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No forfeitures are estimated since Ms. Musick is the major stockholder and essentially controls the board of directors. However, the stock rarely trades even privately and the company elects to use the intrinsic value method. Fair values of the companys shares are estimated annually using valuation techniques described in the AICPA Practice Aid, Valuation of Privately-Held-Company Equity Securities Issued as Compensation. Date 12/31/09 12/31/10 Fair Value $20 $25 Base Price $20 $20 Compensation Expense Share-based compensation liability Deferred tax asset Deferred tax benefit (I/S) 12/31/11 Vesting Date $19 $20 Compensation Expense Share-based compensation liability Deferred tax asset Deferred tax benefit (I/S) $30 $20 Compensation Expense Share-based compensation liability Deferred tax asset Deferred tax benefit (I/S) Total Compensation Pct 0% None Journal Entry Debit Credit
12/31/12
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Compensation Expense Share-based compensation liability Deferred tax asset Deferred tax benefit (I/S)
Share-based compensation liability Cash Current taxes payable Current tax expense (I/S) Deferred tax benefit (I/S) Deferred tax asset
This method is can only be used by nonpublic entities for awards classified as liabilities. If the award was classified as an equity award because no cash settlement was permitted, the award would have to be accounted for by the fair value method even if the companys shares are not publicly traded.
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No forfeitures are estimated since Ms. Musick is the major stockholder and essentially controls the board of directors. Assume that the shares not held by Ms. Musick are publicly traded on an over-the-counter market. Since this is an award classified as a liability, the fair value of the SARS must be estimated on each balance sheet date until exercised (settled).
Total Compensation
Pct 0% None
Compensation Expense Share-based compensation liability Deferred tax asset Deferred tax benefit (I/S) 12/31/11 Vesting Date $19 $5 Compensation Expense Share-based compensation liability Deferred tax asset Deferred tax benefit (I/S) $30 $15 Compensation Expense Share-based compensation liability Deferred tax asset Deferred tax benefit (I/S)
12/31/12
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Compensation Expense Share-based compensation liability Deferred tax asset Deferred tax benefit (I/S)
Share-based compensation liability Cash Current taxes payable Current tax expense (I/S) Deferred tax benefit (I/S) Deferred tax asset
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No forfeitures are estimated since Ms. Musick is the major stockholder and essentially controls the board of directors. Assume that the shares not held by Ms. Musick are publicly traded on an over-the-counter market. Date 12/31/09 12/31/10 FV Stock $20 $25 Compensation Expense APIC - SARS Deferred tax asset Deferred tax benefit (I/S) 12/31/11 Vesting Date $19 Compensation Expense APIC - SARS Deferred tax asset Deferred tax benefit (I/S) $30 $32 No adjustment to Compensation Expense after vesting No adjustment to Compensation Expense after vesting FV SARS $10 Total Compensation Pct 0% None Journal Entry Debit Credit
12/31/12 12/31/13
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Actual tax deduction based on intrinsic value at settlement Current taxes payable Current tax expense (I/S) APIC excess tax deduction
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HOMEWORK A
1. Stone Inc. offered stock appreciation rights (SARS) to its president, Richard Rock, on the appreciation of 100,000 shares of Stone Inc. common stock. The SARS were granted on December 31, 2014 when the stock was selling for $30 per share. Mr. Rock will receive all price appreciation from the date of the grant until the date of exercise in the form of cash. The earliest possible exercise date was identified as January 1, 2017, and, if not exercised, the SARS will expire on July 1, 2018. The relevant market prices for Stone Co. stock are given in the table below along with the fair value estimates for the SARS. Assume that Mr. Rock exercised all of his SARS on March 1, 2018. Stones marginal tax rate is 30%. Mr. Rock holds 51% of the voting shares and is not expected to retire until 2020. The par value of the stock is $1. Date 12/31/14 12/31/15 12/31/16 12/31/17 03/01/18 07/01/18 a. Market Price $30 $36 $29 $33 $39 $41 Base Price $30 $30 $30 $30 $30 $30 Fair Value of SARS computed using Binomial Pricing Model $6.00 $8.25 $3.50 $6.30 $9.50 $11.00
Prepare all necessary entries on Stone Inc.s books assuming that Stone Inc. is a public company with stock trading on the New York Stock Exchange. Prepare all necessary entries on Stone Inc.s books assuming that the appreciation earned by Mr. Rock cannot be paid in cash. Instead, he will receive shares of Stone Inc. common stock with a value equal to the appreciation from grant date to exercise date. Research questions: Determine the measurement date(s) and requisite service period(s) for the following awards: a. An award specifies that vesting will occur after four years of continuous employee service OR when a new product currently under development is officially launched. The employer estimates that it is probable that the product will be launched by the end of the third year of the award. An award is negotiated with a companys CEO relating to 200,000 options with an exercise price of $20 each. The award is structured so that 40,000 options will vest or be forfeit in each of the next 5 years depending on whether performance targets related to the companys market share are achieved. A five year plan establishes the targets at the inception of the plan. Forfeiture of the options in a particular year will not affect the outcome for any other tranche of 40,000 options. If the CEO does not remain employed by the company, any unvested options at the termination date will be forfeit.
b.
