aa seminar 21&22 - eso
TRANSCRIPT
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Seminar 21/22: Share based payments transactions
Three types of SBPT [All questions: Ask if this is a Equity or Cash settled SBPT]Equity SettledSBPT
(Equity Based)
Firm receives goods/services as consideration for equity of entity
Record in journal initial option value when its granted.
If FV of option can be measured reliably: FV of option determined on grant date, NOT adjusted
subsequently
Estimate # of options that will eventually vest at each B/Still vesting date ends, adjust them at each B/S period
After vesting date, no staff cost adjustments
If FV of option cannot be estimated reliably
Intrinsic value (Fair value of share Ex price of option) used Value is re-measured at each reporting date till full
settlement/expiry
Cash SettledSBPT
(Liability Based)
Entity receives goods/services by incurring liabilities to supplierfor cashbased on price of entitys shares
Not only need to adjust for amount of expected ESO in eachperiod, but also FV change of option given this is a liability.After vesting date, still have staff cost adjustments based onFV changes till option expires or fully exercised
Share-basedpayment withcash alternative
Entity receives goods/services and terms of arrangement provideeither entity or counter-party with choice of settlement in cash orshares.
FRS 102 Doesnt apply to:
1. Share based transaction in business combination2. Share based transaction with any party in capacity as entitys shareholder
*Measure fair vale of options given
*Period where service is rendered
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Is ESO an expense?Expenses are decreases in economic benefits during accounting period in form ofoutflows or depletions of assets/incurrence of liabilities that result in decreasesin equity other than those relating to distributions to equity participants.
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IMPORTNANT JOURNAL RECORD RULE: Vesting vs Non-vestingEven if the shares are granted on 1 Jan XXX
- It is only recognized at end of reporting period where shares havegain value through VESTING PERIOD.
- If non-vesting, it is recognized as soon as its grantedVESTING RULES
Does condition determine whether entity receives
services that entitle counterparty to SBP
Yes, Depends on service(Vesting Condition)
No, no(Non-
Does condition require onlyspecified period of service?
Yes (Service Condition)- Recognize based on time No (PerformanceCondition)
Condition related to market price
of entitys equity instrument?
Yes(Market Performance
Condition)i.e. share price performance
No(Non-Market Performance Condition)
i.e. based on vol of sales/revenue
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VESTING RULES (II):Accounting for Conditions
IllustrationsVESTING: Service & Non-Market performance condition [Illustration 6 & 7]- No Fair value @ Grant date Conditions not considered in estimating
instrument Fair value, but considered in est # of instruments expected to vest- Forfeiture True-Up: At each B/S date, est # of options that will eventually
vest, up to vesting date Adjust vesting costs (i.e. staff costs) accordinglyIf Service/Non-market condition exp to change Vesting Period ()* exp to vest
FV per option/SAR # exp to vestinitially
Total FV torecognize
Y1(100%)
Y2(80%)
Y3(70%)
$3 100 $300 100 60 50
Market Performance & Neither entity/CP may choose to meet condition(Illustration 8 & 10)- Fair value @ Grant date Conditions considered in estimating FV of
individual instrument (i.e. probability of meeting condition=inputs to valuation)- No Change Expensed over vesting periodIf Service/Non-market condition fulfillment exp to change Vesting Period ()* exp to vest
FV per option/SAR # exp to vestinitially
Total FV torecognize
Y1(100%)
Y2(80%)
Y3(70%)
$2.40*Take acc probability offulfillment
100 $240 80 80 80
VESTING AMT CONSTANT even if condition not met as earlier taken into account probability ofnon-fulfillment in FV instrument
Counterparty/Entity can choose to meet condition (Illustration 11 & 12)- Fair value @ Grant date Conditions considered in estimating FV of
individual instrument (i.e. probability of meeting condition=inputs to valuation)- Cancellation results in accelerated exp Expense everything
VestingCond.
Non-
Vesting
Cond.
