Seminar 21/22: Share based payments transactions

*Measure fair vale of options given

*Period where service is rendered Three types of SBPT [All questions: Ask if this is a Equity or Cash settled SBPT]
Equity Settled SBPT (Equity Based) Firm receives goods/services as consideration for equity of entity Record in journal initial option value when its granted. If FV of option can be measured reliably: FV of option determined on grant date, NOT adjusted subsequently Estimate # of options that will eventually vest at each B/S till vesting date ends, adjust them at each B/S period After vesting date, no staff cost adjustments If FV of option cannot be estimated reliably Intrinsic value (Fair value of share Ex price of option) used Value is re-measured at each reporting date till full settlement/expiry Cash Settled SBPT (Liability Based) Entity receives goods/services by incurring liabilities to supplier for cash based on price of entitys shares

Not only need to adjust for amount of expected ESO in each period, but also FV change of option given this is a liability. After vesting date, still have staff cost adjustments based on FV changes till option expires or fully exercised
Entity receives goods/services and terms of arrangement provide either entity or counter-party with choice of settlement in cash or shares.

Share-based payment with cash alternative

FRS 102 Doesnt apply to: 1. Share based transaction in business combination 2. Share based transaction with any party in capacity as entitys shareholder

Is ESO an expense? Expenses are decreases in economic benefits during accounting period in form of outflows or depletions of assets/incurrence of liabilities that result in decreases in equity other than those relating to distributions to equity participants.

IMPORTNANT JOURNAL RECORD RULE: Vesting vs Non-vesting Even if the shares are granted on 1 Jan XXX - It is only recognized at end of reporting period where shares have gain value through VESTING PERIOD. - If non-vesting, it is recognized as soon as its granted

VESTING RULES Does condition determine whether entity receives services that entitle counterparty to SBP

Yes, Depends on service (Vesting Condition)

Does condition require only specified period of service? Yes (Service Condition) - Recognize based on time No (Performance Condition)

No, not (Non-V

Condition related to market price of entitys equity instrument?

Yes (Market Performance Condition) i.e. share price performance

No (Non-Market Performance Condition) i.e. based on vol of sales/revenue

VESTING RULES (II): Accounting for Conditions

Vesting Cond.

NonVesting Cond. Illustrations

VESTING: Service & Non-Market performance condition [Illustration 6 & 7] - No Fair value @ Grant date Conditions not considered in estimating instrument Fair value, but considered in est # of instruments expected to vest - Forfeiture True-Up: At each B/S date, est # of options that will eventually vest, up to vesting date Adjust vesting costs (i.e. staff costs) accordingly
If Service/Non-market condition exp to change FV per option/SAR # exp to vest Total FV to initially recognize $3 100 $300 Vesting Period ()* exp to vest Y1 Y2 Y3 (100%) (80%) (70%) 100 60 50

Market Performance & Neither entity/CP may choose to meet condition (Illustration 8 & 10) - Fair value @ Grant date Conditions considered in estimating FV of individual instrument (i.e. probability of meeting condition=inputs to valuation) - No Change Expensed over vesting period
If Service/Non-market condition fulfillment exp to change Vesting Period ()* exp to vest FV per option/SAR # exp to vest Total FV to Y1 Y2 Y3 initially recognize (100%) (80%) (70%) $2.40* 100 $240 80 80 80 Take acc probability of fulfillment VESTING AMT CONSTANT even if condition not met as earlier taken into account probability of non-fulfillment in FV instrument

Counterparty/Entity can choose to meet condition (Illustration 11 & 12) - Fair value @ Grant date Conditions considered in estimating FV of individual instrument (i.e. probability of meeting condition=inputs to valuation) - Cancellation results in accelerated exp Expense everything

If Service/Non-market condition fulfillment exp to change FV per option/SAR # exp to vest Total FV to initially recognize $2.40* 100 $240 Take acc probability of fulfillment

Vesting Period ()* exp to vest Y1 Y2 Y3 (100%) (CANCEL) 80 160

MEASUREMENT EQUITY SETTLED SHARE BASED PAYMENT TO THIRD PARTY Equity settled A. Measure goods/services from third party share based Fair value of goods/services* = share capital issued payment *Rebuttable assumption that fair value of goods/service can be (Third party) estimated reliably Fair value of machine Shares issued to buy machine $100k $1 x 110k shares = $110k We adopt fair value of machine = $100k If fair value of goods/service cannot be measured reliably Value of goods/services = fair value of equity instruments
Illustration 2 Equity shared based payment Goods/service receive cant be recognized as assets should recognize as exp - Firm acquire sundry lab equipment of $120k from associates - Issued 100k ordinary shares

Research expense Share Capital

Dr 120k

Cr 120k

Illustration 3 Market value of goods certain Professional valuer value land at $50m, firm issue 10m ordinary shares to buy them Dr Cr Land 50m Share Capital 50m Illustration 4 Market value of goods uncertain [Cannot measure reliably] Firm acquire building where various valuation range from 10m to 50m Firm bought building by issuing 1m ordinary shares then priced at $22 per share Dr Cr Land 22m Share Capital 22m