2.
b.
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Exercise Period
Compensation expense Additional Paid-in Capital - stock options Deferred tax asset Income tax expense (deferred)
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Compensation expense Additional Paid-in Capital - stock options Deferred tax asset Income tax expense (deferred)
Assume that on April 1, 2013, executives exercised 85,000 of the stock options purchasing 85,000 shares of Genessee Engineering common stock ($10 par value) for $20 per share. The market price was $30. Assume that the stock market crashed early in May, 2013 and the one executive was never able to exercise the remaining 5,000 options. Instead, they expired on July 1, 2013 when the stock price was $15.
Note: Actual value of option is greater than amount computed at grant date.
4/1/13 (Market price $30), 85,000 options exercised
Cash Additional paid-in capital - stock options Common stock ($10 par) Paid in capital in excess of par
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Example 2, continued The actual tax deduction will be $10 per share or $850,000 * .34 = $289,000 We need to zero out the amounts set up in deferred taxes and record actual amount due to government. The unanticipated tax savings are considered an addition to paid-in capital. Income tax expense (deferred) Deferred tax asset Income taxes payable Income tax expense (current) APIC excess tax deduction 7/1/13 (Market price $15), 5,000 remaining options expire APIC - stock options Additional paid-in capital - expired stock options Deferred tax asset Income tax expense (deferred)
(There will never be a deduction for these options. Therefore, there is no effect on current taxes payable)
Note under SFAS 123 there was an alternate accounting treatment that let companies wait until options were actually forfeit. This is no longer permitted under SFAS No. 123 Revised (2004) companies must estimate the number of shares that will be exercised when they measure initial compensation expense (see FAS123(R), Par. 43)
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Options Outstanding at end of year 100,000 95,000 90,000 0 at 12/31 85,000 exercised at 4/1 5,000 expired on 7/1
Average market price $24.32 $24.95 $26.82 For 1/1 to 4/1 $30.25 For 1/1 to 7/1 $27.56
Well come back and work on doing earnings per share for Example 2 later
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12/31/11
12/31/12
Toward the end of 2013, sales growth for several products makes achievement of goals probable. Vice presidents of those divisions hold 55% of the options. None of the vice presidents left employment during 2012 or 2013 so the expected turnover rate is lowered to 3%. 12/31/13 Market Price PPP stock = $37 Options expected to be outstanding at 12/31/14 =
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Example 3, continued
By the end of 2014, five divisions had achieved their market share targets, but one of the five vice presidents had been fired before year end leaving just 36,000 options to vest. 12/31/14 Market Price PPP stock = $39
12/31/15
6/15/16
All options exercised when market price of PPP common stock = $43
6/15/16
Cash APIC stock options outstanding Common stock ($1 par) APIC common stock
6/15/16
Income tax expense (deferred) Deferred tax asset Current taxes payable Income tax expense (current) APIC excess tax deduction
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b.
c. d. e.
2.
Stock based award with a performance condition. On January 1, 2011, the CEO of KanDu Inc. (John Adams) is granted 10,000 options. The award specifies that vesting will occur after four years of continuous employee service OR when a new product currently under development is officially launched. The KanDu Inc. estimates that it is probable that the product will be launched by the end of the third year of the award. The option price is $20 which is the market price of KanDu shares on the grant date. At the grant date, the fair value of the award is $7 per share, determined using the binomial pricing model. The options expire December 31, 2015. Assume that the tax rate for KanDu Inc. is 30%. [You may ignore the forfeiture issue since John Adams is the majority shareholder and is not expected to retire for at least 10 years.]
Prepare the journal entries necessary through vesting. Assume that at the end of 2013, everyone knows the product will be launched within the next six months. The actual launch date is April 1, 2014 and Mr. Adams exercises all the options on Sept. 25, 2015 when the market price is $33 per share. The par value of KanDu stock is $1.
For both problems: There is more than one reasonable way to handle changes in accounting estimates. Accordingly, you must include T-accounts with your answer so that both of us (student and professor) can see if your method worked out correctly. At a minimum, T-accounts should include APIC-stock options outstanding and Deferred Tax Assets.