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If Service/Non-market condition fulfillment exp to change Vesting Period ()* exp to vest
FV per option/SAR # exp to vestinitially
Total FV torecognize
Y1(100%)
Y2(CANCEL)
Y3
$2.40*Take acc probabilityof fulfillment
100 $240 80 160
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MEASUREMENT EQUITY SETTLED SHARE BASED PAYMENT TO THIRD PARTY
Equity settledshare basedpayment(Third party)
A. Measure goods/services from third partyFair value of goods/services* = share capital issued*Rebuttable assumption that fair value of goods/service can beestimated reliably
Fair value of machine Shares issued to buy machine
$100k $1 x 110k shares = $110k
We adopt fair value of machine = $100k
If fair value of goods/service cannot be measured reliablyValue of goods/services = fair value of equity instruments
Illustration 2 Equity shared based paymentGoods/service receive cant be recognized as assets should recognize as exp
- Firm acquire sundry lab equipment of $120k from associates-
Issued 100k ordinary shares Dr Cr
Research expenseShare Capital
120k120k
Illustration 3 Market value of goods certainProfessional valuer value land at $50m, firm issue 10m ordinary shares to buy them
Dr CrLand
Share Capital50m
50m
Illustration 4 Market value of goods uncertain [Cannot measure reliably]Firm acquire building where various valuation range from 10m to 50mFirm bought building by issuing 1m ordinary shares then priced at $22 per share
Dr Cr
LandShare Capital
22m22m
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MEASUREMENT EQUITY SETTLED SBP TO EMPLOYEES
Equitysettled sharebasedpayment
(Employee)
B. Services received from employeesMeasurement = fair value of equity instrument granted*market value of employee service not available*Accounting for terms/conditions which instruments are granted
Fair value of emp service FV of option granted
$100k $1 x 110k shares = $110k
*We adopt fair value of options = $110k
If fair value of instrument cannot measure reliably (i.e. unlistedshares, no liquidity) = Measure services/increase in equity based onintrinsic value of equity instrument granted
Fair value calculation for ESO
Option pricing models to measure fair value. Taking into account:Exercise price of option Expected volatility of share priceCurrent price of underlying shares Dividend expected
Life of option*How long employee hold option & notcontractual period
Risk free interest rate
For Equity Settled SBPT (Calculation of ESO/# of options)Fair value of ESO (i.e. option value) is determined on grant date andnot adjusted for subsequent change in market conditions;
ONLYamount of expected ESO granted in future is adjusted eachperiod (based on total expected attrition at grant date)
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Illustration 5 Vesting based on Length of service[No Attrition, Vesting FV of option can be measured reliably, ESO for employees]
Firm grants 5 executives options to purchase 200,000 shares each (total: 1m)Option exercise price: $5 per share
Granted on 1 Jan 20x2, will vest at 1 Jan 20x5 [Vesting period = 3 years]Option exercisable from 1 Jan 20x5 to 31 Dec 20x8 [Exercise period = 4 year]s
FV of option on 1 Jan 20x2 $1.50 [measured reliably = no change after grant date]Firm expects all employees to stayTotal fair value of options = 1.50 x 1m = 1.5m
Event Dr Cr
For 3 years investing period
Each periodrecorded: vests500k
Staff Cost (1.5m /3)Capital Reserve
Hence total vested in 3 years: 500k x 3 = 1.5m
500k500k
If exercise atend of vesting
Cash (1m shares x Ex value $5)*Capital Reserve (Empty capital reserve)^
Share Capital (Increase in share cap)
5m1.5m
6.5mIf neverexercise tillexpiry
Capital Reserve Stock OptionCapital Reserve General reserve
Note: Expenses NOT reversedas service wereprovided, instead this is transferred to general
reserve for distribution as dividends
1.5m1.5m
*Cash Cash employee paid to buy shares^Cap Reserve Used to record value of service provided by employees
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Illustration 6 Vesting based on Length of service with attrition
Firm grants top 20 executives, 50,000 share options each (total = 1mil)Option exercise price = $1FV of option on 1 Jan 20x2 $1.50 [measured reliably = no change after grant date]
Event Dr Cr
2007 Jan 1 No entry, havent vest
Year 20072 employees left,Expected to stay: 14
Staff CostCapital Reserve ESO(14 emp x 50,000 x 1.5 x 1/3)
350K350K
Year 20081 employee left,Expected to stay: 15
Staff CostCapital Reserve ESO(15 emp x 50,000 x 1.5 x 2/ 3) 350k
400k400k
Year 2009 (End)2 employee leftTotal left: 15
Staff CostCapital Reserve ESO(15 emp x 50,000 x 1.5 x 3/3) 750k
375k375k
Exercise*if never ex till expiry,see illustration 5.
