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Certified Equity Professional > Level 2 Accounting > Flashcards

Level 2 Accounting Flashcards

1
Q

ACS 718

Equity Treatment

A
  • Awards that pay out in stock receive equity treatment
  • Expense is determined at grant date
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2
Q

ASC 718

Liability treatment

A
  • Awards that pay out in cash receive liability treatment
  • Expense for grants that receive liability treatment is not determined until the grant is settled
  • Fluctuations in fair value before settlement increase or decrease expense recognized
  • Cumulative catch up each period (as if the fair value had always been current fair value)
  • stock-based compensation that is settled in a fixed amount of dollars is usually classified as a liability
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3
Q

ASC 718

Events Triggering Liability Accounting Treatment

A

Liability treatment applies to grants that the company can be required to settle in cash upon the occurrence of events outside the company’s control as well as the election of the award holder.

Where the triggering event is “outside the control of the award holder, liability accounting is not required until the triggering event becomes likely to occur”

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4
Q

ASC 718

Cash Settlement

A
  • Fair value re-estimated each period, expense trued up
  • Exercise, cancellation or expiration, where final expense of liability awards is adjusted to settlement date intrinsic value
  • Expires unexercised = expense reversed
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5
Q

ASC 718

For the measurement date to occur, the following must be true

A
  1. Company and award recipient have a mutual understanding of the award’s key terms and conditions.
  2. The company is contingently obligated to issue award or transfer assets to an award recipient who renders the requisite service.
  3. Required approvals for the grant have been obtained.
  4. Award recipient begins to be affected by subsequent changes in the price of the company’s shares.
  5. Communication of the terms of the award must be made within a reasonable time of the grant date.
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6
Q

ASC 718

Measurement Date for cash-settled awards

A

Settlement Date

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7
Q

ASC 718-10-25

A

Clarifies that a mutural understanding is presumed to exist on the date the board of directors approves the grant, provided that the following two conditions are met:
1. Grant is unilateral, and the award recepiant does not have the ability to negotiate terms and contitions
2. Grant is expected to be communicated to the award recipient in a “relitvily short timeframe”

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8
Q

ASC 718 Preferred Pricing/Valuation Model

A

There is no specific pricing model identified or even a strong preference stated, so that means that companies have a variety of different options pricing models that they can choose from.

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9
Q

ASC 718

Black Scholes Merton, “BSM” model inputs:

A
  • Exercise price
  • Fair market value of underlying stock
  • Expected term of option
  • Expected volatility of underlying stock
  • Expected dividend yield on underlying stock
  • Risk-free interest rate
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10
Q

Black Scholes Merton, “BSM” model inputs:

Expected term

A

The length of time option holders are anticipated to wait before exercising their options and is typically shorter than the contractual term because most employees exercise long before their options are due to expire.

Also called “Expected Life”

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11
Q

Black Scholes Merton, “BSM” model inputs

Expected Volatility

A

Over a period of time equal to the expected term the company will measure the annual fluctuation of the stock price that is expected. This can be based on historical fluctuation, but if expectations for the future are different for some reason, this measure should be adjusted.

For purposes of understanding this factor, higher volatility increases the estimated fair value of the options.

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12
Q

Black Scholes Merton, “BSM” model inputs

Expected dividend yield

A

If company offers dividends, but options don’t come with dividend rights, then those dividends decrease the value of the options.

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13
Q

Black Scholes Merton, “BSM” model inputs

Risk-free Interest Rate

A

This is the rate currently available on zero-coupon U.S. government issues that have a remaining term equal to the expected term of the option.

However, because these aren’t usually freely available to the public, most companies use the Treasury rate with a term equal to option’s expected term, which available on the US Treasury website.

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14
Q

Preferred Pricing Model for Full Value Awards

A

use simple intrinsic value.

=Grant date fair market - less the exercise price if any.

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15
Q

Preferred Pricing Model for Market -Based Awards

A

Monte Carlo simulation.

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16
Q

Lattice Option Pricing Model

A

the term does not refer to a specific model but to a type of a model, basiclly a tree of outcomes.

