On April 30, the FASB’s Small Business Advisory Committee (SBAC) met to discuss whether the Private Company Council (PCC) should add the topic of stock plan accounting to their agenda. I listened to the whole discussion–even the parts that were hard to hear–so I figure I’m due a blog entry out of it.
Background
Some of you may recall that, back in February of last year, I blogged about the FASB forming a special group to review whether exceptions or modifications for private companies should be made to GAAP (“A Different Standard for Private Companies,” February 7, 2012). At the time, the name of the group was the Private Company Standards Improvement Council. It’s not quite clear how we got from there to here (maybe FASB didn’t like the fact that everyone would probably pronounce the acronym “pic-sic”), but the PCC seems to be the current iteration of that group.
The SBAC provides a forum for the small business community to share ideas, experiences, etc. with the FASB. The PCC is considering taking up the topic of stock plan accounting–specifically, should the requirements of ASC 718 be modified for private companies or should private companies be exempt from some of the requirements–and asked the SBAC to discuss whether this is a big enough issue for small companies that they (the PCC) should add it to their agenda.
The SBAC Discussion
The FASB, in preparation for the meeting, and the committee did identify a number of concerns for private companies, including:
Valuation of underlying stock and valuation of options can both be difficult and costly.
The required disclosures may be onerous for private companies.
It can be difficult for private companies to interpret and apply the relevant accounting principles without help from paid advisors and there are probably lots of tedious rules that private companies aren’t aware of.
It can be difficult for private companies to determine whether awards are subject to equity or liability treatment due to various redemption provisions that are often utilized by them (e.g., rights of first refusal, repurchase rights, etc.).
The accounting implications of awards issued by private companies don’t really become relevant until a CIC and equity awards could be viewed as a cost to the ultimate buyer, rather than a cost to the issuing company.
Despite these concerns, I was surprised to note that the SBAC wasn’t terribly sympathetic to the idea of carving out some exceptions for private companies. The committee seemed skeptical of how widespread usage of stock compensation is among private companies. Some committee members supported the idea of further research into the level of usage; other members simply didn’t believe that enough private companies offered stock compensation to make the topic worthy of the PCC’s time. Also, some committee members felt that because offering stock compensation is optional, those private companies that offer it should be prepared to devote the resources necessary to account for it correctly.
Interestingly, the committee seemed most concerned about the disclosures. This was a surprise to me because I didn’t think private companies even bothered with the disclosures, given that their financial statements aren’t filed with the SEC. The committee spent so much time talking about the disclosures that I started to think maybe it was a separate agenda item (it wasn’t–I checked). They suggested that for both small public companies and private companies it would be helpful if FASB provided more assistance related to the disclosures, including possibly providing a checklist of annual vs. quarterly and public vs. private disclosures. Coincidentally, in preparing for my session, “Alphabet Soup: 10-K, 10-Q, S-K, Where Does Your Stock Plan Info Go? And Why Should You Care?,” Carrie, Elizabeth, and I had just been discussing the confusion over what information companies are supposed to include in their quarterly disclosures.
The recording of the SBAC meeting is no longer available, but you can access the meeting handouts, which include some of the feedback from SBAC members.
The topic du jour for my Google alerts for the past several days has been that companies are going to be enhancing their ESPPs in the next few years. A recent survey by Fidelity found that 51% of companies that offer an ESPP are planning on modifying their plan in the next two to three years, and 31% of those companies are planning on increasing the discount.
ESPPs: Better than Sliced Bread
For those of us that are strong proponents of ESPPs, this is welcome news. I think ESPPs are the best thing since sliced bread (and I say this as true carb lover) for a number of reasons:
Financial: ESPP expense is usually insignificant compared to stock option and full value award plans; on a per-share basis, even the most generous ESPP is usually cheaper than both an option or full value award; and ESPPs are never underwater, ensuring that a benefit is delivered to employees in exchange for the expense recognized by the company.
Shareholder Optics: The plans are minimally dilutive and rarely encounter shareholder opposition. And employees tend to hold shares acquired under the ESPP.
Employees: Right now, with interest rates at laughably low levels, ESPP make a great investment vehicle for employees. There is no other vehicle with the same low risk where you can earn a 17.6% return in, say, six months.
This is a win-win-win for everyone: employees, shareholders, and the company. The preferential tax treatment is nice too.
Decline in Benefits
But, despite these benefits, we have seen an erosion in ESPPs since ASC 718 went into effect. In the NASPP’s 2011 Stock Plan Administration Survey (co-sponsored by Deloitte):
The percentage of respondents offering ESPPs was 52%, down from 64% in 2004 (the last survey before ASC 718 went into effect).