Cash (15 x 50,000 x $1 ex price)Capital reserve (empty capital reserve)
Share capital
750k1.125m
1.875m
Illustration 7Vesting based on Non-Market performancew attrition
Firm grants 10 executives options to buy 10,000 shares eachOption exercise price: $5 per shareFV of option on grant date = $3 [measured reliably = no change after grant date]
Vesting Conditionso 31 Dec 20x2: If sales increase by > 20%o 31 Dec 20x3: If average sales increase over two year > 15%o 31 Dec 20x4: If average sale increase over 3 year > 10%
Event Dr CrYear 20x2Fail condition,
Exp employee tostay: 8
Staff CostCapital Reserve ESO
(3 x 10,000 x 8 emp x 1/3)Recognized given expectations to achievecondition next period. Hence considered vested
120k120k
Year 20x3Fail condition,Exp employee tostay: 7
Staff CostCapital Reserve ESO(3 x 10,000 x 7 emp x 2/3) 120k
Recognized given exp to achieve condition nextperiod. Hence considered vested
20k20k
Year 20x4 (end)Pass condition,Total stayed: 8
Staff CostCapital Reserve ESO(3 x 10,000 x 8 emp x 3/3) 140k
100k100k
Question: What if fail vesting period in the end?? DERECOGNIZE first 2 years?Illustration 8Vesting based on Market condition with attrition
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[Attrition, Vesting, FV of option can be measured reliably, ESO for employees]Firm grants CEO to purchase 500,000 shares at $5 per share
- Granted on 1 Jan 20x2, vest on 31 Dec 20x4- Option cannot exercise unless market price increase to at least $8 on Dec 20x4
Binomial fair pricing: 1.20 [measured reliably = no change after grant date]
Event Dr Cr
For all 3 years Staff CostCapital Reserve ESO(1.20 x 500,000 x 1/3)
200k200k
Record exercise or non-exercise referencing illustration 5
Even if fail to meet requirements, will still be vested.Given the fair pricing has taken into account the probability of fulfillment
Illustration 9 Modification of terms and conditions of ESOBy right value of option recordedshouldnt change UNLESSterms of ESO changeEntity should recognize effects of modification that increase total fair value of options
- Firm grants top 5 executives options to purchase 20,000 shares each- Option exercise price: $5
Option granted on 1 Jan 20x2, vests on 1 Jan 20x5 [VESTING PERIOD]
Binomial fair pricing: $3 [measured reliably = no change after grant date]
Event Dr Cr1styear Staff CostCapital Reserve ESO(3 x 5 x 20,000 x 1/3)
100k100k
2nd yearEx price reducedto $4
Staff CostCapital Reserve ESO(3 x 5 x 20,000 x 2/3) + (0.2 x 100,000 x) 100k prev recognized
Option value before repricing: $1.60Option value after repricing: $1.80
110k110k
3rd year Staff CostCapital Reserve ESO(3 x 5 x 20,000 x 3/3) + (0.2 x 100,000 x2/2) 210k prev recognized
110k110k
Illustration 10 Entity/Counter-party doesnt choose NOT to meetcondition, but experiencefailure to meet condition (i.e. GDP fail to meet 5%)
- Cancellation No impact, continue to recognize same exp over vesting periodIllustration 11 Entity CHOOSES to cancel/settle option during vesting
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Cancellation/settlementacceleration of vesting period.I.e. option recognized prospectively as vested over shorter accelerated period.
- Firm grant top 5 executives options to purchase 20,000 shares- Option exercise price: $5- Shares granted on 1 Jan 20x2, vest on 1 Jan 20x5- Black scholes fair pricing of option value: $3- ON Dec 20x3. Firm cancels stock option and pays each executive 50kEvent Dr Cr1styear Staff Cost
Capital Reserve ESO(3 x 5 x 20,000 x 1/3)
100k100k
2nd yearStock optioncancelled
Staff CostCapital Reserve ESO(3 x 5 x 20,000 x 2/2) -100k
Option prospectively (accelerate) recognized asvested over 2 yr
200k200k
3rd yearCompensationfrom firm
Capital reserve (5 x 50k)Cash
250k250k
Illustration 12- Counterparty choose NOT to meet non-vesting conditionCancellationaccelerated vesting
- Firm grants CFO to participate in plan where CFO obtains share options- CFO needs to save 10% of monthly salary of $10,000 for 3 year period- CFO may use accumulated savings to exercise options at end of 3 years-
Estimated exp of share-based payment arrangement = 3,600 per year for 3 yrsEvent Dr Cr
20x1Dec 31
Staff CostCashSalary in arrears (10% x 120k)(CFOs salary for 12 months)
Staff costsCapital Reserve ESO
*Keep CFO 10% salary, end of 3 years may use amtto exercise option
120k
3.6k
108k12k
3.6k
20x2Apr 1(After 3months)
CFO pulls outof thisprogramme
Takes refund
Staff CostCashSalary in arrears (10% x 30k)(CFOs salary for 3 months)
Salary in Arrears (extinguish liability)Cash
Staff CostsCapital Reserve - ESO
(Accelerated recognition upon cancellation)
30k
15k
7.2k
27k3k
15k
7.2k
Illustration 13 Unable to estimate reliably FV of equity [IMPT!]
