Please enable JavaScript.
Coggle requires JavaScript to display documents.
Int. Acc. FA LECT 5&6: CH 16 part 4: Dilutive securities and EPS…
Int. Acc. FA LECT 5&6: CH 16 part 4: Dilutive securities and EPS
Describe the accounting for share compensation plans.
Idea of employee stock options (ESO) seems nice: motivational effects, reward executives for performance, tax benefits.
Hotly debated issue:
How to account for ESOs? Are stock options a cost to firm’s shareholders? How to measure and recognize this (does an option have any value)?
Do share options lead to (accounting) manipulations and excessive risk taking?
Share options/ warrants give most important employees the option to purchase ordinary shares at a predetermined price (usually current stock price) over an extended period of time.
Accounts for employee stock options
Partly explained by the old accounting rules which did not require companies to recognize the cost of this compensation in the income statement
--> In contrast to regular salaries or bonuses
For example, in the U.S., companies had the option to either:
1) recognize the (fair) value of options granted to employees as an expense in the income statement OR:
2) provide this information in the notes to the financial statements
Apple decided (as did almost all companies) to choose for option 2) and to provide information in the notes:
--> Income as reported in income statement
--> Income (loss!) if expense recognition was required
Especially during the 1990s, ESOs became the #1 source of compensation to employees around the globe
Accounting for employee stock options (I)
How does this work exactly?
Two main issues:
How to determine compensation expense.
Intrinsic value method: excess of market price over exercise price at grant date is compensation cost -> cost usually 0, OR
Fair value method (required by IFRS)
Over what periods to allocate compensation expense.
Do we recognize everything immediately at grant date?
Do we match it to service performed by the employee?
IFRS rules: companies must recognize the fair value of options granted as an expense in their income statement (IFRS 2)
Accounting for employee stock options (II)
Allocating Compensation Expense
Over the periods in which employees perform the service—
”the service period” (usually also the vesting period) (
Vesting means an employee’s award is no longer contingent on remaining in the service of the employer.
)
Determining Expense
Compensation expense based on the fair value of the options expected to vest on the date the options are granted to the employee(s) – “the grant date”
FYI: options backdating scandal was uncovered by a U.S. professor: