Chapter Eighteen Employee Benefit Plans

Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

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Chapter EighteenChapter EighteenEmployee Benefit PlansEmployee Benefit Plans


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Postretirement Benefit Plan

Encompass all types of retiree health and Encompass all types of retiree health and welfare benefits including . . .welfare benefits including . . .

Medical coverage,Medical coverage, Dental coverage,Dental coverage, Life insurance,Life insurance, Group legal services, andGroup legal services, and Other benefits.Other benefits.


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Postretirement Health Benefits and Pension Benefits Compared

Pension Plan BenefitsPension Plan Benefits Usually based on Usually based on

years of service.years of service. Identical payments Identical payments

for same years of for same years of service.service.

Cost of plan usually Cost of plan usually paid by employer.paid by employer.

Vesting usually Vesting usually required.required.

Postretirement Health Postretirement Health BenefitsBenefits Typically unrelated Typically unrelated

to service.to service. Payments vary Payments vary

depending on medical depending on medical needs.needs.

Company and retiree Company and retiree share the costs.share the costs.

True vesting does not True vesting does not exist.exist.


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The Net Cost of Benefits

Estimated medicalEstimated medicalcosts in eachcosts in each

year of retirementyear of retirement

Estimated medicalEstimated medicalcosts in eachcosts in each

year of retirementyear of retirement

Estimated Estimated netnetcost of benefitscost of benefitsEstimated Estimated netnet

cost of benefitscost of benefits

RetireeRetireeshare ofshare of

costcost

RetireeRetireeshare ofshare of

costcost

MedicareMedicarepaymentspaymentsMedicareMedicarepaymentspayments

Less:Less:

Equals:Equals:


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The Net Cost of Benefits

Estimating postretirement health care benefits is Estimating postretirement health care benefits is like estimating pension benefits, but there are like estimating pension benefits, but there are

some additional assumptions required:some additional assumptions required: Current cost of providing health care benefits (per Current cost of providing health care benefits (per

capita claims cost).capita claims cost). Demographic characteristics of participants.Demographic characteristics of participants. Benefits provided by Medicare.Benefits provided by Medicare. Expected health care cost trend rate.Expected health care cost trend rate.

Estimating postretirement health care benefits is Estimating postretirement health care benefits is like estimating pension benefits, but there are like estimating pension benefits, but there are

some additional assumptions required:some additional assumptions required: Current cost of providing health care benefits (per Current cost of providing health care benefits (per

capita claims cost).capita claims cost). Demographic characteristics of participants.Demographic characteristics of participants. Benefits provided by Medicare.Benefits provided by Medicare. Expected health care cost trend rate.Expected health care cost trend rate.


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Postretirement Benefit Obligation

Accumulated (APBO)Accumulated (APBO)The portion of the EPBO The portion of the EPBO attributed to employee attributed to employee

service to date.service to date.

Accumulated (APBO)Accumulated (APBO)The portion of the EPBO The portion of the EPBO attributed to employee attributed to employee

service to date.service to date.

Expected (EPBO)Expected (EPBO)The actuary’s estimate of the total The actuary’s estimate of the total

postretirement benefits (at their postretirement benefits (at their discounted present value) expected discounted present value) expected to be received by plan participants.to be received by plan participants.

Expected (EPBO)Expected (EPBO)The actuary’s estimate of the total The actuary’s estimate of the total

postretirement benefits (at their postretirement benefits (at their discounted present value) expected discounted present value) expected to be received by plan participants.to be received by plan participants.


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Measuring the Obligation

On December 31, our actuary estimates that the On December 31, our actuary estimates that the present value of the expected benefit obligation for present value of the expected benefit obligation for your postretirement health care costs is $10,250. your postretirement health care costs is $10,250. You have worked for the company for 6 years and You have worked for the company for 6 years and

are expected to have 30 years of service at are expected to have 30 years of service at retirement. The actuary uses a 6% discount rate.retirement. The actuary uses a 6% discount rate.

Let’s calculate the APBO. Let’s calculate the APBO.

On December 31, our actuary estimates that the On December 31, our actuary estimates that the present value of the expected benefit obligation for present value of the expected benefit obligation for your postretirement health care costs is $10,250. your postretirement health care costs is $10,250. You have worked for the company for 6 years and You have worked for the company for 6 years and

are expected to have 30 years of service at are expected to have 30 years of service at retirement. The actuary uses a 6% discount rate.retirement. The actuary uses a 6% discount rate.

Let’s calculate the APBO. Let’s calculate the APBO.