MEASUREMENT EQUITY SETTLED SBP TO EMPLOYEES Equity B. Services received from employees settled share Measurement = fair value of equity instrument granted based * market value of employee service not available payment *Accounting for terms/conditions which instruments are granted (Employee) Fair value of emp service FV of option granted $100k $1 x 110k shares = $110k *We adopt fair value of options = $110k If fair value of instrument cannot measure reliably (i.e. unlisted shares, no liquidity) = Measure services/increase in equity based on intrinsic value of equity instrument granted
Fair value calculation for ESO Option pricing models to measure fair value. Taking into account:
Exercise price of option Current price of underlying shares Life of option *How long employee hold option & not contractual period Expected volatility of share price Dividend expected Risk free interest rate

For Equity Settled SBPT (Calculation of ESO/# of options) Fair value of ESO (i.e. option value) is determined on grant date and not adjusted for subsequent change in market conditions; ONLY amount of expected ESO granted in future is adjusted each period (based on total expected attrition at grant date)

Illustration 5 Vesting based on Length of service

[No Attrition, Vesting FV of option can be measured reliably, ESO for employees] Firm grants 5 executives options to purchase 200,000 shares each (total: 1m) Option exercise price: $5 per share Granted on 1 Jan 20x2, will vest at 1 Jan 20x5 [Vesting period = 3 years] Option exercisable from 1 Jan 20x5 to 31 Dec 20x8 [Exercise period = 4 year]s FV of option on 1 Jan 20x2 $1.50 [measured reliably = no change after grant date] Firm expects all employees to stay Total fair value of options = 1.50 x 1m = 1.5m
Event For 3 years in vesting period Each period recorded: vests 500k If exercise at end of vesting If never exercise till expiry Staff Cost (1.5m /3) Capital Reserve Hence total vested in 3 years: 500k x 3 = 1.5m Cash (1m shares x Ex value $5)* Capital Reserve (Empty capital reserve)^ Share Capital (Increase in share cap) Capital Reserve Stock Option Capital Reserve General reserve Note: Expenses NOT reversed as service were provided, instead this is transferred to general reserve for distribution as dividends 5m 1.5m 1.5m Dr 500k Cr 500k

6.5m 1.5m

*Cash Cash employee paid to buy shares ^Cap Reserve Used to record value of service provided by employees

Illustration 6 Vesting based on Length of service with attrition

Firm grants top 20 executives, 50,000 share options each (total = 1mil) Option exercise price = $1 FV of option on 1 Jan 20x2 $1.50 [measured reliably = no change after grant date]
Event 2007 Jan 1 Year 2007 2 employees left, Expected to stay: 14 Year 2008 1 employee left, Expected to stay: 15 Year 2009 (End) 2 employee left Total left: 15 Exercise *if never ex till expiry, see illustration 5. Dr No entry, havent vest Staff Cost Capital Reserve ESO (14 emp x 50,000 x 1.5 x 1/3) Staff Cost Capital Reserve ESO (15 emp x 50,000 x 1.5 x 2/ 3) 350k Staff Cost Capital Reserve ESO (15 emp x 50,000 x 1.5 x 3/3) 750k Cash (15 x 50,000 x $1 ex price) Capital reserve (empty capital reserve) Share capital 350K Cr 350K

400k

400k

375k 750k 1.125m

375k

1.875m

Illustration 7 Vesting based on Non-Market performance w attrition

Firm grants 10 executives options to buy 10,000 shares each Option exercise price: $5 per share FV of option on grant date = $3 [measured reliably = no change after grant date] Vesting Conditions o 31 Dec 20x2: If sales increase by > 20% o 31 Dec 20x3: If average sales increase over two year > 15% o 31 Dec 20x4: If average sale increase over 3 year > 10%
Event Year 20x2 Staff Cost Fail condition, Capital Reserve ESO Exp employee to (3 x 10,000 x 8 emp x 1/3) stay: 8 Recognized given expectations to achieve condition next period. Hence considered vested Year 20x3 Staff Cost Fail condition, Capital Reserve ESO Exp employee to (3 x 10,000 x 7 emp x 2/3) 120k stay: 7 Recognized given exp to achieve condition next period. Hence considered vested Year 20x4 (end) Staff Cost Pass condition, Capital Reserve ESO Total stayed: 8 (3 x 10,000 x 8 emp x 3/3) 140k Dr 120k Cr 120k

20k

20k

100k 100k

Illustration 8 Vesting based on Market condition with attrition

Question: What if fail vesting period in the end?? DERECOGNIZE first 2 years?