Of those respondents with an ESPP, the percentage offering a 15% discount was 71%, down from 87% in 2004.
Lookbacks fared even worse: only 62% of respondents in 2011 offer a lookback, down from 82% in 2004.
And offering periods got shorter: in 2004, 43% of respondents offered a 12 or 24 month offering period. In 2011, that percentage dropped to 20%.
Where Do You Stand?
So I’m very excited to see Fidelity’s press release stating that companies are reinvigorating their ESPPs. I look forward to a day when all NASPP members proudly offer the most generous ESPP. For now, I’m curious–where does your company stand:
One of the most common types of “unplanned” modifications I see in my consulting work, which we will cover in our presentation, is that of vesting modifications.
The text of the ASC 718 standard says this about modification accounting: Modifications of Awards of Equity Instruments
51. A modification of the terms or conditions of an equity award shall be treated as an exchange of the original award for a new award. …In substance, the entity repurchases the original instrument by issuing a new instrument of equal or greater value, incurring additional compensation cost for any incremental value. The effects of a modification shall be measured as follows:
a. Incremental compensation cost shall be measured as the excess, if any, of the fair value of the modified award determined in accordance with the provisions of this Statement over the fair value of the original award immediately before its terms are modified, measured based on the share price and other pertinent factors at that date. … b. Total recognized compensation cost for an equity award shall at least equal the fair value of the award at the grant date unless at the date of the modification the performance or service conditions of the original award are not expected to be satisfied. Thus, the total compensation cost measured at the date of a modification shall be (1) the portion of the grant-date fair value of the original award for which the requisite service is expected to be rendered (or has already been rendered) at that date plus (2) the incremental cost resulting from the modification.
But then the examples in ASC 718-20-55-111 through ASC 718-20-55-118 go on to delineate four, count them four, different types of vesting modifications, with two different treatments:
Type I: Probable to Probable: Recognize fair value of original award + incremental expense, if any.
Type II: Probable to Improbable: Recognize fair value of original award + incremental expense, if any.
Type III: Improbable to Probable: New fair value only. Reverse expense for any unvested shares.
Type IV: Improbable to Improbable: New fair value only. Reverse expense for any unvested shares.
Type II and Type IV are incredibly uncommon, but we DO see a good number of Type I and Type III. Type I are often triggered by option exchanges, or any modification to already vested shares, like an extension of exercise grace period at termination. Type III modifications are also quite common at the time of termination when unvested shares are accelerated.
How do you handle the modifications? First, decide if they are Type I or Type III. If the shares are vested, chances are good you are dealing with a Type I. If the shares would have been cancelled if not for the termination, then chances are good you have a Type III. If a Type I, perform two fair value calculations: one before the change, and one after, and compare the expense to determine your incremental expense. If a Type III, you need only one fair value calculation, using the attributes of the grant after the modification. Calculate how much expense has already been booked for the unvested shares in the grant and true up (or down) to the new fair value.
There is good news about most modifications, especially those at the time of termination: they are generally fairly simple one-time calculations where all the expense is booked immediately. Once and done. The bad news is that most systems have limited support for modification accounting and the inputs can be quite tricky. What is the expected term of an underwater option before it is exchanged for a new option? Is it the remaining expected term from the original grant date fair value? The remaining contractual life? An expected term calculated by a Monte Carlo simulation? Each company must decide for itself. A few examples in the standard seem to point to remaining contractual term, but the Monte Carlo simulation approach seems to fly past audit as well. No two audit firms, or audit partners, seem to have the same opinions.
Join me and my talented co-panelists in New Orleans as we wrestle modification accounting to the ground and give you a solid understanding of the required treatment and some varying interpretations. Laissez Les Bon Temps Roulez!
With the impending Facebook IPO crowding out just about any other news in my Google alert these days, I’ve got private companies on my mind. I don’t have anything to add on the Facebook IPO, but there has been an interesting development recently relating to accounting standards for private companies.
Debate Rages Over Private Company Accounting There is apparently a heated debate in the accounting community (specifically between the Financial Accounting Foundation, which oversees the FASB, and the American Institute of Certified Public Accountants) over whether the FASB should have oversight of accounting standards for private companies. So much so that the AICPA put together the Blue-Ribbon Panel on Standard Setting for Private Companies (is that the BRPSSPC? what exactly is a blue-ribbon panel, anyway? I thought it was something related to 4H or maybe beer…) to evaluate the matter and make recommendations. In response to the panel’s recommendations, the FAF has proposed creating the Private Company Standards Improvement Council, which would review current US GAAP to determine whether exceptions or modifications should be made for private companies.