Much more complicated than the BSM and may allow for, not only the minimum inputs required, but multiple inputs.

The model takes your grant from grant date to expiration date and breaks that time down into smaller intervals and within each interval that it breaks your grant down into, it calculates the probability of the exercise that may occur.

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17
Q

Binomial Lattice Model

A

Assumes your stock price is going to go up or down.

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18
Q

Trinomial Lattice Model

A

Assume the stock price is going to go up, down, or remain flat.

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19
Q

Lattice models also generally have two additional assumptions outside of the minimum required six factors

A
  • the Sub-optimal exercise factor
  • the post-vesting termination rate
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20
Q

Valuation of Stock Options

Calculating “Expected Term” Under ASC 718 using the SAB 107 simplified method

A
  • If company cannot rely on historical data (insufficient or irrelevant)
  • Average of the vesting term and contractual term of the option
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21
Q

Requirements for SAB 107 Simplified Method (SM)

A
  • Option must be “plain vanilla”
  • Service-based
  • At-the-money and strike price equals market value
  • Unvested shares are forfeited at termination
  • Vested shares only exercisable for a “short period” after termination
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22
Q

SAB 110 restrictions on Simplified Method (SAB 107)

A
  • Requires careful justification for using Simplified Method
  • Financial statement disclosure of reasons for using Simplified Method
  • Simplified Method is prohibited where there is sufficient historical data
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23
Q

Expected Term

ASU 2018-07

A
  • Brought accounting for non-employees under ASC 718
  • To value nonemployees grants, private companies can use the contractual term
  • Not clear that simplified method can be used for non-employee options
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24
Q

ASC 718 – Service Periods

ASC 718 – Explicit Service Periods

A
  • Time-based awards
  • The stated vesting period of the award (e.g. time-based, 33% annually over 3 years, monthly over 4 years).
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25
Q

ASC 718 – Service Periods

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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26
Q

-ASC 718 – Derived Service Periods

A
  • For market-based awards (vesting is contingent on goals related to the stock price)
  • 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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27
Q

Recognition of Expense for Cliff-Vesting Awards

A
  • Full vest on a single date
  • Expense accrued on a straight-line basis
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28
Q

Recognition of Expense for Graded Vesting Awards

A
  • Example: Monthly, Quarterly, Yearly Vesting, combo
  • ASC 718 Permits two alternative methods for time-basedawards:
    1. Straight line
    2. Accelerated Attribution (FIN28)
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29
Q

Recognition of Expense for for time based awards using Straight Line basis

A

Over full-service period provided the amount of expense recorded at any point is proportionate to the percentage of vesting

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30
Q

Recognition of Expense for for ** time based awards** using Accelerated Attribution (FIN28)

A

Where each vesting increment is treated as separate grant expensed starting on grant date. The expense ends up being more “Front-Loaded”

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31
Q

Non-Substantive Vesting

A

“Vesting with no teeth”

The award will ultimately vest despite the vesting “on paper”, the service period is deemed to have completed at the grant date and the expense is recorded immediately.

An example of this is when vesting is accelerated, or continued, at retirement and the service provider is already retirement eligible.

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32
Q

Non-Substantive Vesting

What happens if the service provider is going to become retirement eligible during the vesting period?

A

Then the expense is recognized from the grant date to the retirement eligibility date.

Expense is recorded over shorter period.

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33
Q

ASU 2016-09

A

In 2016 FASB put this out to provide another process for handling forfeitures for service-based awards.

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34
Q

Expense recognized under ASU 718 for Forfeited Shares?

A

No expense recognized for forfeited shares; any expense already recognized is reversed.

Expense only recognized for grants that vest.

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35
Q

Expense recognized under ASU 718 for grants that vest but later expire unexercised?

A

Expense is not reversed for awards that do vest but are later cancelled.

If the requisite service period is met, and the award recipient decides not to exercise it and allows it to expire, the company still expenses the award.