[Attrition, Vesting, FV of option can be measured reliably, ESO for employees] Firm grants CEO to purchase 500,000 shares at $5 per share - Granted on 1 Jan 20x2, vest on 31 Dec 20x4 - Option cannot exercise unless market price increase to at least $8 on Dec 20x4 Binomial fair pricing: 1.20 [measured reliably = no change after grant date]
Event For all 3 years Staff Cost Capital Reserve ESO (1.20 x 500,000 x 1/3) Record exercise or non-exercise referencing illustration 5 Dr 200k Cr 200k

Even if fail to meet requirements, will still be vested. Given the fair pricing has taken into account the probability of fulfillment

Illustration 9 Modification of terms and conditions of ESO

By right value of option recorded shouldnt change UNLESS terms of ESO change Entity should recognize effects of modification that increase total fair value of options - Firm grants top 5 executives options to purchase 20,000 shares each - Option exercise price: $5 Option granted on 1 Jan 20x2, vests on 1 Jan 20x5 [VESTING PERIOD] Binomial fair pricing: $3 [measured reliably = no change after grant date]
Event 1st year 2nd year Ex price reduced to $4 Staff Cost Capital Reserve ESO (3 x 5 x 20,000 x 1/3) Staff Cost Capital Reserve ESO (3 x 5 x 20,000 x 2/3) + (0.2 x 100,000 x ) 100k prev recognized Option value before repricing: $1.60 Option value after repricing: $1.80 3rd year Staff Cost Capital Reserve ESO (3 x 5 x 20,000 x 3/3) + (0.2 x 100,000 x 2/2) 210k prev recognized 110k 110k Dr 100k 110k Cr 100k 110k

Illustration 10 Entity/Counter-party doesnt choose NOT to meet condition, but experience failure to meet condition (i.e. GDP fail to meet 5%)
Cancellation No impact, continue to recognize same exp over vesting period

Illustration 11 Entity CHOOSES to cancel/settle option during vesting

Cancellation/settlement acceleration of vesting period. I.e. option recognized prospectively as vested over shorter accelerated period. - Firm grant top 5 executives options to purchase 20,000 shares - Option exercise price: $5 - Shares granted on 1 Jan 20x2, vest on 1 Jan 20x5 - Black scholes fair pricing of option value: $3 - ON Dec 20x3. Firm cancels stock option and pays each executive 50k
Event 1st year 2nd year Stock option cancelled Staff Cost Capital Reserve ESO (3 x 5 x 20,000 x 1/3) Staff Cost Capital Reserve ESO (3 x 5 x 20,000 x 2/2) -100k Dr 100k 200k 200k Cr 100k

Option prospectively (accelerate) recognized as vested over 2 yr 3rd year Capital reserve (5 x 50k) Compensation Cash from firm

250k 250k

Illustration 12- Counterparty choose NOT to meet non-vesting condition

Cancellation accelerated vesting
Firm grants CFO to participate in plan where CFO obtains share options CFO needs to save 10% of monthly salary of $10,000 for 3 year period CFO may use accumulated savings to exercise options at end of 3 years Estimated exp of share-based payment arrangement = 3,600 per year for 3 yrs

Event 20x1 Dec 31

Staff Cost Cash Salary in arrears (10% x 120k) (CFOs salary for 12 months) Staff costs Capital Reserve ESO *Keep CFO 10% salary, end of 3 years may use amt to exercise option

Dr 120k

Cr 108k 12k

3.6k 3.6k

20x2 Apr 1 (After 3 months) CFO pulls out of this programme Takes refund

Staff Cost Cash Salary in arrears (10% x 30k) (CFOs salary for 3 months) Salary in Arrears (extinguish liability) Cash Staff Costs Capital Reserve - ESO (Accelerated recognition upon cancellation)

30k 27k 3k 15k 15k 7.2k 7.2k

Illustration 13 Unable to estimate reliably FV of equity [IMPT!]

Use intrinsic value (diff btw fair value of shares and exercisable price) Measure intrinsic value every period from start date to final settlement

Example Firm give CEO option to purchase 1,000,000 shares at 0.30 per share Options granted on 1 Mar 20x1, will vest on 1 Jan 20x4 [vest over 3 years] - New startup, FV of options cant measure reliably (no liquidity, volatility data) - Firm measures stock option at intrinsic value Date Share price Intrinsic value (share price ex value) 1 Mar 20x1 0.30 31 Dec 20x1 0.42 0.42-0.3 = 0.12 31 Dec 20x2 0.45 0.45-0.3 = 0.15 31 Dec 20x3 0.50 0.5 0.3 = 0.2 20X4 Post-Vesting 0.6 0.6 0.3 = 0.3 20x5 Post-Vesting 0.8 0.8 0.3 = 0.5 Every period need to re-measure intrinsic value as fair value not obtainable
Event Grant date B/S End date Record @ 20x1 intrinsic B/S End date Record @ 20x2 intrinsic B/S End date Record @ 20x3 intrinsic Post-Vesting period 20x4 Still record change in intrinsic Exercise: 200k options Share price: 0.6 Intrinsic = 0.3 Post-Vesting period 20x5 Still record change in intrinsic Exercises: 800k options Share price: 0.6 Intrinsic = 0.5 Dr No journal entries, have not vested Staff Cost Capital Reserve ESO (0.12 x 1,000,000 x 1/3) Staff Cost Capital Reserve ESO (0.15 x 1,000,000 x 2/3) 40k Staff Cost Capital Reserve ESO (0.2 x 1,000,000 x 3/3) 100k Staff Cost Capital Reserve ESO (0.3 x 1,000,000 (40k+60k+100k)) Record increase in option value for ALL option first Cash (0.3 x 200,000) ex price of 0.30 per share Capital reserve (0.2 x 300k updated option value) Share capital (Current price 0.6 x 200k) Staff Cost Capital Reserve ESO (0.5 0.3) x 800k Record increase in option value for ALL option first Cash (0.3 x 800,000) ex price at 0.30 per share Capital reserve (80% x 300k + 160k value) Share capital (Current price 0.8 x 800k) 40k 60k 100k 100k 100k 100k Cr 40k 60k

