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Certified Equity Professional > Level 1 Accounting > Flashcards

Level 1 Accounting Flashcards

1
Q

Financial Accounting Standards Board (FASB)

A

A Private-sector organization responsible for both establishing financial accounting standards (GAAP) and offering guidance on the implementation of those standards. The SEC retains the authority to veto FASB decisions and to punish companies that fail to follow FASB standards.

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2
Q

International Accounting Standards Board (IASB)

A

Independent standards-setting body whose member countries are free to adopt its standards, known as international financial reporting standards (IFRS). The IASB does not have the authority to set accounting standards for individual countries, but its member countries have sought to standardize their accounting requirements to make it easier for investors and others to assess company financials across country lines.

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3
Q

ASC 718

Accounting Standards Codification Topic No. 718

A

Governs the company’s expensing of employee and non-employee equity compensation awards for grants settled in stock.

Made to give investors better insight on how much equity awards that are granted are costing the issuing company.

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4
Q

ASU 2018-07

A

Brought accounting for non-employee grants under ASC 718.

Required fair value estimates until each vest date was reached.

Stock settled awards are treated like employee options.

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5
Q

Fair Value

A

Is the calculated number used for expense purposes. It is price that would be received to sell an asset or paid to transfer a liability in a transaction between market participants at the Measurement Date.

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6
Q

Fair Market Value

A

Is equal to the current trading value of the underlying stock, dictated by the public market.

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7
Q

ASC 718 –Explicit Service Periods

A

The stated vesting period of the award. Used for time-based awards only.

Usually starts on Grant Date and ends on date award is fully vested.

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8
Q

ASC 718 – Implicit Service Periods

A

For performance-based awards (vesting contingent on goals not related to stock price), period between the grant date and the expected vest date.

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9
Q

ASC 718 – Derived Service Periods

A

For market-based awards (vesting is contingent on goals related to the stock price), the service period is computed via a sophisticated option pricing model. (e.g. When stock price increases by 20%, output of a model like Monte-Carlo Simulation).

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10
Q

Equity Awards

A

paid out in stock

Expense measured on the grant date and not subsequently adjusted unless the award is modified.

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11
Q

Liability Awards

A

paid out in Cash

Fair Value Expense is not determined until the grant is settled. The estimated fair value is re-measured each reporting period (quarterly) and the expense is adjusted.

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12
Q

ASC 718 Equity Compensation Accounting Process:
Determine Measurement Date

A

Looking at the attributes of the award, you will determine the measurement date.

The fair value of an award is determined on its “measurement date.”

Equity awards will have a GRANT DATE for employee and non-employee awards settled in stock. Requires Board Approval.

Liability Awards are measured in the future on Settlement Date when award is settled in Cash.

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13
Q

Equity Compensation Accounting Process:
Measurement

A

In this step you measure how much the expense will be.

For options you’ll use an option-pricing model to measure the fair value of the award.

For restricted stock, use the Fair Market Value.

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14
Q

Equity Compensation Accounting Process:
Service Period

A

The period of time over which the expense will be recognized.

Usually the vesting period.

The period of the time over which the expense will be recognized

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15
Q

Equity Compensation Accounting Process:
Recognition

A

In this step you recognize the expense of the award over the service period. Amortized over the course of the service period.

Example: If vesting over a year, roughly 25% of the expense every quarter.

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16
Q

Equity Compensation Accounting Process

A
  1. Measurement Date
  2. Measurement
  3. Service Period
  4. Recognition
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17
Q

6 Required Option-Pricing Model Factors to be compliant with ASC 718

A
  1. exercise price
  2. Grant Date Fair Market Value
  3. expected term
  4. expected volatility
  5. expected dividend yield
  6. risk-free interest rate
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18
Q

Option-pricing Models:
Black-Scholes

A

Very Standardized Model through a standard formula.

Developed to value exchange-traded options (like pork-belly futures), not employee and consultant stock options. Despite criticisms, it remains the most commonly used model for valuing stock options

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19
Q

Option-pricing Models:
Lattice

A

A type of model, not a specific model, which includes binomial, trinomial, and multinomial models. These models create a lattice of possible future outcomes. More accurate than Black-Scholes, but more complex as well.

