Acct 592 – Spring 2008 (corrected) Prof. Teresa Gordon
sOLUTIONS For examples – FAS123R
EXAMPLE #1A - Stock Appreciation Rights (SARS)
Share-based Compensation Classified as Liability – Nonpublic Entity Electing Intrinsic Value Method
Musick Corporation offered stock appreciation rights (SARS) to its president, Sally Musick, on the appreciation of 10,000 shares of Musick Corporation common stock. The SARS were granted on December 31, 2009 when the stock was selling for $20 per share. Ms. Musick was to receive all price appreciation from the date of the grant until the date of exercise in the form of cash. The exercise date was identified as January 1, 2012, and the SARS were set to expire July 1, 2014 if not exercised. The relevant market prices are given in the following table. Assume that Ms. Musick exercised the SARS on March 1, 2014. The income tax rate for Musick Corporation is 30%.
Grant date 12/10 12/11 12/12 12/31/13 7/1/14
12/31/09
No forfeitures are estimated since Ms. Musick is the major stockholder and essentially controls the board of directors. However, the stock rarely trades even privately and elects to use the intrinsic value method. Fair values of the company’s shares are estimated annually using valuation techniques described in the AICPA Practice Aid, Valuation of Privately-Held-Company Equity Securities Issued as Compensation.
12/31/09 / $20 / $20 / 0 / 0% / N/A
12/31/10 / $25 / $20 / 50,000
$5 intrinsic value * 10,000 units / 50% / Compensation Expense 25,000
SARS Liability 25,000
Deferred tax asset 7,500
Income tax expense (deferred) 7,500
12/31/11
Vesting Date / $19 / $20 / 0
No intrinsic value / 100% / SARS Liability 25,000
Compensation Expense 25,000
Deferred tax asset 7,500
Income tax expense (deferred) 7,500
12/31/12 / $30 / $20 / 100,000
$10 * 10,000 units / 100% / Compensation Expense 100,000
SARS Liability 100,000
Deferred tax asset 30,000
Income tax expense (deferred) 30,000
12/31/13 / $32 / $20 / 120,000
$12 * 10,000 units / 100% / Compensation Expense 20,000
SARS Liability 20,000
Deferred tax asset 6,000
Income tax expense (deferred) 6,000
3/1/14
Settlement Date / $31 Intrinsic value $11 / $20 / 110,000
Amt to be paid = $11 * 10,000 units / 100% / SARS Liability 10,000
Compensation expense 10,000
Income tax expense (deferred) 3,000
Deferred tax asset 3,000
SARS Liability 110,000
Cash 110,000
Deferred tax asset 33,000
Income taxes payable 33,000
Income tax expense (deferred) 33,000
Current tax expense 33,000
Example #1B – SARS - Solution
Share-based Compensation Classified as LiabilityPublicly-traded Company (or Nonpublic Entity Electing Fair Value Method)
Musick Corporation offered stock appreciation rights (SARS) to its president, Sally Musick, on the appreciation of 10,000 shares of Musick Corporation common stock. The SARS were granted on December 31, 2009 when the stock was selling for $20 per share. Ms. Musick was to receive all price appreciation from the date of the grant until the date of exercise in the form of cash. The exercise date was identified as January 1, 2012, and the SARS were set to expire July 1, 2014 if not exercised. The relevant market prices are given in the following table. Assume that Ms. Musick exercised the SARS on March 1, 2014. The income tax rate for Musick Corporation is 30%.
Grant date 12/31/10 12/31/11 12/31/12 12/31/13 7/1/14
12/31/09
No forfeitures are estimated since Ms. Musick is the major stockholder and essentially controls the board of directors. Assume that the shares not held by Ms. Musick are publicly traded on an over-the-counter market.