60k 60k 160k

120k 160k

240k 400k 640k

Note total staff cost over years = 460k *If intrinsic value drop, reverse staff cost and share based payment, as over accounted

Illustration 14 Employee share purchase plan (held in trust)

Firm offers all 120 employees opportunity to participate in share purchase plan Employees entitled to buy 10,000 shares at 20% disc from market price on 30 Jun 20x6 All shares bought held in trust for five years and all dividends paid also held in trust 100 employees accept the plan and 1,000,000 shares were purchased from market at $4 each (20% discount from quoted price of $5) Shares are vested when purchased but cant be sold for five years o Accounting for transfer restriction, fair value of restricted share = $4.40

Since fair value restricted share = $4.40 Purchase price = $4 Then value of equity instrument option granted = (4.40-4) x 1,000,000 = 400k To recognize this instrument immediately, given NO vesting period (only held in trust which diminishes the equity instrument value)
Staff Cost Capital Reserve Dr 400k Cr 400k

Cash settled Share based payment transaction [Liability]

Need to adjust for # of expected ESO in each period, till end of vesting Need to re-measure/adjust for options fair value change even after vesting till settlement/expiry Change in FV recognized as Staff Cost (P&L) Employee entitled to cash in future based on increase in share price over time Advantages - No dilution to share capital base - Pay diff in cash, employee dont have to pay $ to exercise option

Illustration 15 Share appreciation rights (SAR), rewards cash settled

Firm grants CEO 1mil SAR, condition to remain in firm for next 3 years Initial share price @ Jan 20x1: $5
Given Market Price of Shares $5.50 $5.80 $6 $7 $8 Fair value of Share Appreciation Rights $0.9 $1.50 $2.1 $2.5 Year Dec 20x1 Dec 20x2 Dec 20x3 Dec 20x4 Dec 20x5

*Since we know FV of liability, we do not need to use intrinsic value Still as this is liability = need to re-measure fair value of liability at each period
Event Grant Date (20x1 Jan) 20x1 Dec S Price = 5.50 Fair value of rights = 0.90 20x2 Dec S Price = 5.80 Fair value of rights = 1.50 20x3 Dec S Price = 6.00 Fair value of rights = 2.10 20x4 Dec Total Liability = 2.1m Fair value of rights = 2.50 S. price = 7 RECORD EXERCISE Exercise: 400k rights Remaining rights = 600k Dr No journal entries recorded, not vested yet Staff Cost Liability (0.9 x 1,000,000 x 1/3) Staff Cost Liability (1.5 x 1,000,000 x 2/3) 300k Staff Cost Liability (2.1 x 1,000,000 x 3/3) 1m Liability (2.1m - residual 0.6m rights@2.5) Staff cost Cash (S. price $7 initial $5) x 400k Or separate the entries Staff Cost (2.5-2.1) x 600k Liability Re-measurement for those not redeemed yet Liability (2.1m cap reserve x 40%) Staff Cost (2.1 intrinsic $2 actual) Cash [(7-5) x 400k] Record over-provision of staff cost & exercise 20x5 Dec Remaining liab =1.5m S. price = 8 Exercise: Last 600k rights Liability (extinguish rest of liability) Staff cost ($3 actual $2.5 intrinsic) x 600k Cash (S. price $8 initial $5) x 600k Record over-provision of staff cost & exercise 300k 700k 700k 1.1m 1.1m 600k 200k 800k 240k Cr 300k

240k

840k

40k 800k

1.5m 300k

1.8m

Staff cost over the years = 0.3m + 0.7m + 1.1m + 0.2m + 0.3m = 2.6m

Share based payment transactions with cash alternatives IMPT

Arrangement provides either entity or counterparty with choice whether to settle transaction in cash or issuing equity instruments Depends on whether entity/counterparty has right to choose Counterparty If counter party has choice of settlement right to Entity has in fact just issued compound financial instrument with 2 choose components: Debt (i.e. counterparty right to demand cash payment) SPLIT Equity (counterparty right to demand settlement in equity) ACCOUNTING A. Requires split accounting, fair value of debt to determine first Transaction Entity should measure FV of goods/services acquired If got debt w parties and measure FV of debt component first. component not (liability) employees Residual to equity ==> revalue (FV of goods FV of debt) = FV of equity at each Transaction Entity measure fair value of debt component first reporting end w employees then fair value of equity; taking into account date! counterparty must forfeit right to receive cash in order
to receive equity instrument