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- Use intrinsic value (diff btw fair value of shares and exercisable price)- Measure intrinsic value every period from start date to final settlement
ExampleFirm give CEO option to purchase 1,000,000 shares at 0.30 per share
Options granted on 1 Mar 20x1, will vest on 1 Jan 20x4 [vest over 3 years]- New startup, FV of options cant measure reliably (no liquidity, volatility data)- Firm measures stock option at intrinsic value
Date Share price Intrinsic value (share price ex value)
1 Mar 20x1 0.30
31 Dec 20x1 0.42 0.42-0.3 = 0.12
31 Dec 20x2 0.45 0.45-0.3 = 0.15
31 Dec 20x3 0.50 0.5 0.3 = 0.2
20X4 Post-Vesting 0.6 0.6 0.3 = 0.3
20x5 Post-Vesting 0.8 0.8 0.3 = 0.5
Every period need to re-measure intrinsic value as fair value not obtainableEvent Dr CrGrant date No journal entries, have not vested
B/S End dateRecord @ 20x1intrinsic
Staff CostCapital Reserve ESO(0.12 x 1,000,000 x 1/3)
40k40k
B/S End dateRecord @ 20x2intrinsic
Staff CostCapital Reserve ESO(0.15 x 1,000,000 x 2/3) 40k
60k60k
B/S End date
Record @ 20x3intrinsic
Staff Cost
Capital Reserve ESO(0.2 x 1,000,000 x 3/3) 100k
100k
100k
Post-Vestingperiod 20x4Still recordchange inintrinsic
Exercise: 200koptionsShare price: 0.6Intrinsic =0.3
Staff CostCapital Reserve ESO(0.3 x 1,000,000 (40k+60k+100k))
Recordincrease in option value for ALL option first
Cash (0.3 x 200,000) ex price of 0.30 per shareCapital reserve (0.2 x 300kupdatedoption value)Share capital (Current price 0.6 x 200k)
100k
60k60k
100k
120k
Post-Vestingperiod 20x5Still recordchange inintrinsic
Exercises: 800koptionsShare price: 0.6Intrinsic =0.5
Staff CostCapital Reserve ESO(0.5 0.3) x 800k
Record increase in option value for ALL option first
Cash (0.3 x 800,000) ex price at 0.30 per shareCapital reserve (80% x 300k + 160k value)Share capital (Current price 0.8 x 800k)
160k
240k400k
160k
640k
Note total staff cost over years = 460k
*If intrinsic value drop, reverse staff cost and share based payment, as over accountedIllustration 14 Employee share purchase plan (held in trust)
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Firm offers all 120 employees opportunity to participate in share purchase planEmployees entitled to buy 10,000 shares at 20% disc from market price on 30 Jun 20x6All shares boughtheld in trust for five years and all dividends paid also held in trust
- 100 employees accept the plan and 1,000,000 shares were purchased frommarket at $4 each (20% discount from quoted price of $5)
- Shares are vested when purchased but cant be sold for five yearso Accounting for transfer restriction, fair value of restricted share = $4.40
Since fair value restricted share = $4.40Purchase price = $4Then value of equity instrument option granted = (4.40-4) x 1,000,000 = 400k
To recognize this instrument immediately, given NO vesting period(only held in trust which diminishes the equity instrument value)
Dr Cr
Staff CostCapital Reserve
400k400k
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Cash settled Share based payment transaction [Liability]Need to adjust for # of expected ESO in each period, till end of vestingNeed to re-measure/adjust for options fair value change even after vesting tillsettlement/expiry Change in FV recognized as Staff Cost (P&L)
Employee entitled to cash in future based on increase in share price over time Advantages - No dilution to share capital base
- Pay diff in cash, employee dont have to pay $ to exercise option
Illustration 15 Share appreciation rights (SAR), rewards cash settled- Firm grants CEO 1mil SAR, condition to remain in firm for next 3 years- Initial share price @ Jan 20x1: $5
Year Given Market Price of Shares Fair value of Share Appreciation Rights
Dec 20x1 $5.50 $0.9
Dec 20x2 $5.80 $1.50Dec 20x3 $6 $2.1
Dec 20x4 $7 $2.5
Dec 20x5 $8
*Since we know FV of liability, we do not needto use intrinsic value Still as this is liability = need to re-measure fair value of liability at each period
Event Dr CrGrant Date (20x1 Jan) No journal entries recorded, not vested yet
20x1 DecS Price = 5.50Fair value of rights = 0.90
Staff CostLiability(0.9 x 1,000,000 x 1/3)
300k300k
20x2 Dec
S Price = 5.80Fair value of rights = 1.50
Staff Cost
Liability(1.5 x 1,000,000 x 2/3) 300k
700k
700k
20x3 DecS Price = 6.00Fair value of rights = 2.10
Staff CostLiability(2.1 x 1,000,000 x 3/3) 1m
1.1m1.1m
20x4 DecTotal Liability = 2.1mFair value of rights = 2.50S. price = 7
RECORD EXERCISEExercise: 400k rightsRemaining rights = 600k
Liability (2.1m - residual 0.6m [email protected])Staff cost
Cash (S. price $7 initial $5) x 400k
Or separate the entriesStaff Cost (2.5-2.1) x 600k
LiabilityRe-measurement for those not redeemed yet
Liability (2.1m cap reserve x 40%)Staff Cost (2.1 intrinsic $2 actual)Cash [(7-5) x 400k]
Record over-provision of staff cost & exercise
600k200k
240k
840k
800k
240k
40k800k
20x5 DecRemaining liab =1.5mS. price = 8Exercise: Last 600k rights
Liability (extinguish rest of liability)Staff cost ($3 actual $2.5 intrinsic) x 600k
Cash (S. price $8 initial $5) x 600kRecord over-provision of staff cost & exercise
1.5m300k
1.8m
Staff cost over the years = 0.3m + 0.7m + 1.1m + 0.2m + 0.3m = 2.6m
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Share based payment transactions with cash alternatives IMPTArrangement provides either entity or counterparty with choice whether to settletransaction in cash or issuing equity instruments
Depends on whether entity/counterparty has right to choose
Counterpartyright tochoose
SPLITACCOUNTING
If got debtcomponent(liability)
==> revalueat eachreporting enddate!
If counter party has choice of settlement Entity has in fact just issued compound financial instrument with 2components:Debt(i.e. counterparty right to demand cash payment)Equity(counterparty right to demand settlement in equity)
A. Requires split accounting, fair value of debt to determine firstTransactionw partiesnotemployees
Entity should measure FV of goods/services acquiredand measure FV of debt componentfirst.
