Employee Comp + FSA Techniques + Analysis

What are the main types of employee compensation?

Short-term, long-term, stock-based, and post-retirement.

What are examples of short-term compensation?

Salaries, wages, bonuses, health insurance, company match in defined contribution plans, and paid leave.

What are examples of long-term compensation?

Long-term disability and long-term paid leave.

What are examples of stock-based compensation?

Stock options and stock grants.

What are examples of post-retirement compensation?

Defined benefit pensions and health care.

When is employee compensation earned?

At the end of the vesting period.

What is the settlement date?

The date when compensation is settled through cash or stock.

How is short-term compensation treated on the income statement?

Expensed as it vests.

Where is unpaid short-term compensation shown at year-end?

Current liability.

Where is compensation expense usually embedded?

Appropriate expense categories rather than separately disclosed.

Where are wages for factory workers included?

Cost of goods sold.

Where is compensation for employees working on inventory capitalized?

Ending inventory on the balance sheet.

Where is compensation for research employees included?

R&D expense.

Why do firms use share-based compensation?

To motivate and retain key employees and reward them without immediate cash outflow.

What are common forms of share-based compensation?

Stock options and outright share grants.

What is one shareholder drawback of share-based compensation?

Dilution.

Why may share-based compensation have limited motivational value?

Many employees have little impact on the stock price.

Why can stock options encourage excessive risk-taking?

They have asymmetric upside-only payoff.

Why may stock grants encourage less risk-taking than options?

Managers share both upside and downside through ownership value.

What type of option is granted to employees in stock option plans?

Nontradeable call option.

When can an employee exercise a stock option?

After vesting if the stock price is above the exercise price.

What does it mean for an option to be in-the-money?

Stock price is greater than the exercise price.

What is the compensation expense for stock options based on?

Fair value of the options on the grant date.

How is stock option compensation expense recognized?

Straight-line over the vesting period.

What is the vesting period?

Time between the grant date and the vesting date.

Does compensation expense for options change after the grant date because fair value changes?

No.

Where is stock option compensation credited when expense is recognized?

Share-based compensation reserve in equity.

Why is there no change to total equity when option compensation expense is recognized?

Retained earnings decreases while share-based compensation reserve increases by the same amount.

What happens to net income when share-based compensation expense is recognized?

It decreases.

What happens to retained earnings when share-based compensation expense is recognized?

It decreases.

What happens to share-based compensation reserve when expense is recognized?

It increases.

How is the fair value of a stock option determined if a comparable option is available?

Observable market price of a similar option.

What model can be used if no comparable option is available?

Option-pricing model such as Black-Scholes.

Do IFRS or U.S. GAAP mandate one specific option valuation model?

No.

What standard must the valuation model satisfy?

It must be consistent with sound economic principles, fair value measurement requirements, and the substantive elements of the grant.

When is fair value estimated for stock options?

Grant date only.

Are later changes in fair value considered for compensation expense?

No.

What assumptions must firms disclose for option fair value?

Assumptions used to estimate fair value.

Which option valuation assumptions are usually observable?

Grant date, stock price, maturity, exercise price, and risk-free rate.

Which option valuation assumption is subjective?

Future stock price volatility.

What happens if future volatility is underestimated?

Option value and compensation expense are understated.

What happens to reported earnings if option compensation expense is understated?

Reported earnings are higher.

When do employees exercise options?

Only when they are in-the-money.

What happens if employees leave before options vest?

They forfeit the grant.

What is a service condition?

A requirement that the employee remain employed for a specified number of years before vesting.

What is a performance condition?

Vesting depends on achieving a specific nonmarket target.

What is a market condition?

Vesting depends on a market-based target, such as stock price.

What are performance shares?

Performance-based restricted stock grants.

What are restricted stock units?

Awards exchanged for stock when they vest.

Do RSU holders receive dividends during the vesting period?

No.

Why are RSUs often preferred over stock options by employees?

They have value as long as the stock price is above zero and require no exercise price outlay.

What is the value of a stock grant?

Stock price on grant date × number of shares granted.

How is RSU fair value adjusted?

Reduced by the estimated present value of dividends expected during the vesting period.

How is stock grant compensation expense recognized?