B. On settlement date
Counterparty demands settlement in equity Counterparty demands settlement in cash Entity transfer liability to equity, as consideration for equity instrument issued Entity treat payment as full settlement of liability, any equity component previously recognized REMAINS within equity

Entity has right to choose NO SPLIT ACCOUNTING

Entity has Present obligation to settle in cash

Present obligation to settle in cash ONLY if: - Settlement in equity instrument no commercial substance (i.e. cant issue more shares, maxed out) - Past policy/practice of settlement in cash - Generally settle in cash if requested Account as cash-settled SBPT Transaction account as equity settled share based payment

No obligation to settle in cash

ON SETTLEMENT DATE Settle in cash Cash payment acc for as share repurchase Settle by issuing equity instrument no further accounting required Excess payment recognize as expenses

Illustration 17 - Counterparty has right to choose [Transaction w employee]

Firm grants CEO right to choose either: (Grant only if she serve 2 years) - Vesting

- 1.2m shares OR - 1m phantom shares with right to receive cash payment equal to 1mil shares If choose share alternative (1.2m): Shares must be held for two years after vesting date Date Market price of shares Changes in share prices will affect Liability 20x1, Jan 1 $5 per share given it cash paid based on share price given 20x1, Dec 31 $5.40 per share if phantom share alternative chosen 20x2, Dec 31 $6 per share COMPOUND INSTRUMENT 1. Determine FV of debt alternative first: 1,000,000 x Current mkt price ($5) = $5mil 2. Fair value of share alternative Based on option pricing model, taken into account post-vesting 2 year restriction Fair value of each share = $4.50 on grant date Hence FV of share alternative is (1.2m share as proxy) is $5,400,000 (1.2m x 4.50) 3. CEO must forfeit right to receive either one to receive other: Residual fair value of equity component in compound instrument = (5.4m 5m) = 400k Apply: (a) Equity settled SBPT treatment to equity portion (i.e. FV of equity instrument stays) (b) Debt settled SBPT treatment to debt portion Event Dr Cr Grant date No Journal entries 20x1 Staff Cost 2.7m 31 Dec Liability (1m x 5.40 x 1 x 0.5) 2.7m Recording debt portion using cash settled SBPT Staff Cost Capital Reserve (400k unchanged x 1 x 0.5) Record equity portion using equity settled SBPT Entries Combined Staff Cost Liability (price of 5.40 x 1m phantom x ) Capital reserve (equity component 400k x ) Staff Cost Liability (1m x 6 x 1 x 1) 2.7m Staff Cost Capital Reserve (400k unchangedx 1 x 1) 0.2m Entries Combined Staff Cost Liability (price of 6 x 1m phantom x 1) 2.7m Capital reserve (equity component 400k x ) If choose Liability cash Cash settlement Equity (cap reserve) remains, may be transferred to RE If choose Liability equity Capital reserve settlement Share capital (!.2m shares) 0.2m 0.2m

2.9m 2.7m 200k 3.3m 0.2m 0.2m 3.5m 3.3m 200k 6m 6m 400k 6m 3.3m

20x2 31 Dec

6.4m

If options nt exercised; at each period, remeasure ONLY liability portion till expiry/settle TREASURY SHARES

Treasury shares not considered as assets Presented as contra-equity, and deduction from equity in balance sheet Transactions involving treasury shares never give rise to any profit or loss, excess goes to Equity See: Seminar 22, Question 2, NEJ 32-240 Dr 200k 300k Cr 200k 200k 100k

Example of Treasury shares purchase Event Buyback 100k Equity Treasury Shares shares @ $2 each Cash Sale of treasury Cash shares @ $3 each Equity Treasury Shares Equity

Use of Treasury Shares for Employee Share Schemes - Entity grants employees rights to equity instruments of entity - Entity either chooses or is required to buy instruments (i.e. treasury shares) from another party - Accounted for as Equity settled SBPT Two Transactions: 1. Equity settled SBPT 2. Share buyback

Accounting For Deferred Tax: Treasury shares for ESO Hence noting the timing difference for deductions; This leads to a TEMPORARY DIFFERENCE

Amount of Temp Difference Accounting Base (CA) = Nil, given this impact equity portion of B/S Tax Base (TB): Amount IRAS permits as deduction in future periods CA TB DTD TR DTA NIL 100 100 20% 20 NIL 120 120 20% 24 See Illustration 18 below for Treasury Share deferred tax example.