Residual to equity(FV of goods FV of debt) = FV of equity
Transactionw employees
Entity measure fair value of debt component firstthen fair value of equity; taking into accountcounterparty must forfeit right to receive cash in orderto receive equity instrument
B. On settlement dateCounterpartydemandssettlement inequity
Entity transfer liability to equity, as considerationfor equity instrument issued
Counterpartydemandssettlement incash
Entity treat payment as full settlement ofliability, any equity component previouslyrecognized REMAINS within equity
Entity hasright tochoose
NO SPLITACCOUNTING
Entity hasPresentobligation tosettle in cash
Present obligation to settle in cash ONLY if:- Settlement in equity instrument no commercial
substance (i.e. cant issue more shares, maxed out)- Past policy/practice of settlement in cash- Generally settle in cash if requested
Account as cash-settled SBPTNoobligation tosettle in cash
Transaction account as equity settled share basedpayment
ON SETTLEMENT DATE
Settle in cash Cash payment acc for as share repurchase
Settle by issuingequity instrument
- no further accounting requiredExcess payment recognize as expenses
Illustration 17 - Counterparty has right to choose [Transaction w employee]
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Firm grants CEO right to choose either: (Grant only if she serve 2 years) - Vesting- 1.2m shares OR- 1m phantom shares with right to receive cash payment equal to 1mil shares
If choose share alternative (1.2m): Shares must be held for two years after vesting date
Date Market price of shares
Changes in share prices will affect Liabilitygiven it cash paid based on share pricegivenif phantom share alternative chosen
20x1, Jan 1 $5 per share20x1, Dec 31 $5.40 per share
20x2, Dec 31 $6 per share
COMPOUND INSTRUMENT1. Determine FV of debt alternative first: 1,000,000 x Current mkt price ($5) = $5mil2. Fair value of share alternative
Based on option pricing model, taken into account post-vesting 2 year restrictionFair value of each share = $4.50 on grant dateHence FV of share alternative is (1.2m share as proxy) is $5,400,000 (1.2m x 4.50)
3. CEO must forfeit right to receive either one to receive other:Residual fair value of equity component in compound instrument = (5.4m 5m) = 400k
Apply:(a)Equity settled SBPT treatmentto equity portion (i.e. FV of equity instrument stays)(b)Debt settled SBPT treatmentto debt portionEvent Dr CrGrant date No Journal entries
20x131 Dec
Staff CostLiability (1m x 5.40 x 1 x 0.5)
Recording debt portion using cash settled SBPT
Staff Cost
Capital Reserve (400k unchanged x 1 x 0.5)Record equity portion using equity settled SBPT
Entries CombinedStaff Cost
Liability (price of 5.40 x 1m phantom x )Capital reserve (equity component 400k x )
2.7m
0.2m
2.9m
2.7m
0.2m
2.7m200k
20x231 Dec
Staff CostLiability (1m x 6 x 1 x 1) 2.7m
Staff CostCapital Reserve (400k unchangedx 1 x 1) 0.2m
Entries CombinedStaff Cost
Liability (price of 6 x 1m phantom x 1) 2.7mCapital reserve (equity component 400k x )
3.3m
0.2m
3.5m
3.3m
0.2m
3.3m200k
If choosecashsettlement
LiabilityCash
Equity (cap reserve) remains, may be transferred to RE
6m6m
If chooseequitysettlement
LiabilityCapital reserveShare capital (!.2m shares)
6m400k
6.4m
If options nt exercised; at each period, remeasure ONLY liability portion till expiry/settleTREASURY SHARES
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- Treasury shares not considered as assets- Presented as contra-equity, and deduction from equity in balance sheet- Transactions involving treasury shares never give rise to any profit or
loss, excess goes to Equity- See: Seminar 22, Question 2, NEJ 32-240
Example of Treasury shares purchase
Event Dr Cr
Buyback 100kshares @ $2 each
Equity Treasury SharesCash
200k200k
Sale of treasuryshares @ $3 each
CashEquity Treasury SharesEquity
300k200k100k
Use of Treasury Shares for Employee Share Schemes
- Entity grants employees rights to equity instruments of entity- Entity either chooses or is required to buy instruments (i.e. treasury
shares) from another party- Accounted for as Equity settled SBPT
Two Transactions:1. Equity settled SBPT2. Share buyback
Accounting For Deferred Tax: Treasury shares for ESO
Hence noting the timingdifference fordeductions;
This leads to aTEMPORARY
DIFFERENCE
Amount of Temp DifferenceAccounting Base (CA) = Nil, given this impactequity portion of B/STax Base (TB): Amount IRAS permits as deduction in future periods
CA TB DTD TR DTA
NIL 100 100 20% 20
NIL 120 120 20% 24
See Illustration 18 below for Treasury Share deferred tax example.