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Exercise Period
Number of Shares Expected to Vest 6,000 * .996 = 5,649 6,000 * .997 = 5,592 6,000 * .99 = 5,536 6,000 * .999 = 5,481 6,000 * .99 = 5,426 27,684
10 8
Shares that Actually Vest 6,000 6,000 5,600 5,600 5,000 28,200
Note that the information in the final two columns is not known initially facts are provided in this format for simplicity to provide data needed to prepare the journal entries. Note that no adjustments to the original assumption regarding forfeitures was needed during the 10 year period.
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Example 4, continued
12/31/12 through 12/31/21 Same entry to record estimated compensation (using straight-line attribution method)
12/31/17 Market Price $57 - Recognize vesting of first tranche with related income tax impact
There is a required test under ASC 718-10-35-8 (SFAS 123R Para. 42 test): if you use the straight-line attribution method. Per ASC 718-10-35-8, the amount of compensation expense recognized so far must be at least the amount vested. At 12/31/09, 20% of the restricted shares have vested. Check: compensation expense $127,291 * 6 years = 763,746 divided by $1,272,907 total estimated compensation expense= 60%. So we dont need to make an adjustment. In this example, there is no problem at any of the vesting dates but youd probably have trouble if larger numbers vested early [Example: 200,000 options vesting 100,000, 50,000, 25,000, 25,000]
12/31/18 Market Price $60 - Recognize vesting of second tranche with related income tax impact
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Example 4, continued
2019 2 executives quit, each holding 600 shares (200 in each of the last three tranches) See ASC 718-20-55-33 (SFAS123R, para. A103) - we must adjust compensation expense to ACTUAL number vested. With the straight-line method, it makes sense to wait to adjust until the last tranche vests. If we were using the graded vesting method (treating each tranche separately), we would probably need to adjust to actual at the vesting date of each individual tranche.
12/31/19 Market price $62 recognize vesting of third tranche (5,600 shares)
And so on. When testing out a new accounting process, it is important to make sure accounts that are supposed to zero out actually zero out. I find it very helpful to do T-accounts (like the ones on the next page) to verify that I have made the journal entries properly.
See separate solution file for complete set of journal entries and t-accounts
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Deferred Compensation
Compensation Expense
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67,788
78,288
83,040
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HOMEWORK C
Graded Vesting
Merlin Manufacturing Inc. awards 400,000 options on March 1, 2010 to 50 managers (8,000 options each). The options were at-the-money on the grant date when the stock price was $39.00. The options vest according to the following schedule: Vesting Date March 1, 2012 March 1, 2013 March 1, 2014 March 1, 2015 Fair Value $9 $13 $18 $22 Percentage Vested 25% 25% 25% 25% Expiration Date (all tranches) December 31, 2020 (or within 3 months of termination)
At the grant date, the anticipated forfeiture rate is 2%. Round forfeiture estimates to whole employees so that you forecast eliminating all unvested options held by a terminated employee. The company has a calendar year fiscal year. It is not necessary to make quarterly entries. Assume the tax rate is 30% throughout the period. The common stock has a $5 par value. Information on forfeitures, exercise, and market values are presented below: Vesting Date 3/1/2012 3/1/2013 3/1/2014 3/1/2015 Exercise Date 12/5/2014 2/13/2015 12/10/2015 12/3/2019 Actual Options Vested 98,000 92,000 82,000 80,000 Number of Options Exercised 12,000 18,000 54,000 268,000 Market Value of Common Stock at Vesting Date $48.00 $54.25 $49.00 $52.00 Market Value of Common Stock at Exercise Date $50.00 $55.00 $55.50 $62.00
After the first two tranches vest at 3/1/13, the company revises its estimated number of options expected to vest using a retroactive 3% turnover rate. (Hint: it may be easier to make the adjustment through the end of the previous year rather through 3/1/13. Doing it this way might make the recognition of compensation expense for 2013 simpler to compute since it would then be for a full year using the new number of options anticipated.) Requirements: 1. Assume that the company uses the straight-line attribution method permitted under SFAS No. 123R. Since the company does not keep track of the tranche from which each option originated, it chooses the first-vested, first-exercised basis to determine the fair value of options exercised - like the first-in, firstout inventory method. In other words, they are accounting for the four tranches as a single award. 2. Assume that the company uses the graded-attribution method permitted under SFAS No. 123R. This is consistent with treating each of the four tranches as a separate award. The company keeps track of the tranches from which each option originated but you may assume that the actual exercises through 2015 are from the first tranche (to keep it the same as #1). See illustrations that start at about ASC 718-20-55-25 You MUST include T-accounts with your solution so that both of us will know your journal entries accomplished the intended purpose
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