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EPBOEPBO

FractionFractionattributed toattributed toservice toservice to

datedate

APBOAPBO×× ==

$10,250$10,250 663030 = $2,050= $2,050××

APBO at the beginning of the year.APBO at the beginning of the year.APBO at the beginning of the year.APBO at the beginning of the year.


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EPBOEPBOBeginningBeginning

of Yearof Year×× (1 + Discount Rate)(1 + Discount Rate) ==

EPBOEPBOEnd End

of Yearof Year

To calculate the APBO at the end of the year. To calculate the APBO at the end of the year. We start by determining the ending EPBO. We start by determining the ending EPBO.

$10,250 × 1.06 = $10,865$10,250 × 1.06 = $10,865

APBO End APBO End of Yearof Year$10,865$10,865 ××

77 3030 = $2,535= $2,535


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APBO may also be calculated like this:APBO may also be calculated like this:

The APBO increases because of interestThe APBO increases because of interestand the service fraction (service cost).and the service fraction (service cost).


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Attribution

The process of assigning the cost of The process of assigning the cost of benefits to the years during which those benefits to the years during which those

benefits are assumed to be earned by benefits are assumed to be earned by employees.employees.


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Postretirement Benefit Expense


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Interest accrues on the APBO as time passes.Interest accrues on the APBO as time passes.APBO at the beginning of the year times theAPBO at the beginning of the year times the

assumed discount rate equals the interest cost.assumed discount rate equals the interest cost.

Interest accrues on the APBO as time passes.Interest accrues on the APBO as time passes.APBO at the beginning of the year times theAPBO at the beginning of the year times the

assumed discount rate equals the interest cost.assumed discount rate equals the interest cost.


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Unlike pension plans, many postretirement benefitUnlike pension plans, many postretirement benefitplans are not funded currently. For funded plans, theplans are not funded currently. For funded plans, the

earnings on plan assets reduce postretirementearnings on plan assets reduce postretirementbenefit expense.benefit expense.

Unlike pension plans, many postretirement benefitUnlike pension plans, many postretirement benefitplans are not funded currently. For funded plans, theplans are not funded currently. For funded plans, the

earnings on plan assets reduce postretirementearnings on plan assets reduce postretirementbenefit expense.benefit expense.


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Delayed recognition of prior service cost is Delayed recognition of prior service cost is attributed to the service of active employeesattributed to the service of active employeesfrom the date of the amendment to the from the date of the amendment to the fullfull

eligibilityeligibility date date, not the expected retirement date., not the expected retirement date.

Delayed recognition of prior service cost is Delayed recognition of prior service cost is attributed to the service of active employeesattributed to the service of active employeesfrom the date of the amendment to the from the date of the amendment to the fullfull

eligibilityeligibility date date, not the expected retirement date., not the expected retirement date.


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The amount subject to amortization is the net gain or loss atThe amount subject to amortization is the net gain or loss atthe beginning of the year in excess of 10% of the APBO orthe beginning of the year in excess of 10% of the APBO or10% of the plan assets. The excess is amortized over the10% of the plan assets. The excess is amortized over the

average remaining service period of active employees.average remaining service period of active employees.

The amount subject to amortization is the net gain or loss atThe amount subject to amortization is the net gain or loss atthe beginning of the year in excess of 10% of the APBO orthe beginning of the year in excess of 10% of the APBO or10% of the plan assets. The excess is amortized over the10% of the plan assets. The excess is amortized over the

average remaining service period of active employees.average remaining service period of active employees.


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Amortize Net Losses or Gains

APBOReturn on

Plan Assets

Higher Than Expected Loss Gain

Lower Than Expected Gain Loss

APBOReturn on

Plan Assets

Higher Than Expected Loss Gain

Lower Than Expected Gain Loss


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Amortization of the transition amount is part of expense in theAmortization of the transition amount is part of expense in thecurrent period. For financial reporting, the amortization reducescurrent period. For financial reporting, the amortization reducescurrent earnings. For income tax purposes, income is reducedcurrent earnings. For income tax purposes, income is reduced

when actual payments are made. This creates a temporarywhen actual payments are made. This creates a temporarydifference between financial and taxable income.difference between financial and taxable income.

Amortization of the transition amount is part of expense in theAmortization of the transition amount is part of expense in thecurrent period. For financial reporting, the amortization reducescurrent period. For financial reporting, the amortization reducescurrent earnings. For income tax purposes, income is reducedcurrent earnings. For income tax purposes, income is reduced

when actual payments are made. This creates a temporarywhen actual payments are made. This creates a temporarydifference between financial and taxable income.difference between financial and taxable income.