36
Q

Expense recognized under ASU 718 for awards where any part of vesting is based upon service (time) including market and performance conditions

A

Probability of forfeitures may be estimated, and expense initially recorded for shares expected to vest.

  • Whether or not an estimated forfeiture rate is applied, expense is adjusted when expectations change and ultimately adjusted to reflect actual outcome.
  • If market-based awards are forfeited because market-conditions are not met, expense is not reversed.
37
Q

Reflecting Expense using Straignt Line Attribution

A
  • Expense as you go
  • Ammount of expense recognized at any point must be proportionate to the percentage of the award that is vested

Ex. 1/3 Annual
33% | 33% | 33% |

38
Q

Reflecting Expense using Accelortated Accrual

A

Treats each vesting tranche as a separate award and recognizes a portion of the expense for each tranche during each reporting period.

A portion of the expense is recognized for each tranche during each year that it is outstanding, which means that the first tranche is fully expensed in the first year, the second tranche will be expensed in year one and year two, the third tranche in years 1 through 3.

Ex. 1/3 Annual turns into | 60.5% | 27.5% | 12%

100%|
50% | 50%
33% | 33% | 33% |

39
Q

Expense recognized under ASU 718 for Underwater options cancelled as part of a repricing or option exchange

A
  • Expense is not reversed (regardless of vesting status)
  • This is a modification, not a forfeiture
40
Q

The probability of forfeiture needs to be estimated and adjusted from the amount of expense for these types of vesting:

A
  • time-based vesting
  • non-market-based performance conditions
41
Q

2016 FASB issued ASU 2016-09

Process for handling forfeitures for service-based awards.

A

Under the revised standard, a company can choose to continue applying estimated forfeiture rates as before, or it can choose to account for forfeitures only as they occur.

  • 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)
42
Q

After initial adoption period, a change in election is a change in accounting policy that requires

A
  • Preferability letter from auditors
  • Retrospective application to company financials
43
Q

Estimated Forfeiture Rate Method

Static Method

A
  • Uses an annualized forfeiture rate and the full service period of the grant to apply the rate
  • True up at vest or as forfeitures occur
  • Requires careful monitoring of forfeitures throughout the service period
44
Q

Estimated Forfeiture Rate Method

Dynamic Method

A
  • Remaining service period used to apply the forfeiture rate.
  • True up when award is forfeited or vests
  • Self-correcting Since forfeited grants are automatically removed from the calculation and requires fewer adjustments.
45
Q

Estimated Forfeiture Rate Method

Forfeitures As They Occur

A
  • Per ASU 2016-09, a company can now choose to not estimate forfeitures at all but simply recognize the estimated fair value as the award vests
  • Forfeitures are accounted for only as they occur at an
    individual grant level.
46
Q

Measurement & Recognition – Performance

Vesting based on market conditions

A
  • Vesting based on market conditions
  • Awards vest based on measure that involves stock price
  • Likelihood of achieving goal factored into option-pricing model
  • Payout in excess of 100% is still expensed only at 100%
  • Expense for failure to achieve market condition isn’t reversed unless service period isn’t met (i.e. termination before vest)
  • Accelerated method required
47
Q

Measurement & Recognition – Performance

Performance awards without market conditions

A
  • Estimate probability of forfeitures & payout
  • Record expense only for awards expected to vest
  • Adjusted as expectations change (cumulative adjustment)
  • Adjusted for actual outcome
  • Accelerated method required
48
Q

Measurement & Recognition – Performance

Vesting based on IPO/CIC

A
  • “Nothing vests until we go public/ get aquired”
  • Expense recorded only to extent that performance condition is “likely” to be achieved
  • FASB indicated that when vesting is contingent on IPO/CIC, likelihood should be considered 0% until the event occurs
  • No expense recorded until consummation of event
  • Catch up for service period time lapsed before event
  • If acquired instead of IPO, awards accounted for under ASC 805
49
Q

Measurement – Tendering Stock

Stock-for-Stock, Net and Pyramid Exercises

A

Where previously owned shares or a portion of the shares just exercised are being used to cover the exercise cost, **no impact to accounting treatment of the grant

50
Q

Measurement – Tendering Stock

Tendering Stock to Cover Tax Payments under ASC 718

A

To withhold taxes with stock, a company computes the tax due on the spread and retains the number of shares with a fair market value equal to the amount of tax due.