12/31/09 / $20 / $10 / 0 / 0% / N/A
12/31/10 / $25 / $13 / $130,000 / 50% / Compensation Expense 65,000
SARS Liability 65,000
Deferred tax asset 19,500
Income tax expense (deferred) 19,500
12/31/11
Vesting Date / $19 / $5 / $50,000 / 100% / SARS Liability 15,000
Compensation Expense 15,000
Income tax expense (deferred) 4,500
Deferred tax asset 4,500
12/31/12 / $30 / $15 / $150,000 / 100% / Compensation Expense 100,000
SARS Liability 100,000
Deferred tax asset 30,000
Income tax expense (deferred) 30,000
12/31/13 / $32 / $12.75 / 127,500 / 100% / Compensation Expense 22,500
SARS Liability 22,500
Deferred tax asset 6,750
Income tax expense (deferred) 6,750
3/1/14
Settlement Date / $31
Base price=
$20 / $11.25
Intrinsic Value=
$11 = fair value / 110,000 / 100% / SARS Liability 17,500
Compensation expense 17,500
Income tax expense (deferred) 5,250
Deferred tax asset 5,250
SARS Liability 110,000
Cash 110,000
Deferred tax asset 33,000
Income taxes expense (deferred) 33,000
Current taxes payable 33,000
Current tax expense 33,000
The entry at settlement makes the assumption that fair value = intrinsic value. This is a simplification of a more complex set of journal entries where we recognize compensation expense at fair value and then pay at intrinsic value and have to adjust the balance of the liability account to zero (because it is a different amount than recognized in compensation expense.
Example #1C – SARS Solution
Share-based Compensation Classified as EquityPublicly-traded Company or Nonpublic EntityCash settlement not permitted
Musick Corporation offered stock appreciation rights (SARS) to its president, Sally Musick, on the appreciation of 10,000 shares of Musick Corporation common stock. The SARS were granted on December 31, 2009 when the stock was selling for $20 per share. Ms. Musick was to receive all price appreciation from the date of the grant until the date of exercise in the form of shares of Musick Corporation common stock (par value $10 each). The exercise date was identified as January 1, 2012, and the SARS were set to expire July 1, 2014 if not exercised. The relevant market prices are given in the following table. Assume that Ms. Musick exercised the SARS on March 1, 2014. The income tax rate for Musick Corporation is 30%.
Grant date 12/31/10 12/31/11 12/31/12 12/31/13 7/1/14
12/31/09
No forfeitures are estimated since Ms. Musick is the major stockholder and essentially controls the board of directors. Assume that the shares not held by Ms. Musick are publicly traded on an over-the-counter market.
Solution notes: The original fair value estimate is used to compute compensation expense and deferred tax asset. The fiar value estimate plus the strike price = $30 which is our estimate of the value of the common stock at the exercise date. However, at settlement, the actual market value is $31. We owe Ms. Musick the market price of $31 less the $20 base price or $11 per share. Instead of paying cash, we give her shares of common stock worth $110,000, the amount owed. $110,000 owed ÷ $31 market price =3,548 shares issued.
Tax deduction is based on intrinsic value at exercise of $11 – 10,000 shares @ $11 = $110,000 tax deduction * 30% = $33,000 reduction in income taxes currently owed. Since this is more than the $30,000 deferred taxes accrued based on fair value estimated at grant date, the excess is treated as additional paid in capital per SFAS No. 123R, para. 62.
12/31/09 / $20 / $10 / 0 / 0% / N/A
12/31/10 / $25 / $10 / 100,000 / 50% / Compensation Expense 50,000
APIC – SARS 50,000
Deferred tax asset 15,000
Income tax expense (deferred) 15,000
12/31/11 / $19 / $10 / 100,000 / 100% / Compensation Expense 50,000
APIC – SARS 50,000
Deferred tax asset 15,000
Income tax expense (deferred) 15,000
12/31/12 / $30 / $10 / 100,000 / 100% / No entry needed at vesting date
12/31/13 / $32 / $10 / 100,000 / 100% / No entry needed because measurement of compensation does not change since it is an equity award rather than a liability award
3/1/14
Settlement Date / $31
Base price=
$20 / Original est. FV = $10
Actual FV = Intrinsic value = $11 / $100,000 compensation recognized using est. FV but an obligation to “pay” $110,000 using actual FV=intrinsic value / 100% / APIC - SARS 100,000
Common stock ($10 par) – see above 35,480
APIC – common stock 64,520
Income tax expense (deferred) 30,000
Deferred tax asset 30,000
Income taxes payable 33,000
APIC – excess tax deduction 3,000
Options Set 1 Solutions FAS123R Examples S07.doc as of 2/12/08 Page 2