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Amortization of Transition Amount

An employer may choose to recognize:An employer may choose to recognize:

The entire transition obligation immediately,The entire transition obligation immediately, oror

Amortize the transition obligation on a straight-Amortize the transition obligation on a straight-line basis over the plan participants’ future line basis over the plan participants’ future service periods (or 20 years if that is longer).service periods (or 20 years if that is longer).

An employer may choose to recognize:An employer may choose to recognize:

The entire transition obligation immediately,The entire transition obligation immediately, oror

Amortize the transition obligation on a straight-Amortize the transition obligation on a straight-line basis over the plan participants’ future line basis over the plan participants’ future service periods (or 20 years if that is longer).service periods (or 20 years if that is longer).


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Determining the Expense

Recall our example of your postretirement benefits.Recall our example of your postretirement benefits.

Let’s calculate postretirement benefits expense.Let’s calculate postretirement benefits expense.


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Determining the Expense

The beginning APBO ($2,050) is the initial transition liability. The beginning APBO ($2,050) is the initial transition liability. Your service life is 24 years (30 - 6). The amortization amount Your service life is 24 years (30 - 6). The amortization amount

is is $85$85 rounded ($2,050 ÷ 24 years). rounded ($2,050 ÷ 24 years).

The beginning APBO ($2,050) is the initial transition liability. The beginning APBO ($2,050) is the initial transition liability. Your service life is 24 years (30 - 6). The amortization amount Your service life is 24 years (30 - 6). The amortization amount

is is $85$85 rounded ($2,050 ÷ 24 years). rounded ($2,050 ÷ 24 years).

Because most postretirement health plansBecause most postretirement health plansare not funded, there are no fund assets,are not funded, there are no fund assets,

no credit for prior service, and no net loss.no credit for prior service, and no net loss.

Because most postretirement health plansBecause most postretirement health plansare not funded, there are no fund assets,are not funded, there are no fund assets,

no credit for prior service, and no net loss.no credit for prior service, and no net loss.


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Required Disclosures

Changes in the APBO.Changes in the APBO. Changes in the plan assets (if any).Changes in the plan assets (if any). Net periodic postretirement benefit expense and its Net periodic postretirement benefit expense and its

components.components. Reconciliation of the funded status of the plan with Reconciliation of the funded status of the plan with

amounts reported in the balance.amounts reported in the balance. Weighted average discount rate, rate of Weighted average discount rate, rate of

compensation, and the expected long-term rate of compensation, and the expected long-term rate of return used to measure the postretirement benefit return used to measure the postretirement benefit obligation.obligation.

Changes in the APBO.Changes in the APBO. Changes in the plan assets (if any).Changes in the plan assets (if any). Net periodic postretirement benefit expense and its Net periodic postretirement benefit expense and its

components.components. Reconciliation of the funded status of the plan with Reconciliation of the funded status of the plan with

amounts reported in the balance.amounts reported in the balance. Weighted average discount rate, rate of Weighted average discount rate, rate of

compensation, and the expected long-term rate of compensation, and the expected long-term rate of return used to measure the postretirement benefit return used to measure the postretirement benefit obligation.obligation.


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Share-Based Compensation Plans

Now let’s look at some incentiveNow let’s look at some incentivecompensation plans.compensation plans.


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Stock Award Plans

Restricted stock award plans usually are Restricted stock award plans usually are tied to continued employment of the tied to continued employment of the

person receiving the award.person receiving the award. The compensation associated with a share The compensation associated with a share

of restricted stock is the market price at the of restricted stock is the market price at the grant date of an unrestricted share of the grant date of an unrestricted share of the same stock. same stock.

The amount is accrued as compensation The amount is accrued as compensation expense over the service period for which expense over the service period for which participants receive the shares.participants receive the shares.

Restricted stock award plans usually are Restricted stock award plans usually are tied to continued employment of the tied to continued employment of the

person receiving the award.person receiving the award. The compensation associated with a share The compensation associated with a share

of restricted stock is the market price at the of restricted stock is the market price at the grant date of an unrestricted share of the grant date of an unrestricted share of the same stock. same stock.

The amount is accrued as compensation The amount is accrued as compensation expense over the service period for which expense over the service period for which participants receive the shares.participants receive the shares.


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Stock Award Plans

On January 1, 2005, Matrix, Inc. awarded On January 1, 2005, Matrix, Inc. awarded 10,000 shares of its $2 par value common 10,000 shares of its $2 par value common stock to its CEO.stock to its CEO.

The shares will be forfeited if the CEO The shares will be forfeited if the CEO leaves within the next five years.leaves within the next five years.

