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ASC generally requires that the fair value as defined in ASC of stock-based compensation be determined on the date of grant and recorded as an expense over the vesting period of the award. There are many types of stock-based compensation, but some of the arrangements that are seen most commonly in practice are summarized below: If stock options are being issued, however, there are actually two steps that need to be undertaken: Unless the option is properly valued, a company cannot correctly record the associated compensation expense, which may lead to difficulties during its year-end financial statement audit.
Given the complexity of ASCit is a best practice for companies to get out in front of the accounting for stock-based compensation before their year-end audit begins. Proactively addressing these issues can lead to a much smoother audit process and avoid potential delays that may be encountered otherwise.
ASC provides guidance on a number of topics encountered in accounting for stock-based compensation. Some of the more common issues encountered in accounting for stock options, stock grants and other stock-based compensation arrangements are summarized below: Awards to employees vs.
There are six inputs in the Black-Scholes model that drive the resultant stock option value: Stock Price — The stock price is the per share fair value including any applicable discounts for lack of control and lack of marketability of the stock class into which the option is convertible.
For privately-held companies, this is often the most difficult input to reliably support in the Black-Scholes model and the assistance of a valuation expert is often required to determine the value per share.
The AICPA has issued extensive guidance on the factors that should be considered when valuing shares in privately-held companies for stock-based compensation purposes.
Exercise Price of Option — The exercise price is the amount that the option holder must pay in order to receive a share of stock when exercising an option. The exercise price will be identified in the stock option agreements.
Option Term — The option term is the length of time that the option holder has to exercise the option. The maximum term of the option will be disclosed in the option agreements, but that is often not used as the term in the Black-Scholes model. Instead, companies must look to the length of time that previously-issued options were outstanding before being exercised.
Since detailed option exercise histories are not available for many companies, an alternative approach often used to arrive at a term for the Black-Scholes model is based on the following formula from SAB Volatilities for privately-held companies are typically based on the historical volatilities of similar guideline public companies over a period of time consistent with the option term used in the Black-Scholes model.
Risk-Free Rate of Return — This is the rate of return associated with risk-free investments — typically U. Treasuries — which can be found on the U.
Treasury maturity that is used should be consistent with the option term used in the Black-Scholes model. Dividend Rate — The dividend rate is the rate of expected future dividends expressed as a percentage of total equity value.
The higher the level of dividends, the lower the option value since the option holder does not receive any dividends and vice versa.
The dividend rate is oftentimes estimated to be zero for privately-held companies without histories of paying dividends, particularly those with significant levels of debt or those that will require the reinvestment of profits to support future projected growth.
While the six Black-Scholes inputs are easily auditable, the key consideration for companies issuing options is to develop supportable assumptions that are consistent with the content of the option agreements and the financial position of the company issuing the options.
There can be significant tax ramifications if share-based compensation is not properly valued, particularly with stock options. If a company sets the stock option exercise price lower than the fair market value of the underlying stock on the grant date, the stock option could be deemed to be deferred compensation according to Internal Revenue Code A.
In addition, employers would be responsible for withholding income taxes for employees on these types of option grants, which if not done, could result in additional tax penalties.NMC is the automotive specialist that offers strategic and operational support to your business using a variety of cost-effective and flexible services such as mystery shopping, training, consultancy and auditing, for dealers and vehicle manufacturers in sales and after sales.
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