Fair value = average of those outcomes.

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20
Q

Measurement of Compensation Expense for Restricted Stock Award (RSA) and Restricted Stock Unit (RSU)

A

Expense is measured by using the price of the stock because they are Full Value Awards.

Fair Value = FMV - exercise price

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21
Q

Measurement of Compensation Expense for Stock Options and Stock Appreciation Rights settled in Stock

A

Treated as a Stock Option under ASC 718 when settled in stock.

  • Fair value calculated on date of grant using an option-pricing model
  • Expense is recorded over service period
  • Expense is reversed for unvested, forfeited awards
  • Expense is not reversed for vested awards that expire unexercised
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22
Q

Measurement of Fair Value for Restricted Stock Awards (RSA) and Restricted Stock Units (RSU)

A

Expense for RSA/RSU is based not on an option-pricing model but on the intrinsic value of the award on the grant date.

Fair Value = Grant Date FMV - Exercise Price

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23
Q

Intreinsic Value of Fair Value for RSA/RSUs

A

Stock’s fair market value less price paid per share (if any) = Fair Value for RSA/RSU (compensation cost)

Fair Value = FMV - Exercise Price

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24
Q

Effect of Dividends Measurement of Fair Value on RSA/RSUs

A

If dividends are paid on the company’s stock but not on the grant, the fair value may be reduced to reflect that.

Similar stock that is getting dividends are worth more than stock that is not. Fair value for the dividend paying stock would have a higher Fair Value.

Higher Dividend = Higher Fair Value

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25
Q

Recognition of Compensation Cost for Employers with Employee and Non-employee Grants

A

Fair Value is expensed over the service period of the award
• The amount of amortization must always be at least as great as the number of shares actually vested
• Expense is reversed for forfeitures
• Expense is not reversed for awards that vest but expire unexercised

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26
Q

ASC 718 Recognition of Compensation Expense for Employers on Time Based Award:
Straight-line Accrual

A
  • The fair value of the entire award is recognized in EQUAL INSTALLMENTS across the vesting period of the award
  • Permissible for grants with time-based vesting only
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27
Q

ASC 718 Recognition of Compensation Expense for Employers on Time Based Award:
Accelerated Accrual (FIN-28)

A

Each vesting tranche treated as a separate award and expensed from grant date to each, separate vest date.

ex for 3 Year Annual Vesting schedule:

The fair value for the first vesting tranche would be completely recognized during the first year; the fair value for the second vesting tranche would be recognized over the first two years; and the fair value for the third vesting tranche would be recognized over three years.

Expense Recognized for 3 Year in:
Year 1= 183%
Year 2= 83%
Year 3= 33%

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28
Q

True up

A

Company may estimate the percentage of forfeiture it expects. Expense recognition may be reduced by the estimated forfeiture rate.

Must adjust future expense recognized based on actual forfeitures at end of service period

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29
Q

ASU 2016-09

A

Companies may now elect to only account for forfeitures as they occur. Previously did not have a choice.

  • Full amount of calculated fair value expense is recorded
  • As grants forfeit, previously recorded expense attributable to forfeited portion of grant is reversed
  • Requires affirmative policy election to adopt this method.
  • Election is applied to all awards granted by company (cannot estimate forfeitures for some grants but not others)
30
Q

ASU 2017-09

A

Describes when changes to options and awards are subject to modification accounting.

Narrowed the definition of a modification to encompass changes that impact value, vesting or balance sheet classification.

NO Modification if the Vesting conditions, Fair Value, and award balance sheet classification has not changed.

31
Q

423 ESPP Non-Compensatory Plan

A

Plans designed to avoid accounting expense on income statement.

No accounting expense if:
* Offer a purchase discount of no more than cost of raising capital in a public offering (5% discount safe harbor)
* Have no option-like features (look-back feature)
* Allow substantially all employees to participate but limit enrollment period to 31 days after purchase price is set

32
Q

423 ESPP Compensatory Plan

A

Triggers accounting and compensation expense that the company must recognize on the income statement for compensatory plans:

• Most ESPPs have a bigger purchase discount or a look-back feature and so will recognize an accounting expense.