Withholding over the “minimum statutory rate” triggered liability accounting for affected shares.

51
Q

Measurement – Tendering Stock

Tendering Stock to Cover Tax Payments after ASU 2016-09

A

Amended the accounting standard to allow for withholding at the maximum statutory rate if it’s allowed at the Plan level. Under the updated standard, any shares withheld up to that maximum statutory rate can still receive equity accounting treatment.

52
Q

Measurement – Tendering Stock

Supplemental Income Tax Rate

A

22% on earnings under $1m, 37% for earnings over $1m

53
Q

Measurement – SARs

Stock-settled SARs

A
  • Under ASC 718 treated the same as stock options
  • Fair value calculated on date of grant using an optionpricing model
  • Expense is recorded over service period
  • Expense is reversed for unvested, forfeited awards but not reversed for vested awards that expire unexercised
54
Q

Measurement – SARs

Cash-settled SARs

A
  • Under ASC 718 treated as liability
  • If cash settlement, is at the grant holder’s election, liability treatment.
  • If cash settlement, is at the company’s discretion, liability treatment only if the company has a pattern of cash settlement.
55
Q

ASC 718 Accounting Modifications

What happens when Modifications to Option Agreement is made, including repricing acceleration of vesting, extension of the option term, ect.?

A

Is viewed as an option cancelation and then a reissuance of a new one on the modification date

56
Q

ASC 718 defined 4 types of modifications:

Type I

A

Probable-to-Probable (of vesting)

Keep recognized expense, continue expensing original award, estimate fair value of replacement award and expense

57
Q

ASC 718 defined 4 types of modifications:

Type II

A

Probable-to-Improbable (of vesting)

Keep recognized expense, continue expensing original award, estimate fair value of replacement award and expense

58
Q

ASC 718 defined 4 types of modifications:

Type III

A

Improbable-to-Probable (of vesting)

Keep expense for original vested shares, reverse expense on original unvested portion as forfeit, estimate fair value of replacement award and expense

59
Q

ASC 718 defined 4 types of modifications:

Type IV

A

Improbable-to-Improbable (of vesting)

Keep expense for original vested shares, reverse expense on original unvested portion as forfeit, estimate fair value of replacement award and expense

Only recognize expense on replacement award if vesting occurs

60
Q

ASC 718 Modifications

Repricing Modifications

A
  • Type 1 Modification (Probable-to-Probable (of vesting))
  • Great for underwater options
  • Must establish modification date fair value
    *
61
Q

ASC 718 Repricing Modifications

If the award is worth more after the modification…

A

There will be an additional compensation cost to be accounted for.

62
Q

ASC 718 Repricing Modifications

If the award is worth the same amount after the modification as before the modification…

A

Then there are no additional compensation cost

63
Q

ASC 718 Repricing Modifications

If the award is worth less after the modification…

A

Then there are special rules which apply depending upon whether the original award was expected to vest.

64
Q

ASC 718 Repricing Modifications

Before and After test

A

Modification accounting requires calculation of the fair value of the original and replacement awards at the same point in time, generally the modification date.

Origional Fair Value - New Fair Value = Value Effect

65
Q

ASC 718 Repricing Modifications

Treatment of Cancelled Options

A

Options cancelled in a repricing continue to be accounted for, they are not considered forfeit

66
Q

ASC 718 Accounting - Modifications

Non-Price Related Modifications-
Acceleration of vesting upon termination

A
  • Type 3 modification (Improbable-to-Probable (of vesting))
  • Reverse expense booked for unvested shares
  • Calculate new fair value
67
Q

ASC 718 Accounting - Modifications

Non-Price Related Modifications-
Extension of post-termination exercise period

A
  • Type 1 modification (Probable-to-Probable (of vesting))
  • Continue to recognize original expense
  • Calculate incremental expense
68
Q

ASC 260- Earnings Per Share

Calculating Basic Earning Per Share (EPS)

A

reports the company’s net income available to common shareholders divided by the weighted average number of common shares outstanding during the period. The shares are weighted for the time they were outstanding as common stock during the period.

