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Overview
We’ve discussed a variety of employee compensation plans in prior chapters, including pension
and other postretirement benefits in Chapter 17. In this chapter we look at some common forms
of compensation in which the amount of the compensation employees receive is tied to the
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
LO19-1 Explain and implement the accounting for stock award plans.
LO19-2 Explain and implement the accounting for stock options.
LO19-3 Explain and implement the accounting for employee share purchase plans.
LO19-4 Distinguish between a simple and a complex capital structure.
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Part A: Share-Based Compensation
A. Typically, an executive compensation plan is tied to performance in a way that uses
compensation to motivate its recipients.
19-2 Intermediate Accounting, 8/e
I. Stock Award Plans (T19-1)
A. The compensation is a grant of shares of stock (restricted stock) or the right to receive
shares of stock (restricted stock units).
B. The shares usually are restricted so that benefits are tied to continued employment.
1. Usually shares are subject to forfeiture if employment is terminated within some
II. Stock Option Plans (T19-3)
A. Allow recipients the option to purchase (a) a specified number of shares of the firm’s
stock, (b) at a specified price, (c) during a specified period of time.
B. For tax purposes, plans can either qualify as an “incentive stock option plan” under the
D. Compensation is measured at the grant date, estimated using an option-pricing model that
considers the exercise price and expected term of the option, the current market price of
the underlying stock and its expected volatility, expected dividends, and the expected
risk-free rate of return.
E. When forfeiture estimates change, the cumulative effect on compensation is reflected in
current earnings. (T19-6)
F. When options are exercised, cash is debited for the amount received, and stock accounts
replace paid-in capital – stock options. (T19-7)
K. Under IFRS, the straight-line choice is not permitted. Also, there’s no requirement that
the company must recognize at least the amount of the award that has vested by each
reporting date.
III. Employee Share Purchase Plans (T19-10)
A. Employee share purchase plans allow employees to buy company stock under convenient
Part B: Earnings Per Share
I. For analysts and the financial press, earnings per share is the most frequently cited and
reported measure of a company’s performance.
II. If a company has no “potential common shares” we consider it to have a simple capital
structure.
A. For a simple capital structure, a single presentation of basic EPS is sufficient.
III. When the number of shares changes, EPS calculations are based on the weighted average
number of shares outstanding during the period.
A. New shares issued during a reporting period are time-weighted by the fraction of the
B. On the contrary, an increase in shares due to a stock dividend or stock split is not time–
weighted. (T19-13)
1. For a stock dividend or stock split, the shares outstanding prior to the stock
distribution are restated to reflect the increase in shares. That is, we simply increase
are restated for comparability.
C. If common shares are reacquired (as treasury stock or to be retired) those shares are time–
weighted for the fraction of the period they were not outstanding. The time-weighted
shares then are subtracted from the number of shares in the denominator of the EPS
fraction. (T19-14)
19-4 Intermediate Accounting, 8/e
IV. Any dividends on preferred stock outstanding are subtracted from reported net income. (T19-
15)
A. This is because the denominator in the EPS calculation is the weighted average number
V. When a company has securities that could potentially dilute (i.e., reduce) earnings per share, it
is classified as a complex capital structure. (T19-16)
A. These potential common shares include stock options and convertible securities.
D. Stock options (also stock rights and stock warrants) give their holders the right to
exercise their option to purchase common stock, typically at a specified exercise price.
The increase in shares would reduce EPS. (T19-17)
1. When calculating diluted EPS, we pretend the stock options had been exercised at
the beginning of the period (or at the time the options are issued, if later).
2. We also assume the cash proceeds from the assumed sale were used to buy back (as
E. For convertible securities, we pretend for the purpose of calculating diluted EPS that the
conversion already has occurred. (T19-20)
1. To include convertible bonds in the calculation of diluted EPS, we pretend the
conversion occurred at the beginning of the period (or at the time the convertible
security is issued, if later). (T19-21)
2. To include convertible preferred stock in the calculation of diluted EPS, we pretend
the conversion occurred at the beginning of the period (or at the time the
convertible security is issued, if later). (T19-22)
VI. If the effect of the assumed conversion or exercise of potential common shares would be to
increase, rather than decrease, EPS, we consider them “antidilutive securities.” Antidilutive
securities are ignored when calculating both basic and diluted EPS. (T19-23)
VII. Contingently issuable shares also are potential common shares. (T19-24)
A. These are considered outstanding in the computation of diluted EPS if the conditions for
VIII. Financial statement disclosures include both basic and diluted EPS for both income from
continuing operations and net income. (T19-25)
A. Per share amounts also are reported for discontinued operations,
Decision-Makers’ Perspective
A. Analysts frequently use EPS data in connection with the price-earnings ratio.
1. The P/E ratio is the market price per share divided by the earnings per share.
2. The P/E ratio measures the decision makers’ perception of the “quality” of a
19-6 Intermediate Accounting, 8/e
Appendix B. Stock Appreciation Rights (SARs) (T19-27)
A. SARs enable an executive to benefit by the amount that the market price of the
company’s stock rises, but without having to buy shares.
