Page 49 - FINAL CFA II SLIDES JUNE 2019 DAY 5.2

LOS 15.g: Explain issues associated with accounting for share- READING 15: EMPLOYEE COMPENSATION: POST-EMPLOYMENT AND SHARE BASED
based compensation.

May be stock options and outright share grants designed to motivate and retain MODULE 15.7: SHARE-BASED COMPENSATION
employees as well as being a way to reward employees with no additional outlay of cash.

Reporting is complicated:
• If the shares are not publicly traded, an estimate of value must be used for stock grants.
• Unless the market price of the options is available, the value of stock options must be estimated using an options valuation model.

When shares or options are granted with contingencies, the estimated expense may be spread over the period of time for which they reward the
employee (service period).

Accounting for share-based compensation is similar under IFRS and U.S. GAAP.

LOS 15.h: Explain how accounting for stock grants and stock options affects financial statements,
and the importance of companies’ assumptions in valuing these grants and options. MODULE 15.6: ANALYST ADJUSTMENTS

Stock Options: Compensation expense is based on the fair value of the options on the grant date based on the number of options that are expected to vest.
The compensation expense is allocated in the income statement over the service period. Recognition of compensation expense will decrease net income
and retained earnings; however, paid-in capital is increased by an identical amount. This results in no change to total equity.

Determining Fair Value: Based on the observable market price of a similar option if one is available. Absent a market-based instrument, the firm can use
an option-pricing model such as Black-Scholes or the binomial model. There is no preference of a specific model in either IFRS or U.S. GAAP.

Stock grants: Compensation expense for stock granted is based on the fair value of the stock on the grant date. The compensation expense is allocated
over the employee’s service period.
May be outright transfer of stock without conditions, restricted stock, and performance stock. With restricted stock, transferred stock cannot be sold until
vesting has occurred. Performance stock is contingent on meeting performance goals like ROE. May may result in earnings manipulation though!

Stock appreciation rights: A stock appreciation award gives the employee the right to receive compensation based on the increase in the price of the
firm’s stock over a predetermined amount. With stock appreciation rights, employees have limited downside risk and unlimited upside potential, thereby
limiting the risk aversion problem discussed earlier. Also, since no shares are actually issued, there is no dilution to existing shareholders. A
disadvantage of stock appreciation rights is that they require current period cash outlay.

Phantom stock. Phantom stock is similar to stock appreciation rights except the payoff is based on the performance of hypothetical stock instead of the
firm’s actual shares. Phantom stock can be used in privately held firms and firms with highly illiquid stock.