= Net earnings / shares issued & outstanding

69
Q

ASC 260- Earnings Per Share

Calculating Diluted Earnings Per Share (EPS)

A

Using the Treasury Stock Method

The same as basic earnings per share except that the denominator is increased to reflect any outstanding common stock equivalents (Options, SARS, unvested RSA, Unvested RSUs, convertible preferred stock, warrants and other arrangements where the company is obligated to issue stock).

70
Q

Treasury Stock Meathod

A

Gives us a worse case scenerio and helps up mitagate this scenerio.

Assumes that all options and all restricted stock are vested, then assume they are all exercised.

Calculate proceeds and assumes company will use “proceeds” from exercise/award to buyback own stock out on the open market.

Antidilutive Options are excluded from the calculation

71
Q

Treasury Stock Meathod

Two sources of “Assumed Proceeds”

A
  • Exercise proceeds (price)
  • Average Unamortized Expense
72
Q

Treasury Stock Meathod

Options that are dilutive have what effect on Earnings Per Share (EPS)?

A

Reduce the Earnings Per Share (EPS) and ownership.

73
Q

Treasury Stock Method

Options that are Antidilutive have what effect on Earnings Per Share (EPS)?

A

Maintain or increase EPS and shareholder voting power.

Cannont be used in the Treasury Stock Method

74
Q

Diluted Earnings Per Share Equation

A

=(Net Income - Dividands)/(Total Authorized Shares)

Do not need to calculate for Options Underwater

75
Q

Earnings Per Share Equation

A

= Net Income / Outstanding Shares

76
Q

ASC 718 ESPP

If an employee terminates or is involuentarily withdraws for any reason during an offering period

A

That is a forfeiture and the company does not recognize expense for forfeit ESPP shares and may reverse any previously recognized expense attributable to forfeit shares.

77
Q

ASC 718 ESPP

If an employee voluntarily withdraws from an offering period

A

ASC 718 does not consider this a forfeiture of the shares and the company will continue to recognize expense for the shares that the employee could have purchased as if the withdrawal had not been requested

78
Q

ASC 718 ESPP

If an employee decreases their contribution rate

A

the company will continue to expense based on the original contribution rate, as if no change had been made at all to the employee’s participation level.

79
Q

ASC 718 ESPP

If an employee increases contribution rates

A

Triggers modification accounting

80
Q

Tax Accounting – Post 2016-09

Tax-Qualified Awards (ISO/423-Qualified ESPP)

A
  • No tax deduction assumed while expense accrues
  • Tax benefit cannot be “assumed” and is recognized at time of disqualifying disposition
81
Q

Tax Accounting – Post 2016-09

Non-Qualified Awards (NQs, RSA, RSU, etc.)

A
  • Deferred Tax Asset (DTA) booked as expense is recognized –to anticipate the future tax deduction
  • At exercise/release/expiration, DTA compared to actual tax benefit - recorded in income statement as an increase or decrease to tax expense.
82
Q

Tax Accounting – Post 2016-09

Deferred Tax Asset (DTA)

A

Is an item on a company’s balance sheet that reduces its taxable income in the future. Such a line item asset can be found when a business overpays its taxes. This money will eventually be returned to the business in the form of tax relief.

83
Q

Tax Accounting – Post 2016-09

If tax deduction > DTA

A

excess tax benefit = reduction to tax expense
“Windfall”

84
Q

Tax Accounting – Post 2016-09

If tax deduction < DTA

A

“shortfall” = increase to tax expense

85
Q

If the company has adopted ASU 2016-09, then treatment of non-qualified awards is…..

A

The same as for qualified awards and you will take no assumed tax deduction as the award
expenses. You will only record income tax effects on the income statement when awards
are settled.

Certified Equity Professional (8 decks)

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