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ILLUSTRATION 18: Treasury shares for ESO and Deferred TaxRCL approved plan to grant 10,000 ESOs to each 13 employees
- Strike price: $3- Options granted on 1 Jan 2006
o Vesting conditional upon employee working till 31 Dec 2008o After 3 years vesting, employee has until 31 Mar 2009 to exercise
Year Blackscholes fair pricing SGX Market price
2006 Jan 1.5 Keep this constant for equity SBPT 3
2006 Dec 1.6 3.3
2007 Dec 1.85 3.6
2008 Dec 1.9 4
Date Attrition: Expect one employee to leave each year,
Dec 2006 Total estimated remaining after vesting: 10
Dec 2007 Total estimated remaining after vesting: 10
Dec 2008 Actual remaining: 11 employees
RCL to transfer treasury shares to employees under ESOS, take advantage of tax deduction
Tax: 20%:RCL Share buyback 110,000 shares at $4 on 31 Dec, all 11 employees exercised option
IRAS: Deduction: Diff btw cost in acquiring shares & amt paid by employee
Date CA TB (Note: exercise amt is $3) DTD DTD X TR = DTA Change
20x6 NIL [3.3-3) x 10 x 1,000 x 1/3 10,000 2,000 +2,000
20x7 NIL (3.6-3) x 10 x 1,000 x 2/3 40,000 8,000 +6,000
20x8 NIL (4-3) x 11 x 1,000 x 3/3 110,000 22,000 +14,000
Non-cash settled, stick with original fair pricing for option when grantedEvent Dr Cr
20x6 Dec
Record staff cost
Temp diff, claimdeductible in future
Staff Cost
Capital Reserve ESO(10 x 10,000 x 1.5 x 1/3)
Deferred Tax AssetTax Expense
50k
2k
50k
2k
20x7 DecRecord staff cost
Temp diff, deductiblein future
Staff CostCapital Reserve ESO(10 x 10,000 x 1.5 x 2/3) -50k
Deferred Tax AssetTax Expense
50k
6k
50k
6k
2008 Dec
Record staff cost
Share buyback
Temp diff, claimdeductible in future
Staff Cost
Capital Reserve ESO(11 x 10,000 x 1.5 x 3/3) -100k
Equity - Treasury Shares ($4 x 110,000)Cash
Deferred Tax AssetTax Expense
65k
440k
14k
65k
440k
14k
2009, Mar 31
Empty DTA
Cash (110,000 x $3)what employees paid to exerciseCapital reserve ESO Empty the cap reserve
Equity -Treasury Shares you provided T-sharesEquity Capital revenue gain on disposal of T-Shares
Tax ExpenseDeferred Tax Asset (Empty DTA on closing)
330k165k
22k
440k55k
22k
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DEFERRED TAX FOR STAFF COST DEDUCTIONSA. If IRAS accord staff cost deductions when its incurred (no temp diff)
Date Dr Cr
2008Jan 1
No entry as havent vest
Dec 31 Staff CostLiability
Tax payableTax expense (20% x 20,000)
20k
4k
20k
4k
2009Dec 31
LiabilityStaff Cost (4.5k x 10,000 x 1) 20k
Cash
Tax payableTax expense (20% x 25k)
20k25k
5k
45k
5k
B. If IRAS accord tax deductions based on staff costs related to SARs onlywhen paid to employees (Cash Basis)
Date Events2008Jan 2
Precision entered into agreement to give 1,000 share appreciation rights(SARs) to each 100 senior employees
Each SAR entitles employee cash payment equal to PELs share price onexercise date in excess of exercise price of $20
SAR vests conditionally upon employee working for PEL until 31 Dec2010Employee has until 31 Dec 2011 to exercise SAR after vesting period
2008Dec
Total expected to leave PEL: 2Exp Remaining: 98
2009Dec
Total expected to leave PEL: 7Exp Remaining: 93
2010Dec
End of vesting periodTotal actual remaining: 8840 employees exercised their SARs on 31 Dec 2010None of remaining SARs were exercised in 2011
201131 Dec
Share price = $19
TAX ISSUEStaff costs incurred in relation to SARs was deductible for tax purpose only when paidto employees
Tax rate = 20%, may assume probable PEL sufficient taxable profit for utilization of DTA.