Any suggestions made by the PCSIC (is that pronounced “pic-sic”?) would be subject to approval by the FASB. The problem with this, however, is that the Blue-Ribbon Panel recommended creating a completely separate, independent entity that wouldn’t be beholden to the FASB. The AICPA seems to be vehemently opposed to any approach where the FASB still has authority over the standards for private companies, and has threatened to take their toys and go home to create their own standards setting authority if the FAF proceeds with its proposal. (See “AICPA Turns Up Volume on Call for Independent Board,” Matthew Lamoreaux, Journal of Accountancy, October 18, 2011.)
I have no idea what this might mean for how private companies account for stock compensation, but I can definitely think of a few things I’d like to change about ASC 718 if I were a private company. (Ok, heck, I can think of some things I’d like to change even if I were a public company. In fact, let’s just scrap the whole standard.) It does surprise me that when the rest of the world seems to be focused on convergence, we are actually considering bifurcating our accounting standards here in the U.S. Kind of seems like the wrong direction…
Why Can’t Public Companies Do This?
Now, I imagine some of you that work for public companies are thinking: “Hey! Wait a minute here. If private companies can ignore the FASB and create their own standards setting organization, why can’t we?” Private companies can do this because, for the most part, their financial statements aren’t filed with the SEC, which requires the statements to be prepared in accordance with GAAP as determined by the FASB. Since private companies don’t file their financial statements with the SEC, they don’t have to follow the SEC’s rules (at least with respect to financial statements–there are other securities laws they still have to comply with, more on this in a future blog). And, other than the authority vested in FASB by the SEC, there’s no law that says that FASB is the supreme ruler of GAAP. So private companies can do whatever they want with their financial statements, so long as any investors and lenders that might want to review their financials are willing to accept them. Public companies, however, are still stuck with the FASB, unless you can somehow convince the SEC to let you do what you want, too. Good luck with that.
NASPP “To Do” List We have so much going on here at the NASPP that it can be hard to keep track of it all, so I keep an ongoing “to do” list for you here in my blog.
Last week, I compared Apple and Google’s stock compensation expenses and determined that Google’s expense is significantly higher because Google’s grants have historically been for greater amounts of fair value. This week I look at the underlying question of why Google is granting more value (and, thus, presumably more compensation) to its employees.
Apple and Google: The Real Question All other things being equal, both companies are competing for the same talent pool, in the same area of the country, and should presumably be granting about the same amount of fair value. In fact, because Google has about half as many employees as Apple, you might expect Google to be granting awards for about half as much aggregate fair value as Apple, not almost twice as much fair value, as has been the case in some years.
Mitigating Circumstances
Of course, it’s not that simple. I’m sure part of the problem is perceived value. From a fair value standpoint, the higher the stock price, the more value an option has (both companies grant a combination of options and stock). But employee’s tend to assign a lower value to options with a higher exercise price. So while Google’s skyrocketing stock price (averaging about 2.4 times higher than Apple’s over the four years of grants that I compared) has also caused their stock plan expense to skyrocket, that hasn’t translated into higher perceived value for employees. In fact, the reverse is true. So Google has likely had to grant a disproportionately high number of shares for its employees to assign the same value to their option grants as Apple’s employees do. This is one of the inefficiencies of stock options.
Another consideration may be other compensation programs that each company offers. A response to the blog I referenced last week noted that Apple has an ESPP but Google doesn’t. (Wait–what? Google doesn’t have an ESPP? How in the heck can that be? It’s true though, their 10-K makes no mention of an ESPP.) Because Apple has an ESPP, which, in my opinion, has a high perceived value in comparison to fair value (especially in Silicon Valley), they may be able to make smaller awards to employees. Apple’s ESPP increases its stock plan expense, however, so this clearly isn’t the whole story. But Apple may offer other benefits–bigger cash bonuses, work-life programs, etc.– that aren’t included in their stock plan expense and that offset the smaller awards to employees.
And, although we think of these companies as being located in Silicon Valley, they are both large organizations with offices and employees in many locations. Apple, for example, has main campuses in Austin, Singapore, and Ireland, in addition to Silicon Valley. Having offices outside of the valley may impact Apple’s compensation structure.
The Real Reason
Finally, however, I suspect that the real reason Google is recognizing more expense for their stock plan can be found in the Beneficial Ownership of Management Table in the proxy statements of the two companies. As a group, Apple’s executives and directors control less than 1% of Apple’s outstanding common stock. Google’s executives and directors as a group control 69% of the votes on Google’s stock. In fact, the two founders together control close to 58% of the votes.