D. The share appreciation usually is payable in cash but may be payable in shares equal in
value to the share appreciation.
1. The award is considered to be equity if the employer can elect to settle in shares of
stock rather than cash.
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A PowerPoint presentation of the chapter is available at the textbook website.
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The following can be reproduced on transparency film as they appear here, or
19-8 Intermediate Accounting, 8/e
STOCK AWARD PLANS
Usually, restricted shares are subject to forfeiture if the
T19-1
STOCK AWARD PLANS ILLUSTRATION
Under its restricted stock award plan, Universal Communications
grants 5 million of its $1 par common shares to certain key
Calculate total compensation expense:
$12 fair value per share
x 5 million shares awarded
= $60 million total compensation
December 31, 2019
Paid-in capital– restricted stock (5 million sh. at $12) … 60
Common stock (5 million shares at $1 par) …………….. 5
Paid-in capital – excess of par (to balance) ………… 55
T19-2
19-10 Intermediate Accounting, 8/e
STOCK OPTION PLANS
Stock option plans give employees the option to purchase (a)
a specified number of shares of the firm’s stock, (b) at a
specified price, (c) during a specified period of time.
This requires the use of an option pricing model. The model
should take into account the:
• exercise price of the option
Tax Implications
For tax purposes, plans can either qualify as an “incentive
stock option plan” under the Tax Code or be “unqualified
plans.”
Among the requirements of a qualified option plan is that
T19-4
19-12 Intermediate Accounting, 8/e
EXPENSING STOCK OPTIONS
At January 1, 2016, Universal Communications grants options
that permit key executives to acquire 10 million of the
company’s $1 par common shares within the next 8 years, but
Calculate total compensation expense:
$8 estimated fair value per option
x 10 million options granted
= $80 million total compensation
T19-5
ESTIMATED FORFEITURES
If a forfeiture rate of 5% was expected, annual compensation
expense would have been $19 million ($76 / 4) instead of
2016 ($ in millions)
Compensation expense ($80 x 95% x 1/4) ……………… 19
Paid-in capital –stock options …………………… 19
2017
T19-6
19-14 Intermediate Accounting, 8/e
WHEN OPTIONS ARE EXERCISED
If half the options (five million shares) are exercised on July 11,
2019, when the market price is $50 per share, the following journal
entry is made:
July 11, 2019 ($ in millions)
Cash ($35 exercise price x 5 million shares) ………………….. 175
If options that have vested expire without being exercised, the
following journal entry is made (assuming none of the options
were exercised):
PLANS WITH PERFORMANCE OR
MARKET CONDITIONS
The way we account for such plans depends on whether the condition is
performance-based or market-based.
Plans with Performance Conditions
If compensation from a stock option depends on meeting a
performance target, then whether we record compensation depends
2018
Compensation expense ([$80 x ¾] – $0) ………. 60
Paid-in capital –stock options ……………. 60
2019
Plans with Market Conditions
If the award contains a market condition (e.g., a share option with an
T19-8
19-16 Intermediate Accounting, 8/e
INTERNATIONAL FINANCIAL REPORTING STANDARDS
Recognition of Deferred Tax Asset for Stock Options. Under
U.S. GAAP, a deferred tax asset is created for the cumulative
T19-9
EMPLOYEE SHARE PURCHASE PLANS
Permit employees to buy shares directly from their
company.
T19-10
19-18 Intermediate Accounting, 8/e
EARNINGS PER SHARE
In the most basic setting, earnings per share is simply a
company’s earnings (or loss) divided by the number of shares
outstanding.
Common stock
January 1, 2016 60 million shares outstanding
(in millions, except per share amount)
Basic EPS:
net
income
ISSUANCE OF NEW SHARES
If the number of shares has changed, it’s necessary to find the
weighted average of the shares outstanding during the period
entire period.
Sovran Financial Corporation reported net income of $154
million for 2016 (tax rate 40%). Its capital structure included:
Common stock
Basic EPS:
(amounts in millions, except per share amount)
net
income
STOCK DIVIDENDS AND STOCK SPLITS
The additional shares created by a stock dividend or split are
not weighted for the time period they were outstanding.
Shares outstanding prior to the stock distribution are
Common stock
January 1 60 million common shares were outstanding
Basic EPS:
(amounts in millions, except per share amount)
net
T19-13