IA FSA Long term compensation

Why do share-based compensation and post-employment benefits present modeling challenges?

Because they are settled in the future at uncertain costs, requiring assumptions and estimates.

What is the basic accounting principle for employee compensation?

Recognize the fair value of compensation as an expense in the period the employee provides services.

What is the fair value of a Restricted Stock Unit (RSU)?

The market price of the underlying share at the grant date.

How is RSU compensation expensed and settled?

Expensed over the vesting period if conditions are met; settled with share issuance at vesting.

How is the fair value of stock options determined?

Using an option pricing model (e.g., Black-Scholes) at the grant date

What happens upon exercise of employee stock options?

Cash inflow is recorded in financing activities, and shares are issued.

How is share-based compensation usually forecast in models?

As a percentage of revenue, separate from other operating expenses

How should analysts treat share-based compensation in DCF valuation?

Deduct it from free cash flow or account for dilution separately.

What components of DB plans appear on the income statement?

ervice cost, interest cost, and remeasurements.

What DB plan items appear on the balance sheet and cash flow statement?

Funded status on balance sheet; contributions on the cash flow statement.

How do analysts forecast DB plans in valuation models?

By forecasting service cost, discount rate, plan contributions, and benefit payments.

What is the offsetting entry to compensation expense for equity-settled share-based payments?

An increase in equity (share-based compensation reserve), not a liability

What is the accounting treatment on settlement of an RSU?

Transfer the balance from share-based compensation reserve to common stock and paid-in capital.

Why are RSUs preferred over stock options in recent years?

They offer guaranteed value (if not worthless), better risk alignment, are simpler to understand, and require no cash payment upon settlement.

Under financial reporting, how is share-based compensation expense recognized in terms of timing and amount?

Timing: Over the vesting period; Amount: Grant-date fair value.

When is the tax deduction for share-based compensation typically recognized for tax purposes?

At settlement (e.g., vesting for RSUs, exercise for options

What is a tax windfall (excess tax benefit)

When the share price at settlement is higher than at the grant date, leading to a higher tax deduction than the recognized compensation expense.

What is a tax shortfall?

When the share price at settlement is lower than at grant date, leading to a lower tax deduction than the recognized compensation expense.

How does IFRS treat tax windfalls and shortfalls from share-based compensation?

Recognized directly in equity (not through the income statement).

How does US GAAP treat tax windfalls and shortfalls from share-based compensation?

Recognized as reductions or increases in income tax expense on the income statement

What is the treasury stock method used for?

To calculate diluted shares outstanding by accounting for share-based awards and assumed share repurchases.

When are RSUs considered anti-dilutive?

When the average share price is materially below the grant-date fair value of the RSUs.

What happens to diluted EPS if a company reports a net loss?

Diluted EPS = Basic EPS; potentially dilutive securities are excluded because their inclusion would be anti-dilutive.

In which two cases should analysts adjust diluted share count to include anti-dilutive securities?

1) When a company reports a net loss, and (2) when there has been a significant share price decline or volatility.

Under IFRS 2, what are the three key disclosure requirements for share-based payments?

(1) Nature and extent of arrangements, (2) Fair value determination, (3) Effect on income and financial position.

How is the funded status of a DB pension plan calculated?

Funded status = Fair value of plan assets − Present value of defined benefit obligation (DBO)

What is the Defined Benefit Obligation (DBO)?

The actuarial present value of all future pension benefits earned by employees up to the reporting date, discounted using the appropriate discount rate.

What are the main components of pension expense under IFRS for DB plans?

1. Service cost: Increase in pension obligation due to employee service in the period (expense in income statement).

2. Net interest cost: Interest on net defined benefit liability (DBO minus plan assets) using the discount rate (expense/income).

3. Remeasurements: Changes in actuarial assumptions and plan asset returns; recognized in OCI, not in profit or loss.

How does the service cost affect the financial statements?

Recorded as an operating expense in the income statement, reflecting the cost of employee service for the period.

What are Other Post-Employment Benefits (OPEB), and how are they accounted for?

Benefits like healthcare after retirement. Usually accounted for like DB plans, often unfunded, creating a liability on the balance sheet and an expense in the income statement based on actuarial valuation.

How do accounting standards differ for post-employment benefits?

FRS (IAS 19) requires:

• Full recognition of the net defined benefit liability/asset on the balance sheet.

• Pension expense split into service cost, net interest, and remeasurements.
  US GAAP (ASC 715) is similar but has differences in recognition and presentation of components.

What disclosures are required related to post-employment benefits?

• Description of plan(s) and funding policies

• Amounts recognized in financial statements

• Assumptions used (discount rate, mortality, salary growth)

• Sensitivity analysis of assumptions

• Reconciliation of opening and closing balances of DBO and plan assets