Expensed over the vesting period.

Where is the stock grant amount taken in equity during vesting?

Share-based compensation reserve.

What happens to the share-based compensation reserve at settlement of a stock grant?

It is transferred out of the reserve and allocated to common stock and paid-in capital.

What happens upon exercise of stock options?

Cash is received from the strike price and reported as financing cash inflow.

Where is the exercise amount allocated?

Common stock and paid-in capital.

What happens to the compensation expense reserve upon option exercise?

It is allocated to common stock and paid-in capital.

What happens if options expire out-of-the-money?

No further accounting treatment.

For financial reporting, what is share-based compensation expense based on?

Grant-date value.

For tax purposes, when is the deduction allowed?

Settlement.

What is the tax deduction formula for stock grants?

Tax deduction = share price on settlement date × number of shares vested.

What is the tax deduction formula for options?

Tax deduction = intrinsic value on settlement date × number of options vested.

What is the expanded tax deduction formula for options?

Tax deduction = (stock price on settlement date − strike price) × number of options vested.

When does an excess tax benefit occur?

Tax deduction is greater than cumulative compensation expense.

When does a tax shortfall occur?

Tax deduction is less than cumulative compensation expense.

What causes an excess tax benefit for stock-based compensation?

Settlement-date stock price is higher than grant-date stock price.

What causes a tax shortfall for stock-based compensation?

Settlement-date stock price is lower than grant-date stock price.

Under IFRS, where are tax windfalls and shortfalls reported?

Directly to equity.

Under U.S. GAAP, how are tax windfalls and shortfalls reported?

They reduce or increase tax expense in the income statement.

Under U.S. GAAP, what can tax windfalls and shortfalls create?

Volatility in net income and the effective tax rate.

What happens to basic shares outstanding upon settlement of stock and option grants?

They increase.

Before settlement, how can stock and option grants affect EPS?

They can be potentially dilutive.

Which EPS measure includes dilutive securities?

Diluted EPS.

How can stock and option grants affect EPS before settlement?

They can be potentially dilutive.

What method is used to include potentially dilutive shares?

Treasury stock method.

If a company reports a net loss, how do basic EPS and diluted EPS compare?

They are the same.

Why are basic EPS and diluted EPS the same when there is a net loss?

Dilutive securities are treated as zero.

When are unvested in-the-money options considered dilutive?

Before settlement.

When are RSUs and restricted stock grants antidilutive?

When current stock price is significantly below grant-date price.

Why can RSUs or restricted stock grants be antidilutive?

Unrecognized compensation expense per share is higher than the current market price.

What determines whether performance shares are potentially dilutive?

Whether vesting conditions are expected to be met.

Why can performance share dilution be subjective?

It depends on expectations about future performance metrics.

What does the treasury stock method do?

Nets hypothetical repurchased shares against potentially dilutive securities.

What is the formula for treasury shares under the treasury stock method?

Treasury shares = assumed proceeds / average share price during the reporting period.

What is the formula for dilutive shares?

Dilutive shares = potentially dilutive securities − treasury shares.

What are assumed proceeds?

Cash proceeds + average unrecognized share-based compensation expense.

What are cash proceeds for options?

Number of options × exercise price.

What are cash proceeds for stock grants?

Zero.

What is average unrecognized share-based compensation expense?

Average of the last two period-end unamortized share-based compensation amounts.

Why are assumed proceeds included in the treasury stock method?

They represent hypothetical funds used to repurchase shares.

What share price is used in the denominator for treasury shares?

Average share price during the reporting period.

What happens to dilutive shares when assumed proceeds increase?

Dilutive shares decrease.

What happens to dilutive shares when average share price increases?

Treasury shares decrease and dilutive shares increase.

Is share-based compensation expense usually reported separately on the income statement?

No.

Where is share-based compensation expense usually included?

COGS, R&D expense, and SG&A.

Why might an analyst separate share-based compensation from expense categories?

To keep expense-to-revenue relationships stable in forecasts.

How should fixed portions of share-based compensation be forecast?

Subtract them from expense categories and forecast the remaining expenses as a proportion of revenue.

How should share-based compensation be forecast after separating it?

Forecast it separately.