 (1,000 * $1 * 85%)
PIC – Common Stock (B-S/E) 7,650 [PLUG]
Stock options example
Firm A grants 1,000 options to purchase its $1 par common stock to its employees on January 1st, 2020. The strike price is $5 per share. The fair value of each option at the grant date is $10. The vesting period is 3 years – shares are exercisable for all of 2023. Firm A accounts for forfeitures in the period that they occur. In 2021, 15% of the options were forfeited by employees leaving the firm. Prepare all journal entries assuming all vested options were exercised January 1st, 2023.
? Jan 1, 2020 – No entry for the option grant because no shares were issued.
? Dec 31, 2020 – Compensation expense for year 1.
Compensation Expense (I-E) 3,333 (1,000 * $10 /3)
Paid-in Capital—Stock Options (B-S/E) 3,333
? Dec 31, 2021 – Compensation expense for year 2 would be the same as year 1, but we have forfeitures. Our total compensation expense as of year 2 is 85% * 1,000 * $10 * 2/3 = $5,667. We already recognized 3,333 in year 1, so the difference will be used in our entry.
Compensation Expense (I-E) 2,334 (5,667 – 3,333)
Paid-in Capital—Stock Options (B-S/E) 2,334
? Dec 31, 2022 – Compensation expense for year 3 – we adjusted for the cumulative effect of the change in estimate in year 2 and did not have a subsequent change in estimate, so year 3 compensation expense can be calculated straight line.
Compensation Expense (I-E) 2,833 (8,500 / 3)
Paid-in Capital—Stock Options (B-S/E) 2,833
Note: The sum of compensation expense from all three years totals $8,500.
? Jan 1, 2023 – Record the exercise of the 85% of options that vested.
Cash (B-A) 4,250 (1,000 * 85% * $5)
Paid-in Capital—Stock Options (B-S/E) 8,500 (1,000 * 85% * $10)
Common Stock (B-S/E) 850 (1,000 * 85% * $1)
Paid-in Capital—Common Stock (B-S/E) 11,900 [PLUG]
Stock appreciation rights example
Firm A grants 1,000 stock appreciation rights to its employees on January 1st , 2020. The specified price is $5 per share. The vesting period is 3 years – rights are exercisable for all of 2023. Prepare all journal entries assuming all rights were exercised January 1st, 2023. Relevant stock prices are given below:
? Jan 1, 2020 – No entry for the SAR grant because no shares were issued.
? Compensation expense – It is helpful to make a table to determine each year’s compensation expense:
? Dec 31, 2020
Compensation Expense (I-E) 333 (see table)
SAR Liability (B-L) 333
? Dec 31, 2021
Compensation Expense (I-E) 1,667 (see table)
SAR Liability (B-L) 1,667
? Dec 31, 2022 – The decrease in stock price leads to a reversal of compensation
SAR Liability (B-L) 250 (see table)
Compensation Expense (I-E) 250
? Jan 1, 2023 – Record the exercise of the SARs. Since the stock price increased between the end of the vesting period and the exercise date, our compensation expense has changed.
SAR Liability (B-L) 1,750
Compensation Expense (I-E) 500 (see table)
Cash (B-A) 2,250 (1,000 * [7.25 – 5])
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