ILLUSTRATION 18: Treasury shares for ESO and Deferred Tax

RCL approved plan to grant 10,000 ESOs to each 13 employees - Strike price: $3 - Options granted on 1 Jan 2006 o Vesting conditional upon employee working till 31 Dec 2008 o After 3 years vesting, employee has until 31 Mar 2009 to exercise
Year 2006 Jan 2006 Dec 2007 Dec 2008 Dec Blackscholes fair pricing 1.5 Keep this constant for equity SBPT 1.6 1.85 1.9 SGX Market price 3 3.3 3.6 4

Date Attrition: Expect one employee to leave each year, Dec 2006 Total estimated remaining after vesting: 10 Dec 2007 Total estimated remaining after vesting: 10 Dec 2008 Actual remaining: 11 employees RCL to transfer treasury shares to employees under ESOS, take advantage of tax deduction Tax: 20%: RCL Share buyback 110,000 shares at $4 on 31 Dec, all 11 employees exercised option IRAS: Deduction: Diff btw cost in acquiring shares & amt paid by employee Date CA TB (Note: exercise amt is $3) DTD DTD X TR = DTA 20x6 NIL [3.3-3) x 10 x 1,000 x 1/3 10,000 2,000 20x7 NIL (3.6-3) x 10 x 1,000 x 2/3 40,000 8,000 20x8 NIL (4-3) x 11 x 1,000 x 3/3 110,000 22,000 Change +2,000 +6,000 +14,000

Non-cash settled, stick with original fair pricing for option when granted
Event 20x6 Dec Record staff cost Temp diff, claim deductible in future 20x7 Dec Record staff cost Temp diff, deductible in future 2008 Dec Record staff cost Share buyback Temp diff, claim deductible in future 2009, Mar 31 Empty DTA Staff Cost Capital Reserve ESO (10 x 10,000 x 1.5 x 1/3) Deferred Tax Asset Tax Expense Staff Cost Capital Reserve ESO (10 x 10,000 x 1.5 x 2/3) -50k Deferred Tax Asset Tax Expense Staff Cost Capital Reserve ESO (11 x 10,000 x 1.5 x 3/3) -100k Equity - Treasury Shares ($4 x 110,000) Cash Deferred Tax Asset Tax Expense Cash (110,000 x $3) what employees paid to exercise Capital reserve ESO Empty the cap reserve Equity -Treasury Shares you provided T-shares Equity Capital revenue gain on disposal of T-Shares Tax Expense Deferred Tax Asset (Empty DTA on closing) Dr 50k Cr 50k 2k 2k 50k 50k

6k 65k

6k 65k

440k 440k 14k 14k 330k 165k 440k 55k 22k 22k

DEFERRED TAX FOR STAFF COST DEDUCTIONS

A. If IRAS accord staff cost deductions when its incurred (no temp diff)
Date 2008 Jan 1 Dec 31 Dr No entry as havent vest Staff Cost Liability Tax payable Tax expense (20% x 20,000) 2009 Dec 31 Liability Staff Cost (4.5k x 10,000 x 1) 20k Cash Tax payable Tax expense (20% x 25k) 20k 4k 20k 25k 5k 20k 4k Cr

45k 5k

B. If IRAS accord tax deductions based on staff costs related to SARs only
when paid to employees (Cash Basis) Events
Precision entered into agreement to give 1,000 share appreciation rights (SARs) to each 100 senior employees Each SAR entitles employee cash payment equal to PELs share price on exercise date in excess of exercise price of $20 SAR vests conditionally upon employee working for PEL until 31 Dec 2010 Employee has until 31 Dec 2011 to exercise SAR after vesting period 2008 Dec 2009 Dec 2010 Dec Total expected to leave PEL: 2 Exp Remaining: 98 Total expected to leave PEL: 7 Exp Remaining: 93 End of vesting period Total actual remaining: 88 40 employees exercised their SARs on 31 Dec 2010 None of remaining SARs were exercised in 2011 Share price = $19

Date
2008 Jan 2

2011 31 Dec TAX ISSUE Staff costs incurred in relation to SARs was deductible for tax purpose only when paid to employees Tax rate = 20%, may assume probable PEL sufficient taxable profit for utilization of DTA. Year 31/12/08 31/12/09 31/12/10 Fair value of SAR $3 $4 $5 Share price $20 $22 $24

Tax for Liabilities [Staff cost exp] CA: Liability account arising from staff cost TB: Carry Amt Future deductible (only when paid to employee ~ cash basis)
Year 31/12/08 31/12/09 31/12/10 CA 98k 248k 248+192200= 240k TB 0 0 0 DTD (CA-TB) 98k 248k 240k DTA (Temp diff x TR) 19,600 49,600 48,000 Change 19,600 30,000 (1,600)

Date Year 1 Record staff cost through vesting

Staff Cost Liability (3 x 98 x 1,000 x 1/3) Deferred Tax Asset Tax Expense (Principle 2, underlying) Staff Cost Liability (4 x 93 x 1,000 x 2/3) 98k Deferred Tax Asset Tax Expense Staff Cost Liability (5 x 88 x 1,000 x 3/3) 248k Liability (440k remaining 48 x 1,000 x 5*) Staff cost diff placed here Cash (S. price $24 - $20) x 40 x 1,000 Tax expense Deferred Tax Asset Tax payable (cash given of 160k x 20%) Tax expense Given deductibles accorded when cash given
Analytical Check P&L staff cost: (192k-40k) x 20% = 30,400 Tax accounted for: 32,000 1,600 = 30,400