Year Fair value of SAR Share price
31/12/08 $3 $2031/12/09 $4 $22
31/12/10 $5 $24
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Tax for Liabilities [Staff cost exp]CA: Liability account arising from staff costTB: Carry Amt Future deductible (only when paid to employee ~ cash basis)
Year CA TB DTD (CA-TB) DTA(Temp diff x TR)
Change
31/12/08 98k 0 98k 19,600 19,60031/12/09 248k 0 248k 49,600 30,000
31/12/10 248+192-200= 240k
0 240k 48,000 (1,600)
Date Dr Cr
Year 1Record staffcost throughvesting
Staff CostLiability(3 x 98 x 1,000 x 1/3)
Deferred Tax Asset
Tax Expense (Principle 2, underlying)
98,000
19,600
98,000
19,600
Year 2Record staffcost throughvesting
Staff CostLiability(4 x 93 x 1,000 x 2/3) 98k
Deferred Tax AssetTax Expense
150,000
30,000
150,000
30,000
Year 3Last vesting
40 exercised48 remaining*FV of SAR = 5Record 160kpaid to staff
Account forDeferred tax
*Deductiblesgiven as cashis paid, as 40employeesexercised
Staff CostLiability
(5 x 88 x 1,000 x 3/3) 248k
Liability (440k remaining 48 x 1,000 x 5*)Staff costdiff placed hereCash (S. price $24 - $20) x 40 x 1,000
Tax expenseDeferred Tax Asset
Tax payable (cash given of 160k x 20%)Tax expenseGiven deductibles accorded when cash given
Analytical CheckP&L staff cost: (192k-40k) x 20% = 30,400Tax accounted for: 32,000 1,600 = 30,400
192,000
200,000
1,600
32,000
192,000
40,000160,000
1,600
32,000
2011Dec 31
Liability (remaining extinguished)Staff Cost
Tax expense (240k x 20%)Deferred Tax Asset empty DTA
240,000
48,000
240,000
48,000
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INT FRS 111: Group Share-Based Payment Transactions
Accounting for share based payment transactions involves:- Entity buying shares of another entity to satisfy obligation to employee- Two or more entities in same group
Entityreceiving the goods/services shall measure
Nature of Award Own EquityInstruments
Cash or other assets(including another groupentitys equity instrument)
Entitys Obligation toSettle?
Yes Equity-Settled Cash-Settled
No Equity-Settled Equity-settled
Entity settling SBPT when another entity receives goods/services shall recognizetransaction as an equity-settledSBPT only if its settled in entitys own instruments.
- Otherwise recognize as cash-settled SBPTScenario 1: Subsidiary employees granted rights to Subsidiarys equityinstrument by either Subsidiary/Parent
Subsidiary:Obligation: YesOwn Instrument: Yes
- Equity SettledParentObligation: Yes??Own Instrument: No
- Cash SettledConsolidated:Equitysettled
Scenario 2A: ILLUSTRATION A1Parent grants right to its own equity instrument to subsidiary employee
Subsidiary
Obligation: NoOwn Instrument: No
- Equity Settled- Capital contri
ParentObligation: YesOwn Instrument: Yes
- Equity SettledConsolidated:Equity Settled
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Scenario 2B: ILLUSTRATION A2Subsidiary grant rights to its parents equity instruments to its employees
Subsidiary:
Obligation: YesOwn Instrument: No
- Cash SettledParent:
- No EntryConsolidated:Equity Settled
Scenario 3: Involving cash-settled SBPTWhen parent obliged to pay cash to supplier/employees of subsidiary linked to:
(a)Price of Subsidiary equity or (b) price of Parent equity
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Illustration A1: Parent grants right to its instruments direct to subsidiary staffINT FRS 111: ESOPto be accounted for as equity settledfor all books.
- P approve plan that grants top 5 executives of Subsidiary ESO to purchase 200kshares each
- Exercise price: $5 per share- Options granted on 1 Jan 20x1, vested on 31 Dec 20x3- Fair value of each option is $1.50
Event Dr Cr
S Books Staff Cost (1,500,000 /3)Capital Reserve Contribution from P
500k500k
P Books Investment in S (1,500,000 /3)Capital Reserve ESOP
500k500k
Group F/SConsolidated
adjustments
Capital reserveInvestment in S
500k500k
As a result, in group statement: Staff cost increase by 500k, Capital reserve ESOP increase by 500k.
- Effect similar to case where company issue own equity instrument to ownemployees (I.e. subsidiary employee as parents employee)
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Illustration A2: Subsidiary grants rights to parents equity instrument to its staffINT FRS 111:Require subsidiary to account it as cash settledRequire accounting ofequity settled in consolidated statements No accounting entries in parents book
- Subsidiary approve plan to grant top 5 executive right to purchase 200k each ofparents share
- Exercise price: $5- Option granted on 1 Jan 20x1, vest on 31 Dec 20x2- ALL employees exercised option in Dec 20x3 when share price is at 6.40
Share Market Price Fair value of Option
1 Jan 20x1 $5 $1 (For equity based payment, this dont change)
31 Dec 20x1 $5.90 $1.20
31 Dec 20x2 $6.20 $130
Event Dr Cr
31 Dec 20x1 - VESTINGS Books Staff Cost (1.20 x 5 x 200k) x ~ liability reval
Liability600k
600kGrpStatement
LiabilityStaff Cost
(Reverse cash settled entry by subsidiary)
Staff cost ($1 constant option value x 200k x 5) X Capital reserve ESOP
(To record ESOP as equity settled)
600k
500k
600k
500k
31 Dec 20x2 - VESTING
S Books Staff Cost (1.30 x 5 x 200k) x 2/2 600kLiability
Liability revaluation less prior recognition
700k700k
GrpStatement
For beg20x2
LiabilityStaff cost
Reverse cash settled entry by subsidiary
Staff Cost ($1 constant value x 200k x 5) X 1 500k
Capital Reserve ESOP
LiabilityBeginning Retained ProfitBeginning Capital reserve ESOP
(Consolidation adjustments for20x1!)
