Compensation: Share-Based

Restricted Stock Plans

• Compensation using stock shares or options.

Restricted Stock Awards

• Two types:

  • Restricted stock share awards.

  • Restricted stock unit awards.

Restricted Stock Share Awards

• Shares are issued and held in trust.

Restricted Stock Unit Awards

• Shares are not issued.

General Vesting Information

• Shares are received after a service period.

• Employee must provide service to the company to earn compensation.

• If service period not met, shares are forfeited.

• Vesting: Earning the compensation after a specific time period.

• Grant Date: Date of award.

• Vesting Conditions Met: Receiving the shares.

• Service Period: Time during which the employee provides service.

• Vesting Period: From grant date to vest date, typically the end of the service period.

Restricted Stock Share Awards Accounting

• Shares are issued on the grant date but not yet earned.

• Unearned Compensation Account: Also known as deferred compensation; a contra equity account where the fair value of the stock is held until earned.

  • Represents compensation expense waiting to be recognized.

  • Parking it on the balance sheet.

• On grant date:

  • Debit: Unearned Compensation (contra equity account) - fair value (FV) of the stock.

  • Credit: Common Stock - par value.

  • Credit: Additional Paid-In Capital (APIC) - excess over par value.

• Balance Sheet Equation: Assets = Liabilities + Stockholders' Equity

• Unearned compensation has a debit balance, decreasing total stockholders' equity.

• Common stock and APIC have credit balances, increasing total stockholders' equity.

• The net effect on total stockholders' equity at the grant date is zero (debit and credit balance).

• Recognizing Compensation Expense:

  • Debit: Compensation Expense.

  • Credit: Unearned Compensation.

  • This decreases the debit balance in the unearned compensation account, increasing total stockholders' equity.

  • Compensation expense is reported on the income statement and closed to retained earnings, decreasing total stockholders' equity.

Restricted Stock Units Accounting

• The stock is not actually issued, but acknowledges the right to receive the stock if requirements are met.

• On the grant date: No entry.

• Over the service period:

  • Debit: Compensation Expense.

  • Credit: Paid-In Capital (Stock Units) - a made-up name for paid-in capital accounts.

  • Expenses increase, decreasing retained earnings, which decreases total stockholders' equity.

• Electronic systems are used to keep track of individual employee vesting.

Example: Restricted Stock Share Awards

• Facts: On 01/01, 1,000 shares of $10 par restricted common shares are awarded with a fair value of $60,000 and a three-year vesting period.

• On the grant date:

  • Debit: Unearned Compensation: 1,000 \text{ shares} \times $60 \text{ fair value} = $60,000

  • Credit: Common Stock: 1,000 \text{ shares} \times $10 \text{ par} = $10,000

  • Credit: Paid-In Capital Common Stock: $60,000 \text{ (Fair Value)} - $10,000 \text{ (Par Value)} = $50,000

• Recognition over three-year vesting period:

  • Debit: Compensation Expense: $60,000 / 3 \text{ years} = $20,000 \text{ per year}

  • Credit: Unearned Compensation: $20,000 per year.

Effect on Stockholders' Equity

• Original entry: Debit decreased total stockholders' equity by $60,000, credits increased it by $60,000 (net zero).

• Expense recognition: Debit decreases total stockholders' equity by $20,000, credit increases it by $20,000 (net zero).

Forfeiture Example

• Employee leaves after one year; reverse out compensation expense.

• Credit: Compensation Expense: $20,000.

• Debit: Paid-In Capital Common Stock: $50,000.

• Debit: Common Stock: $10,000.

• Credit: Unearned Compensation: $60,000 ($40,000 balance + $20,000 reversed).

• The debits make total stockholders' equity go down by 60, the credits make total stockholders' equity go up by 60 - net effect of zero.

• Assets of the company have not changed.

Example: Restricted Stock Units

• 1,000 shares, $10 par, same facts as before, but using units instead of share awards.

• Grant Date: No entry.

• Year One:

  • Debit: Compensation Expense: $20,000.

  • Credit: Paid-In Capital Stock Unit: $20,000.

• Vesting Period: Same as before; repeat for years two and three.

• After three years: Issue the shares.

Issuance of Shares After Vesting

• Paid-in Capital Stock Units will have a balance of $60,000 (20,000 * 3 years).

  • Debit: Paid-In Capital Stock Units: $60,000.

  • Credit: Common Stock: 1,000 \text{ shares} \times $10 \text{ par} = $10,000

  • Credit: Paid-In Capital in Excess of Par Value: $60,000 - $10,000 = $50,000

Stock Options

• The right to buy shares of stock at an exercise price.

• Companies used to argue that if the exercise price equals the market price on the grant date, there is no compensation.

• Compromise: Use option pricing models (e.g., Black-Scholes) to determine fair value on the grant date.

• No entry on the grant date.

• The fair value determined by the option pricing model is expensed over the service period.

Accounting for Stock Options

• Debit: Compensation Expense.

• Credit: Paid-In Capital Stock Options.

• The total fair value (determined by the option pricing model) divided by the service period equals the expense each period.

• Compensation expense decreases total stockholders' equity, while the paid-in capital account increases it, resulting in zero as a net effect.

• Changes in market value are irrelevant until the option is exercised.

Exercise of Stock Options

• The company receives cash (exercise price).

• The company issues stock.

  • Debit: Cash (number of shares multiplied by the exercise price per share).

  • Credit: Common Stock (number of shares multiplied by par value).

  • Credit: Additional Paid-In Capital - Excess of Par (balance).

  • Debit: Paid-In Capital Stock Options (balance - total fair value).

• Cash is an asset, so total stockholders' equity increases.

Expiration of Stock Options

• If options expire (are not exercised):

  • Debit: Paid-In Capital Stock Options.

  • Credit: Paid-In Capital Stock Options Expired.

Employee Stock Purchase Plans

• Stock purchase plans for all employees.

• If all eligible employees are given the option to buy at a discount less than or equal to 5% of the market price, there is no compensation expense.

• Any discount greater than 5%, the total discount is compensation.

Example: Employee Stock Purchase Plan

• Purchase plan with a $1 par value at a 5% discount.

• Employees purchase 100 shares when the market price is $30 per share.

  • Cash: 100 \text{ shares} \times ($30 \times 95%) = $2,850

  • Credit: Common Stock: 100 \text{ shares} \times $1 \text{ par} = $100

  • Credit: Additional Paid-In Capital: $2,750.

• 10% discount:

  • Cash: 100 \text{ shares} \times ($30 \times 90%) = $2,700

  • Compensation Expense: 100 \text{ shares} \times ($30 \times 10%) = $300

Earnings Per Share

• Earnings per share focused only on common shareholders

• Basic earnings per share = (Net income available to common shareholders) / (Weighted average common shares outstanding)

• Preferred stock dividends reduce income available to common shareholders.

• In the denominator:

  • Weighted average calculations consider the timing of share transactions (issuance, buybacks, treasury shares, stock splits, stock dividends).

• Stock dividends and stock splits are restated retroactively.