Dr 98,000

Cr 98,000

19,600 19,600 150,000 150,000 30,000 30,000 192,000 192,000

Year 2 Record staff cost through vesting

Year 3
Last vesting

40 exercised 48 remaining *FV of SAR = 5 Record 160k paid to staff

200,000

40,000 160,000

Account for Deferred tax *Deductibles given as cash is paid, as 40 employees exercised

1,600 1,600 32,000 32,000

2011 Dec 31

Liability (remaining extinguished) Staff Cost Tax expense (240k x 20%) Deferred Tax Asset empty DTA

240,000 48,000

240,000 48,000

INT FRS 111: Group Share-Based Payment Transactions

Accounting for share based payment transactions involves: - Entity buying shares of another entity to satisfy obligation to employee - Two or more entities in same group Entity receiving the goods/services shall measure Nature of Award Own Equity Instruments Entitys Obligation to Settle? Yes Equity-Settled No Equity-Settled Cash or other assets (including another group entitys equity instrument) Cash-Settled Equity-settled

Entity settling SBPT when another entity receives goods/services shall recognize transaction as an equity-settled SBPT only if its settled in entitys own instruments. - Otherwise recognize as cash-settled SBPT Scenario 1: Subsidiary employees granted rights to Subsidiarys equity instrument by either Subsidiary/Parent Subsidiary: Obligation: Yes Own Instrument: Yes - Equity Settled Parent Obligation: Yes?? Own Instrument: No - Cash Settled Consolidated: Equity settled Scenario 2A: ILLUSTRATION A1 Parent grants right to its own equity instrument to subsidiary employee Subsidiary Obligation: No Own Instrument: No - Equity Settled - Capital contri Parent Obligation: Yes Own Instrument: Yes - Equity Settled Consolidated: Equity Settled

Scenario 2B: ILLUSTRATION A2 Subsidiary grant rights to its parents equity instruments to its employees Subsidiary: Obligation: Yes Own Instrument: No - Cash Settled Parent: - No Entry Consolidated: Equity Settled Scenario 3: Involving cash-settled SBPT When parent obliged to pay cash to supplier/employees of subsidiary linked to: (a) Price of Subsidiary equity or (b) price of Parent equity

Illustration A1: Parent grants right to its instruments direct to subsidiary staff INT FRS 111: ESOP to be accounted for as equity settled for all books.
P approve plan that grants top 5 executives of Subsidiary ESO to purchase 200k shares each Exercise price: $5 per share Options granted on 1 Jan 20x1, vested on 31 Dec 20x3 Fair value of each option is $1.50 Dr 500k 500k 500k 500k 500k Cr 500k

Event S Books P Books Group F/S Consolidated adjustments

Staff Cost (1,500,000 /3) Capital Reserve Contribution from P Investment in S (1,500,000 /3) Capital Reserve ESOP Capital reserve Investment in S

As a result, in group statement: Staff cost increase by 500k, Capital reserve ESOP increase by 500k. - Effect similar to case where company issue own equity instrument to own employees (I.e. subsidiary employee as parents employee)

Illustration A2: Subsidiary grants rights to parents equity instrument to its staff INT FRS 111: Require subsidiary to account it as cash settled Require accounting of equity settled in consolidated statements No accounting entries in parents book
Subsidiary approve plan to grant top 5 executive right to purchase 200k each of parents share Exercise price: $5 Option granted on 1 Jan 20x1, vest on 31 Dec 20x2 ALL employees exercised option in Dec 20x3 when share price is at 6.40

1 Jan 20x1 31 Dec 20x1 31 Dec 20x2

Share Market Price $5 $5.90 $6.20

Fair value of Option $1 (For equity based payment, this dont change) $1.20 $130
Dr 600k 600k 600k 600k 500k 500k Cr

Event 31 Dec 20x1 - VESTING S Books Staff Cost (1.20 x 5 x 200k) x ~ liability reval Liability Grp Liability Statement Staff Cost (Reverse cash settled entry by subsidiary) Staff cost ($1 constant option value x 200k x 5) X Capital reserve ESOP (To record ESOP as equity settled) 31 Dec 20x2 - VESTING S Books Staff Cost (1.30 x 5 x 200k) x 2/2 600k Liability Liability revaluation less prior recognition Grp Statement Liability Staff cost Reverse cash settled entry by subsidiary Staff Cost ($1 constant value x 200k x 5) X 1 500k Capital Reserve ESOP For beg 20x2 Liability Beginning Retained Profit Beginning Capital reserve ESOP (Consolidation adjustments for 20x1!)