700k
500K
600k
700k
500k
100k500k
31 Dec 20x3 REDEMPTION DATES Books Staff Cost (1.30 x 5 x 200k) x 2/2 600k
Liability (all liability emptied, all exercised)Cash (actual 6.40 initial share 5) x 5 x 200k
Additional cost incurred as shares went up by 100k
0.1m1.3m
1.4m
Group Treasury Shares 100k
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statement
For beg20x3
Staff cost(Reverse cash settled recognized by subsidiary)
Treasury shares (700k + 600k)Staff Cost
Beginning capital reserve (500k + 500k)(Consolidation adjustments for20x1, 20x2, 20x3)
Capital Reserve ESOPStaff Cost
Treasury shares(Record exercise of ESOP and cancellation of treasuryshares)
1.3m
1m0.4m
100k
0.3m
1m
1.4m
Note: In subsequent years no future consolidation adjustments required,group incurred 1.4m in staff compensation, amount charged to groupbeginning RE.
NO accounting entries required in parents book
Disclosure Page 953
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EXTRA
Miscellaneous: Company act amendments (2005)
The reform of the share buyback regime Enabling of redemption of preference shares The introduction of the concept of treasury shares allow a company to
hold re-purchased shares in treasury instead of cancelling themo Though treasury shares has no voting/dividend rights
Miscellaneous: IRAS Tax Circular- Companies able to use treasury shares to fulfill ESO/Share awards- Firms that grants ESOs/Share awards through treasury shares accorded
a tax deduction- Given equity-based remuneration that are effected through treasury
shares involve companies incurring actual outlay in buying back own
shares Outlay given tax deduction- For purpose of allowing deductions for treasury shares under ESO
o Tax treatment not aligned w accounting treatment under FRS102o Amount of deduction is based on amount firm actually incurred
(i.e. diff btw cost to firm of acquiring treasury shares transferred toemployee and amount paid by employee for treasury shares)
Miscellaneous: Hagopian and boring professors with accountants
Why ESO should beexpensed (FASB)
Why ESO should not be expensed (Hagopian)
Share price dilution ESO Is a gain sharing instrumentHas no accounting costs unless and until there isgain to be shared
Cost of gain sharing instrument must be located onbooks of party that reap gain, shareholders reapthe gain (in higher share price) hence cost of ESOborne by shareholders (i.e. share price dilution)
Cost to shareholders already properly accountedfor under the treasury stock method of accounting
as a transfer of value from shareholders toemployee option holders
ESO Is a transferrableoption, has tangible valueonce vested is a paymentfor employee service andshould be expensed
Neither granting nor vesting ESO meet standardaccounting definition of expense
Granting of ESO is not opportunity cost either.
ESO is diff from transferable stock option with acall premium
Hard to value ESO, due to liquidity and otherissues
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Miscellaneous: More boring professors arguing w Hagopian
Why ESO should be expensed (Bodie, Kaplan, Mrton)
1. Fallacy that stock options do not represent real costa. Transfer of value do not have to involve transfers of cashb. Issuing stock options to employees incurs a sacrifice of cash opp cost
which needs to be accounted for.c. Seen as cash forgone by issuing options to employees rather than
selling to investors opportunity costd. Options use to offset cash company conserves by paying employees
lesspart of remuneration package
2. Fallacy: Cost of employee stock options cannot be estimateda. Claim that employee stock options are private contrat, illiquid
instruments that cant be sold, swapped or pledged, hence hard tovalue
b.
True that instrument lack of liquidity will reduce value to holder, butholder liquidity loss makes no diff to what it costs issuer to createinstrument. Hence issuer should record!
c. May use blackscholes model or variant of it to value, esp with currentfinancial technology Though less precise than cash payouts/sharegrants but financial statements should be as representative as possible
3. Fallacy: Stock option cost are already adequately discloseda. Fallacy that cost of option grants in footnotes to financial statements,
investors/analysts may adjust income statements for cost of optionsand will have necessary data available in footnotes
b. But, relegating such item of major economic significance as employeeoption grants in footnotes would systematically distort reports
c. Esp when database and programmes calculate profitability ratiosbased on numbers in companies audited P&L/B/S. affectcomparability, need for more faithful presentation
d. Also, auditors and executives place lesser emphasis on footnotes thanmain figures, hence might miss out this significant item.
4. Fallacy: Expensing stock options will hurt young businessa. Irony to point 3, as it current disclosure in footnotes is adequate for
communicating economics of stock option grants, then moving costfrom footnote to main balance sheet, income statement figures willhave no market effect
What will expensing involve?1. Benefits accrue to firm from issuing stock options occur in future periods2. Use a straight line amortization formula that will reduce management
error/bias despite some loss of accuracy. i.e. Option that vests over period3. Besides reporting issue of options as expenses in income statement, option
grant should appear on balance sheet. Cost of options recognize in B/S attime of grant as paid in capital
4. Firm to revise income number they have reported should employees forfeitoption and leave company
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Extra Questions in Seminar
Answer:A
Careful for exams!!Must check if FV can be measured:If can be reliably measured, dont use intrinsic value even ifshare prices for each period providedIf cant be reliably measured, use intrinsic value but must re-measure every period
Answer:A