The amount of votes that Google management controls means that Google gets to do things with its stock plan that Apple’s shareholders probably won’t stand for, including offer a one-for-one option exchange and grant awards for greater value year after year. Google doesn’t care about burn rates and overhang: they aren’t worried about getting approval for their next allocation of shares to their plan (or their Say-on-Pay proposal)–they already have the votes they need.
Paid Out?
It’s interesting to me that the blogger characterized the stock plan expense as amounts that were “paid out”: “On last week’s Google (GOOG) earnings call, CFO, Patrick Pichette revealed that Google paid out [emphasis added] $384 million in stock-based compensation in the June quarter.” He makes a similar statement regarding Apple.
I didn’t listen to the earnings calls, but I’d be surprised if the companies characterized this as a pay-out. When I first read the blog, I thought maybe he was referring to the intrinsic value realized upon exercise of options, and not stock compensation expense, but Google employees only realized $86 million in intrinsic value on their option exercises (and an undisclosed amount, but less than $4 million, on sales of options in Google’s TSO program), so this isn’t the case.
I suspect this is a common misperception in the media and I wonder if the blogger understands that the expense Google and Apple recognized has no relation whatsoever to the amounts employees are actually realizing on their stock compensation.
NASPP Conference Hotel is Filling Up Don’t wait any longer to make your hotel reservations for the 19th Annual NASPP Conference–the Conference hotel is quickly filling up. The Conference will be held from November 1-4 in San Francisco; register today and make your hotel reservations before it’s too late!
NASPP “To Do” List We have so much going on here at the NASPP that it can be hard to keep track of it all, so I keep an ongoing “to do” list for you here in my blog.
Don’t miss your local NASPP chapter meetings in Michigan, Phoenix, and San Diego. Robyn Shutak, the NASPP’s Education Director, will be at the San Diego meeting and both Robyn and I will be at the Phoenix meeting. We hope to see you there!
Indecent Disclosures: Polishing and Perfecting Disclosures under ASC 718 By Elizabeth Dodge, Stock & Option Solutions
Disclosures under ASC 718 are a dreaded topic for nearly all my clients. The standard is unclear in some areas and flouts common sense in others, so what is a company to do? The answer? Do your best and try not to sweat the small stuff, unless your auditors force you to do so. In this entry, I’ll review one confusing part of the standard relating to disclosures and suggest ‘the right’ approach to take.
What Are “Shares of Nonvested Stock”?
In FAS 123(R), pre-codification, paragraph 240(b)(2) required the disclosure of:
The number and weighted-average grant date fair value…of equity instruments not specified in paragraph A240(b)(1) (for example, shares of nonvested stock), for each of the following groups of equity instruments: (a) those nonvested at the beginning of the year, (b) those nonvested at the end of the year, and those (c) granted, (d) vested, or (e) forfeited during the year. [emphasis added]
Paragraph 240(b)(1) asked for the number and weighted-average exercise price of options (or share units) outstanding. So what the standard seemed to require in the paragragh I quote above is the number and grant-date fair value for instruments other than options and share units, such as “shares of nonvested stock.” Clear as mud, so far? What is a share of nonvested stock, you ask? See footnote 11 on page 7 of the standard which reads:
Nonvested shares granted to employees usually are referred to as restricted shares, but this Statement reserves that term for fully vested and outstanding shares whose sale is contractually or governmentally prohibited for a specified period of time.
As if the standard wasn’t complicated enough, the FASB needed to define their own terms and use terms we thought we understood to refer to something else. Great idea. So a share of nonvested stock is therefore a restricted stock award (not a unit, but the kind of award on which you can file a Section 83(b) election). Here the FASB is lumping options and units (RSUs) together and separating out RSAs into a separate category. Perfectly logical, because RSUs are much more like options than RSAs, wouldn’t you agree? (And if you’re not getting the depth of my sarcasm, try re-reading the text above.)
Okay. So what do we use for weighted average exercise price for an RSU? Most RSUs that I’ve encountered don’t have an exercise price (and in fact, aren’t even exercised!). So obviously you should report zero here?
And most audit partners are unfamiliar with this issue all together. The good news is that most of them seem to ignore the actual language of the standard and, instead, require the same disclosures for RSUs and RSAs, which honestly does make a lot more sense, but isn’t what the standard calls for.
Unfortunately many systems/software providers were reading the standard carefully when they designed their disclosure reports, so often the RSU disclosures have “exercise price” but lack grant date fair value, so you’re often forced to calculate some of these numbers manually.
So now you’re thinking, but the Codification cleared all this confusion right up, didn’t it? Well, no… it did change the language just slightly. It removed “(for example, shares of nonvested stock).” It also added a link to the definition of “Share Units,” which reads: “A contract under which the holder has the right to convert each unit into a specified number of shares of the issuing entity.” Sounds like an RSU to me.
