Stock Compensation

Question 1

What is a stock purchase plan?

Answer 1

employees purchase stock directly from firms, they may receive a small discount, and the employer may match a portion of the purchase.

Question 2

What is a noncompensatory stock purchase plan?

Answer 2

plans are considered noncompensatory (no significant compensation is provided) if all apply:

i. Essentially all employees can participate;
ii. Employee must decide within one month of the firm setting the price for the stock whether to enroll in the plan;
iii. Discount does not exceed the employer cost savings inherent in issuing directly to employees (<5% market price meets this criterion);
iv. Purchase price must be based solely on the market price of the stock;
v. Employees can cancel their enrollment before purchase date and obtain a full refund.

Question 3

What are the journal entries for a noncompensatory stock purchase plan?

Answer 3

Compensation expense amount paid by firm
Cash amount paid by employee
Common stock par of stock issued
PIC-CS price - par of stock issued

the shares are recorded as any other stock issuance. The only expense is the portion paid for by the firm (the matching portion), if any

Question 4

What is a compensatory stock purchase plan?

Answer 4

If not all 5 criteria for a compensatory plan are met, then the plan is compensatory

Question 5

What are the journal entries for a compensatory stock purchase plan?

Answer 5

Compensation expense discount from market price on date of purchase
Cash discounted price
Common stock par of stock issued
PIC-CS remainder

Question 6

What is a stock option plan?

Answer 6

Provides an employee with the option to purchase shares of employer firm stock at a fixed price in the future, after a reasonable service period. The options expire beyond a certain point

Question 7

What is cliff vesting?

Answer 7

all options vest at the same time.

Question 8

What is compensation expense for a stock option plan?

Answer 8

To measure compensation expense, the FASB chose the more reliable of the following (1) value of employee services to be received, and (2) value of options provided.

Question 9

What happens when stock options expire?

Answer 9

When the market price fails to increase above the option price (here $5), the options expire. There is no retroactive adjustment and the compensation expense remains (because there was value at grant date), and the PIC-stock options account is simply renamed.

Question 10

What happens when stock options are forfeited?

Answer 10

Firms must incorporate an estimate of forfeitures if probable and estimable because the expense must be based on the number of options expected to vest. This reduces the total amount of compensation expense to recognize.

If the firm is unable to estimate forfeitures and forfeitures occur, the expense recognized in previous periods on the forfeited shares is reversed in the current period. This procedure reduces the compensation expense otherwise recognized in the current period.

Question 11

What is a stock award plan?

Answer 11

stock is awarded for continuing employment but the employee cannot sell the stock (the main restriction) until the award is vested - and the employee may not receive the shares until vested

Question 12

What is compensation expense for a stock award plan?

Answer 12

total compensation expense is the number of shares awarded measured at the market price of the stock at grant date (the fair value at that date). This amount is recognized as expense over the period the employee provides the service for which the grant was awarded. When the award vests, there is no additional incentive and expensing is complete. Changes in stock price after the grant have no effect on the accounting.

Question 13

What is the net accounting effect for a stock award plan?

Answer 13

The net effect of the accounting:
An expense equal to the value of the stock at grant date is recognized;
Contributed capital increases by that amount;
Retained earnings is reduced by the same amount permanently;
There is no net effect on OE. (The firm did not pay or receive anything that can be objectively measured.)

Question 14

What happens if a stock award plan is forfeited?

Answer 14

If employees do not continue employment through the vesting date then the expense recognized on those awards is reversed.

The forfeiture is treated as an estimate change; retrospective application is not permitted.

If the firm is able to estimate forfeitures, the procedure followed for stock options is applied to stock awards as well. The initial total compensation expense amount is reduced by estimated forfeitures before allocating to the service periods. There is no need to reverse previous compensation expense amounts in this case.

Question 15

What are stock appreciation rights (SARs)?

Answer 15

(1) employee receives the difference between the stock price at grant date, and the stock price at exercise date, (2) pays nothing, (3) the SAR specifies payment of the benefit in either cash or stock (employee may have a choice).

Question 16

What happens if the SAR plan allows an employer to issue stock?

Answer 16

then the SAR is accounted for as a stock option plan. The fair value of the SAR is estimated at grant date and the total fair value is allocated to compensation expense over the service period

Question 17

What happens if the SAR plan specifies payment in cash or allows the choice of a cash payment?

Answer 17

1. The firm records a liability rather than paid-in-capital when compensation expense is recognized;
2. For each year in the service period, the fair value of each right is reestimated in light of new information using an option pricing model;
3. Compensation expense is recorded each year based on the fair value at the end of the period (fair value is reestimated each year through exercise), for the portion of the service period elapsed using the catch up procedure for stock options. Expense recognition continues through the exercise date.
4. Expected forfeitures are built into the calculation of total compensation expense as illustrated previously for stock options;
5. At exercise date, the fair value of the SAR equals the difference between price at grant date and the price paid for the stock.