700k

700k

700k

700k

500K 600k

500k 100k 500k

31 Dec 20x3 REDEMPTION DATE S Books Staff Cost (1.30 x 5 x 200k) x 2/2 600k Liability (all liability emptied, all exercised) Cash (actual 6.40 initial share 5) x 5 x 200k Additional cost incurred as shares went up by 100k Group Treasury Shares

0.1m 1.3m

1.4m

100k

statement For beg 20x3

Staff cost (Reverse cash settled recognized by subsidiary) Treasury shares (700k + 600k) Staff Cost Beginning capital reserve (500k + 500k) (Consolidation adjustments for 20x1, 20x2, 20x3) Capital Reserve ESOP Staff Cost Treasury shares (Record exercise of ESOP and cancellation of treasury shares) 1.3m

100k

0.3m 1m

1m 0.4m

1.4m

Note: In subsequent years no future consolidation adjustments required, group incurred 1.4m in staff compensation, amount charged to group beginning RE. NO accounting entries required in parents book

Disclosure Page 953

EXTRA Miscellaneous: Company act amendments (2005) The reform of the share buyback regime Enabling of redemption of preference shares The introduction of the concept of treasury shares allow a company to hold re-purchased shares in treasury instead of cancelling them o Though treasury shares has no voting/dividend rights Miscellaneous: IRAS Tax Circular - Companies able to use treasury shares to fulfill ESO/Share awards - Firms that grants ESOs/Share awards through treasury shares accorded a tax deduction - Given equity-based remuneration that are effected through treasury shares involve companies incurring actual outlay in buying back own shares Outlay given tax deduction - For purpose of allowing deductions for treasury shares under ESO o Tax treatment not aligned w accounting treatment under FRS102 o Amount of deduction is based on amount firm actually incurred (i.e. diff btw cost to firm of acquiring treasury shares transferred to employee and amount paid by employee for treasury shares) Miscellaneous: Hagopian and boring professors with accountants Why ESO should be Why ESO should not be expensed (Hagopian) expensed (FASB) Share price dilution ESO Is a gain sharing instrument Has no accounting costs unless and until there is gain to be shared Cost of gain sharing instrument must be located on books of party that reap gain, shareholders reap the gain (in higher share price) hence cost of ESO borne by shareholders (i.e. share price dilution) Cost to shareholders already properly accounted for under the treasury stock method of accounting as a transfer of value from shareholders to employee option holders ESO Is a transferrable option, has tangible value once vested is a payment for employee service and should be expensed Neither granting nor vesting ESO meet standard accounting definition of expense Granting of ESO is not opportunity cost either. ESO is diff from transferable stock option with a call premium Hard to value ESO, due to liquidity and other issues

Miscellaneous: More boring professors arguing w Hagopian Why ESO should be expensed (Bodie, Kaplan, Mrton) 1. Fallacy that stock options do not represent real cost a. Transfer of value do not have to involve transfers of cash b. Issuing stock options to employees incurs a sacrifice of cash opp cost which needs to be accounted for. c. Seen as cash forgone by issuing options to employees rather than selling to investors opportunity cost d. Options use to offset cash company conserves by paying employees less part of remuneration package 2. Fallacy: Cost of employee stock options cannot be estimated a. Claim that employee stock options are private contrat, illiquid instruments that cant be sold, swapped or pledged, hence hard to value b. True that instrument lack of liquidity will reduce value to holder, but holder liquidity loss makes no diff to what it costs issuer to create instrument. Hence issuer should record! c. May use blackscholes model or variant of it to value, esp with current financial technology Though less precise than cash payouts/share grants but financial statements should be as representative as possible 3. Fallacy: Stock option cost are already adequately disclosed a. Fallacy that cost of option grants in footnotes to financial statements, investors/analysts may adjust income statements for cost of options and will have necessary data available in footnotes b. But, relegating such item of major economic significance as employee option grants in footnotes would systematically distort reports c. Esp when database and programmes calculate profitability ratios based on numbers in companies audited P&L/B/S. affect comparability, need for more faithful presentation d. Also, auditors and executives place lesser emphasis on footnotes than main figures, hence might miss out this significant item. 4. Fallacy: Expensing stock options will hurt young business a. Irony to point 3, as it current disclosure in footnotes is adequate for communicating economics of stock option grants, then moving cost from footnote to main balance sheet, income statement figures will have no market effect What will expensing involve? 1. Benefits accrue to firm from issuing stock options occur in future periods 2. Use a straight line amortization formula that will reduce management error/bias despite some loss of accuracy. i.e. Option that vests over period 3. Besides reporting issue of options as expenses in income statement, option grant should appear on balance sheet. Cost of options recognize in B/S at time of grant as paid in capital 4. Firm to revise income number they have reported should employees forfeit option and leave company

Extra Questions in Seminar Answer: A

Answer: A

Careful for exams!! Must check if FV can be measured: If can be reliably measured, dont use intrinsic value even if share prices for each period provided If cant be reliably measured, use intrinsic value but must remeasure every period