On January 1, the common stock of Matrix On January 1, the common stock of Matrix is selling for $62 per share.is selling for $62 per share.

On January 1, 2005, Matrix, Inc. awarded On January 1, 2005, Matrix, Inc. awarded 10,000 shares of its $2 par value common 10,000 shares of its $2 par value common stock to its CEO.stock to its CEO.

The shares will be forfeited if the CEO The shares will be forfeited if the CEO leaves within the next five years.leaves within the next five years.

On January 1, the common stock of Matrix On January 1, the common stock of Matrix is selling for $62 per share.is selling for $62 per share.


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Stock Award Plans

No entry is required on January 1, 2005, but No entry is required on January 1, 2005, but total compensation is calculated as follows:total compensation is calculated as follows:

Number ofNumber ofShares issuableShares issuable

Fair valueFair valueper shareper share

TotalTotalCompensationCompensation==××

10,00010,000 ×× ==$62.00$62.00 $620,000$620,000

Compensation expense is measured on the Compensation expense is measured on the date of grantdate of grant..Subsequent changes in the market price of theSubsequent changes in the market price of the

stock do not impact compensation.stock do not impact compensation.

Compensation expense is measured on the Compensation expense is measured on the date of grantdate of grant..Subsequent changes in the market price of theSubsequent changes in the market price of the

stock do not impact compensation.stock do not impact compensation.


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Stock Award Plans

The total compensation of $620,000 will be recognized The total compensation of $620,000 will be recognized over the service period of 5 years.over the service period of 5 years.

On December 31, 2005, through 2009, we will prepare On December 31, 2005, through 2009, we will prepare the following journal entry:the following journal entry:

$620,000$620,000 ÷÷ 55 == $124,000 per year$124,000 per year

GENERAL JOURNAL

Date Description Debit Credit

Dec 31 Compensation expense 124,000 Paid-in capital - restricted stock 124,000


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Stock Award Plans

On December 31, 2009, the restrictions are lifted, On December 31, 2009, the restrictions are lifted, and the following entry will be made:and the following entry will be made:

GENERAL JOURNAL


Dec 31 Paid-in capital - restricted stock 620,000 Common stock (10,000 x $2) 20,000 Paid-in capital in excess of par 600,000


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Stock Option Plans

In most cases, employees are In most cases, employees are notnot awarded shares awarded shares of stock. Rather they are given an option to buy of stock. Rather they are given an option to buy

shares at some time in the future.shares at some time in the future.

Options are usually grantedOptions are usually granted for a specified number of shares,for a specified number of shares, at a specified price,at a specified price, during a specified period of time.during a specified period of time.

In most cases, employees are In most cases, employees are notnot awarded shares awarded shares of stock. Rather they are given an option to buy of stock. Rather they are given an option to buy

shares at some time in the future.shares at some time in the future.

Options are usually grantedOptions are usually granted for a specified number of shares,for a specified number of shares, at a specified price,at a specified price, during a specified period of time.during a specified period of time.


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Expense – The Great Debate

Historically, options have been measured at Historically, options have been measured at their intrinsic value – the simple difference their intrinsic value – the simple difference

between the market price of the shares and the between the market price of the shares and the option price at which they can be acquired. If option price at which they can be acquired. If

the market and exercise price are equal on the the market and exercise price are equal on the date of grant, no compensation expense is date of grant, no compensation expense is

recognized even if the options provide recognized even if the options provide executives with substantial income.executives with substantial income.

Historically, options have been measured at Historically, options have been measured at their intrinsic value – the simple difference their intrinsic value – the simple difference

between the market price of the shares and the between the market price of the shares and the option price at which they can be acquired. If option price at which they can be acquired. If

the market and exercise price are equal on the the market and exercise price are equal on the date of grant, no compensation expense is date of grant, no compensation expense is

recognized even if the options provide recognized even if the options provide executives with substantial income.executives with substantial income.


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Expense – The Great Debate

Critics to current practice have identified three Critics to current practice have identified three objections.objections.

Options with no intrinsic value at issue have zero Options with no intrinsic value at issue have zero fair value and should not give rise to expense fair value and should not give rise to expense recognition.recognition.

It is impossible to measure the fair value of It is impossible to measure the fair value of compensation on the date of grant.compensation on the date of grant.

Current practices have unacceptable economic Current practices have unacceptable economic consequences.consequences.

Critics to current practice have identified three Critics to current practice have identified three objections.objections.

Options with no intrinsic value at issue have zero Options with no intrinsic value at issue have zero fair value and should not give rise to expense fair value and should not give rise to expense recognition.recognition.

