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Share-Based Awards

Share-Based Awards.  Many compensation plans include one or more types of share-based awards. These include outright awards of shares , stock options , or cash payments tied to the market price of shares .

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Share-Based Awards

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  1. Share-Based Awards Many compensation plans include one or more types of share-based awards. These include outright awards of shares, stock options, or cash payments tied to the market price of shares. Usually, an executive compensation plan is tied to performance in a way that uses compensation to motivate its recipients. Regardless of the form such a plan takes, the accounting objective is to record the fair value of the compensation expense over the periods in which related services are performed.

  2. STOCK AWARD PLANS ILLUSTRATION Universal Communications grants 5 million of its $1 par common shares to certain key executives at January 1, 2013. The shares are subject to forfeiture if employment is terminated within 4 years. Shares have a current price of $12 per share. January 1, 2013 No entry Calculate total compensation expense: $12 fair value per share x 5 million shares awarded = $60 million total compensation The total compensation is allocated to expense over the 4-year service (vesting) period: 2013 - 2016 $60 million ÷ 4 years = $15 million per year December 31, 2013, 2014, 2015, 2016($ in millions) Compensation expense ($60 million ÷ 4 years) 15 Paid-in capital – restricted stock 15

  3. STOCK AWARD PLANS ILLUSTRATION Upon vesting: ($ in millions) Paid-in capital– restricted stock (5 million sh. at $12) 60 Common stock (5 million shares at $1 par) 5 Paid-in capital – excess of par (to balance) 55  If restricted stock is forfeited because, say, the employee quits the company, related entries previously made would simply be reversed.

  4. STOCK OPTION PLANS  Stock option plans give employees the option to purchase (a) a specified number of shares of the firm's stock, (b) at a specified exercise price, (c) during a specified period of time. The fair value is accrued as compensation expense over the service period for which participants receive the options, usually from the date of grant to when the options become exercisable (the vesting date).

  5. Recognizing Fair Value of Options Estimating fair value requires the use of anoption pricing modelthat incorporates the:1.Exercise price of the option.2. Expected term of the option.3. Current market price of the stock.4. Expected dividends.5. Expected risk-free rate of return.6. Expected volatility of the stock.

  6. CHANGING VALUE OF STOCK OPTIONS

  7. EXPENSING STOCK OPTIONS At Jan. 1, 2013, Universal grants options to acquire 10 million of the company’s $1 par common shares within the next 8 yrs, but not before Dec. 31, 2016 (the vesting date). The exercise price is the market price on the date of grant, $35 per share The fair value of the options is $8 per option. January 1, 2013 No entry Calculate total compensation expense: $8 estimated fair value per option x 10 million options granted = $80 million total compensation The total compensation is allocated to expense over the 4-year service (vesting) period: 2013 - 2016 $80 million ÷ 4 years = $20 million per year December 31, 2013, 2014, 2015, 2016($ in millions) Compensation expense ($80 million ÷ 4 years) 20 Paid-in capital – stock options 20

  8. ESTIMATED FORFEITURES If a forfeiture rate of 5% was expected, annual compensation expense would have been $19 million ($76 / 4) instead of $20 million. 2013 ($ in millions) Compensation expense ($80 x 95% x 1/4) 19 Paid-in capital –stock options 19 2014 Compensation expense ($80 x 95% x 1/4) 19Paid-in capital –stock options 19

  9. ESTIMATED FORFEITURES  During 2015, the third year, Universal revises its estimate of forfeitures from 5% to 10%. The new estimate of total compensation would then be $80 million x 90%, or $72 million.  The expense each year is the current estimate of total compensation that should have been recorded to date less the amount already recorded ($19 million in 2013 and 2014). 2015($ in millions) Compensation expense ([$80 x 90% x ¾] – [$19 + 19]) 16 Paid-in capital –stock options 16 2016 Compensation expense ([$80 x 90% x 4/4] – [$19 + 19 + 16]) 18 Paid-in capital –stock options 18

  10. WHEN OPTIONS ARE EXERCISED If half the options (five million shares) are exercised on July 11, 2016, when the market price is $50 per share: July 11, 2016($ in millions) Cash ($35 exercise price x 5 million shares) 175 Paid-in capital - stock options (1/2 account balance) 40 Common stock (5 million shares at $1 par per share) 5 Paid-in capital – excess of par (to balance) 210 If options that have vested expire without being exercised (assuming none of the options were exercised): ($ in millions) Paid-in capital – stock options (account balance) 80Paid-in capital – expiration of stock options 80 Irrelevant

  11. GRADED VESTING Example: A company awards 1,000 stock options vesting 20% the first year, 30% the second year and 50% the third year. Account for each vesting amount separately, as if they were three separate awards. U.S. GAAP / IFRS Difference U.S. GAAP permits this treatment, but also allows companies the option to account for the entire award on straight-line basis over the entire vesting period as long as the company recognizes at least the amount of award vested by that date

  12. Plans with Performance Conditions Sometimes compensation from a stock option depends on meeting a performance target. Then, whether we record compensation depends on whether or not we feel it’s probable the target will be met. If the initial expectation is that it is not probable that the target will be met, we record no annual compensation expense.  Suppose that in the third year it becomes probable that the target will be met. Then, record the cumulative effect on compensation in 2013 earnings: 2013 Compensation expense ([$80 x 3/4] - $0) 60 Paid-in capital –stock options 60 2014 Compensation expense ([$80 x 4/4] - $60) 20 Paid-in capital –stock options 20 Also, continue to record compensation thereafter. 3 years’ cumulative compensation

  13. Plans with Market Conditions  Sometimes an award contains a market condition (e.g., an option that can be exercised only if the stock price reaches a specified level).  In that case, we recognize compensation expense regardless of when, if ever, the market condition is met.

  14. EMPLOYEE SHARE PURCHASE PLANS Permit employees to buy shares directly from their employer. Usually the plan is considered compensatory, and compensation expense is recorded. Assume an employee buys shares (no par) under an ESPP plan for $850 rather than the current market price of $1,000. The $150 discount is recorded as compensation expense: Cash (discounted price) 850 Compensation expense ($1,000 x 15%) 150 Common stock (market value) 1,000

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