So where does all this leave us? My conclusion: Listen to your auditor, follow their guidance, which may not follow the standard to the letter, but makes more sense. Other folks are unlikely to notice the issue in the first place, but your auditors will.
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A few weeks ago, the following headline showed up in one of my Google alerts: “Why Did Google Pay Nearly Twice In Stock-Based Comp than Apple last Quarter?” I like to think of myself as being pretty smart about stock plan accounting, so this seemed like a question I ought to be able to answer. Today, I take it on.
Apple to Google: Stock-Based Compensation As noted in the story, both companies are Silicon Valley high-tech companies, competing for a lot of the same talent pool against a lot of the same companies, so you’d expect them to have similar compensation strategies. Digging a little further into their Forms 10-K, I was able to determine that they both grant a mix of stock options and RSUs. Apple has some RSUs that vest in as few as two years and Google has some RSUs that have some sort of cliff vesting that I couldn’t figure out from their disclosures, but other than those minor differences, their options and awards vest over four years. In addition, both companies recognize expense on a straight-line basis, so monthly versus annual vesting wouldn’t account for a difference in the expense they recognize. (Google has options that vest monthly; Apple’s options vest annually, bi-annually, or quarterly. Google appears to have at least some RSUs that vest annually, I couldn’t figure this out for Apple).
Apple’s stock plan expense for their quarter ending on June 25, 2011 was $284 million. Google’s stock plan expense for essentially the same quarter was $435 million.
Is it Google’s Exchange Program?
At first I thought maybe the difference was due to Google’s option exchange program. In March 2009, Google completed an option exchange program that was notable in that 1) it was a one-for-one exchange, which is virturally unheard of these days and 2) they allowed options that were barely underwater to be included in the exchange, rather than including only those options that had exercise prices in excess of their 52-week high. The incremental expense for a one-for-one exchange that included somewhere around 50% of their outstanding options seemed like a good candidate to explain the difference in expense.
But I don’t think this is it. The exchange resulted in a charge of $360 million, of which $189 million has already been recognized and the rest ($171 million) will be recognized over another three or so years. This could account for some of the difference, but I don’t think it is the whole story.
So What Is the Difference?
I think it just comes down to the fact that Google has been making grants for more value in the past few years than Apple. This is probably in part due to the fact that Apple’s average stock price for the past four years is around $210 per share and Google’s average stock price for this same period is around $510 per share. Where grants are based on a percentage of compensation or some other monetary amount, a higher stock price theoretically means that the company will grant options and awards for fewer shares. But, given differences in compensation philosophies between companies, I’m not sure that this will be true when comparing, say, Apple to Google.
In other words, if Apple’s stock price were to double from one year to the next, I would expect that the number of shares they grant might decrease commensurately. But just because Apple’s stock price is less than half Google’s price doesn’t necessarily mean that they are granting a commensurately greater number of shares than Google. There are just too many other factors at play in compensation decisions.
And, in fact, the total fair value of Google’s grants (both options and RSUs) for their 2010 fiscal year was somewhere around $2.4 billion, whereas the total fair value of Apple’s grants for the same period was somewhere around $1.3 billion. For their 2009 fiscal years, there is a similar discrepancy: $1.6 billion in fair value for Googe’s grants and .9 billion in fair value for Apple’s grants. Interestingly, for 2008, the companies granted about the same amount of fair value. but for the 2007 year, the aggregate fair value of Google’s grants was $1.8 billion to $.6 billion for Apple.
BTW: 1) Note that I am backing into the aggregate fair value per year numbers by multiplying the shares granted by the weighted average fair value for grants during the year. 2) Kudos to Apple for voluntarily including three years in their stock plan activity roll-forward, so that I didn’t have to pull up each 10-K separately to get their grant amounts for all three years.
With vesting schedules–and, consequently, service periods–of four years, both Google and Apple’s current expense includes the fair value of grants made in prior years, going all the way back to 2007. Because Google has historically issued awards with a greater aggregate fair value than Apple, they are now recognizing more expense for those awards (plus they have some additional cost as a result of the option exchange program).
Tune in Next Week
This perhaps explains the difference in the current period expense, but it doesn’t explain why Google is granting awards for significantly more fair value than Apple, especially given that as of their most recent Forms 10-K, Google has only 24,400 employee compared to Apple’s 46,600 employees. Tune in next week when I discuss this question.
NASPP “To Do” List We have so much going on here at the NASPP that it can be hard to keep track of it all, so I keep an ongoing “to do” list for you here in my blog.