33
Q

Compensatory ESPP Expense Accounting Process: Measurement Date

A

Offering/Grant Date = Measurement Date.

Generally the date when the ESPP offering begins.

34
Q

Compensatory ESPP Expense Process: Requisite Service Period

A

Time of service period from the offering date/grant date through the purchase date.

Synonymous with vesting schedule

35
Q

Compensatory ESPP Expense Process: Measure the expense

A

Calculate fair value, along with an estimate of how many shares are likely to be purchased during the offering period.

= fair value per share x estimated shares purchased

36
Q

Compensatory ESPP Expense Process: Recognize the expense

A

Estimated expense recognized from offering date to purchase date and trued up to actual shares purchased after purchase occurs if the final number of shares purchased differs from estimated number of shares.

37
Q

Component Measurement Approach on awards with “Option Like Features” –
ASC 718-50

A

Use the ESPP plan components to determine FMV/Expense Measurement

  • Discount
  • Lookback Feature (Black-Scholes for Call Option)
  • No beginning price limit (Black-Scholes for Put Option)
  • Call (Purchase)/Put (Sell) Option of Share
38
Q

Equity Treatment

A

When an award is settled through stock

39
Q

Difference in Equity Award vs. Liability Award.

A

Equity awards are paid out in stock.

Liability awards are paid out in cash.

40
Q

How does Compensatory/Non-Compensatory accounting status effect the tax Qualification Status?

A

It has no effect on Tax Qualification. Either way, the ESPP can still qualify as a Section 423 Plan for tax purposes if it meets the statutory requirements.

41
Q

How to recognize the compensation cost for option awards to non-employees under ASU 2018-07

A

Calculate the award’s fair value on the grant date and recognize expense over the service period of the award.

42
Q

Estimating volatility for employee options for Public Companies

A

The volatility of a public company’s stock may be based on an analysis of the stock over a period equal to the expected term of the option being valued.

43
Q

Estimating volatility for employee options for Private Companies

A

Private companies that cannot produce a reliable estimate of their stock volatility can look at similar public companies or industry indices over the expected term

44
Q

Option Volatility

A

Volatility measures risk and high volatility means that the chance of a big upward swing is just as likely as a big downward swing. While a big downward swing doesn’t affect option holders, because they just don’t exercise their options, a big upward swing could result in a big profit if the option holder exercises the options.

45
Q

FAS 123R

A

The basic idea behind FAS 123R is that the costs associated with equity payment for employee services are to be expensed on financial statements.

Equity compensation was previously not expensed because it’s not a real monetary expense. However, equity compensation is a direct expense to a company’s shareholders.

46
Q

Generally Accepted Accounting Principles (GAAP)

A

Nationally accepted accounting standard, different countries have different standards. EX: US GAAP

47
Q

International Financial Reporting Standards (IFRS)

A

Standard proposed by the IASB that countries are free to adopt, US did not accept

48
Q

What Is the Difference Between Fair Value and Market Value?

A

Fair value is a broad measure of an asset’s intrinsic worthwhile market value refers solely to the price of an asset in the marketplace as determined by the laws of demand and supply. As such, fair value is most often used to gauge the true worth of an asset. Also, the fair value of an asset tends to be more static, especially in the context of financial statements, while its market value is at the whims of market forces.

49
Q

When using Option Pricing Models, how does the Exercise Price effect the Fair Value

A

Higher, Premium Priced(Under Water) = Lower Fair Value

Lower, Discounted Exercise Price = Higher Fair Value

1 OF 2 INVERSE RELATIONSHIPS FOR FAIR VALUE CALCULATION

50
Q

When using Option Pricing Models, how does the Grant Date Fair Market Value effect the Fair Value

A

Higher FMV = Higher Fair Value

51
Q

When using Option Pricing Models, how does the Expected Term effect the Fair Value

A

Period that the option is exercised to be outstanding for. Period between Grant to Exercise/Cancellation

Longer Term = Higher Fair Value

52
Q

When using Option Pricing Models, how does the Option Volatility effect the Fair Value

A

Higher Volatility = Higher Fair Value

Higher chance for stock to be sold during an upswing in price, holder would hold the stock during a downward swing.

How much the company is expected to oscillate using:

  • Company’s historical Volatility
  • Company’s Implied Volatility
  • Exchange-Traded options
  • Historical or implied Volatility of Peer companies
53
Q

When using Option Pricing Models, how does the Dividend Yield effect the Fair Value

A

Higher Dividend Yield = Lower Fair Value

An increase in the expected dividend yield causes a decrease in the calculated fair value of an award because the dividend is a stock-related benefit that the award holder will not receive while the award is unvested.
1 OF 2 INVERSE RELATIONSHIPS FOR FAIR VALUE CALCULATION

54
Q

When using Option Pricing Models, how does the presence of Risk Free Interest Rates effect the Fair Value?

A

Higher Risk Free Interest Rates = Higher Fair Value

Less overall risk increases value

55
Q

Monte Carlo Simulation

A

Example of a Lattice Model

Used to model the probability of different outcomes in a process that cannot easily be predicted due to the intervention of random variables. It is a technique used to UNDERSTAND THE RISK and uncertainty in prediction and forecasting models.

56
Q

Forfeiture

A

Is the cancelation of an option before it is vesting period is completed.

When performance goals are not achieved during its term, it is NOT a forfeiture because the risk of not meeting the goal should be incorporated with the Option Pricing Model.

57
Q

Compensatory ESPP Expense Process from start to end

A
  1. Measurement Date at Grant established
  2. Requisite Service Period Established
  3. Measurement of Expenses (Fair Value x est. # of Shares)
  4. Expense Recognition (May trigger a True Up)
58
Q

Measurement of Fair Value for Section 423 ESPP Awards

A

Fair Value calculated using an option pricing model with THREE components: Discount, Put and Call, different plan features.

Results in expense if discount is greater than the cost of raising capital or if plan includes a Lookback feature.

Fair Value Determined at grant date and recognized over service period.

59
Q

Measurement of Fair Value for Cash Settled SARs

A

Fair Value is estimated and recognized over the life of the award, then finalized upon settlement or expiration.

Fair Value calculated using an option-pricing model on the reporting date and intrinsic value on settlement date.

60
Q

Measurement of Fair Value for Phantom Stock paid in Cash (cash settled RSU)

A

Fair Value estimated and recognized over the life of the award, finalized upon settlement.

Fair value calculated as the intrinsic value on the reporting and settlement date.

61
Q

IFRS #2

A

International Finacial Reporting Standards that requires an entity to recognise share-based payment transactions (such as granted shares, share options, or share appreciation rights) in its financial statements, including transactions with employees or other parties to be settled in cash, other assets, or equity instruments of the entity.

62
Q

Appreciation Awards:
Stock Options

A

The Right to purchase a share of stock at a specific price at the time of vesting. Expense is measured by using an option-pricing model

63
Q

Appreciation Awards:
Stock Appreciation Right

A

The right to recieve the difference between the value of a share of stock on the grant date and the value of stock on the vest date.

64
Q

Full Value Awards:
Restricted Stock Award (RSA)

A

Grant of an actual share of stock at the time of grant

65
Q

Full-Value Awards:
Restricted Stock Unit (RSU)

A

The right to recieve the full value of a share of stock at the time of vesting.

66
Q

Measurement of Stock-settled SARs

A
  • ASC 718 treats them the same as stock options
  • Expense is recorded over service period
  • Expense is revested for unvested, forfeited awards
  • Expense is not reversed for vested awards that expire unexercised
67
Q

True Up for Time Based Awards

A

Final True Up at vesting based on actual forfeitures, not estimated forfeitures

68
Q

True Up for Performance Awards

A

Final True Up based on actual settlement

69
Q

True Up for Market Based Awards

A

NOT Trued-Up if the shares are forfeited due to a failue to meet target
* Likelihood of achiveing vesting is included in origional fair value measurement
* If shares are forfeited for a termination of service, expense is reversed

70
Q

Component Measurement Approach forPain Grants (no option like features) - ASC 718-50

A

$ Grant Price x % Discount = Fair Value

Certified Equity Professional (8 decks)

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