It is impossible to measure the fair value of It is impossible to measure the fair value of compensation on the date of grant.compensation on the date of grant.

Current practices have unacceptable economic Current practices have unacceptable economic consequences.consequences.


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Recognizing Fair Value of Options

Companies are encouraged, but not required, to estimateCompanies are encouraged, but not required, to estimatethe fair value of stock options on the grant date.the fair value of stock options on the grant date.

Companies are encouraged, but not required, to estimateCompanies are encouraged, but not required, to estimatethe fair value of stock options on the grant date.the fair value of stock options on the grant date.

This encouragement requires the use of an optionThis encouragement requires the use of an optionpricing model that deals with the:pricing model that deals with the:1.1. Exercise price of the option.Exercise price of the option.2. Expected term of the option.2. Expected term of the option.3. Current market price of the stock.3. Current market price of the stock.4. Expected dividends.4. Expected dividends.5. Expected risk-free rate of return.5. Expected risk-free rate of return.6. Expected volatility of the stock.6. Expected volatility of the stock.


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Stock Option Plans

On January 1, 2005, Matrix, Inc. grants options to On January 1, 2005, Matrix, Inc. grants options to purchase 100,000 shares of the company’s $1 purchase 100,000 shares of the company’s $1 par value common stock to four key executives. par value common stock to four key executives.

The options may be exercised during the next 10 The options may be exercised during the next 10 years, but not before December 31, 2009. The years, but not before December 31, 2009. The

exercise and market price of the stock on exercise and market price of the stock on January 1 is $57 per share. The fair value of the January 1 is $57 per share. The fair value of the

options, estimated using an options pricing model options, estimated using an options pricing model is $5 per option.is $5 per option.

On January 1, 2005, Matrix, Inc. grants options to On January 1, 2005, Matrix, Inc. grants options to purchase 100,000 shares of the company’s $1 purchase 100,000 shares of the company’s $1 par value common stock to four key executives. par value common stock to four key executives.

The options may be exercised during the next 10 The options may be exercised during the next 10 years, but not before December 31, 2009. The years, but not before December 31, 2009. The

exercise and market price of the stock on exercise and market price of the stock on January 1 is $57 per share. The fair value of the January 1 is $57 per share. The fair value of the

options, estimated using an options pricing model options, estimated using an options pricing model is $5 per option.is $5 per option.


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Stock Option Plans

January 1, 2005: Calculate total January 1, 2005: Calculate total compensation expense.compensation expense.

Shares per executive 100,000 Number of executives 4 Total shares 400,000 Compensation per share 5$ Total compensation 2,000,000$

Shares per executive 100,000 Number of executives 4 Total shares 400,000 Compensation per share 5$ Total compensation 2,000,000$

$2,000,000 $2,000,000 ÷ 5 years (2005 through 2009) = $400,000.÷ 5 years (2005 through 2009) = $400,000.


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Stock Option Plans

The following entry will be made on December The following entry will be made on December 31, 2005 through 2009, the service period.31, 2005 through 2009, the service period.

GENERAL JOURNAL


Dec 31 Compensation expense 400,000 Paid-in capital - stock options 400,000


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Stock Option Plans

On May 2, 2010, two executives exercise On May 2, 2010, two executives exercise their options when the market price of the their options when the market price of the

stock is $92 per share. stock is $92 per share. 200,000 shares × $57 per share = $11,400,000200,000 shares × $57 per share = $11,400,000

GENERAL JOURNAL


May 2 Cash 11,400,000Paid-in capital - stock options 1,000,000 Common stock ($1 par) 200,000 Paid in capital in excess of par 12,200,000


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Stock Option Plans

If no options were exercised during the If no options were exercised during the 10-year exercise period, the following entry 10-year exercise period, the following entry

would be made when the options expire:would be made when the options expire:

GENERAL JOURNAL


Dec 31 Paid-in capital - stock options 2,000,000 Paid-in capital - expired options 2,000,000


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Stock Option Plans and Taxes

For incentive plans . . .For incentive plans . . . The recipient pays no tax at the time of The recipient pays no tax at the time of

the grant or when the options are the grant or when the options are exercised.exercised.

Tax is paid on the difference between the Tax is paid on the difference between the market price and exercise price on the market price and exercise price on the date of subsequent sale.date of subsequent sale.

For incentive plans . . .For incentive plans . . . The recipient pays no tax at the time of The recipient pays no tax at the time of

the grant or when the options are the grant or when the options are exercised.exercised.

Tax is paid on the difference between the Tax is paid on the difference between the market price and exercise price on the market price and exercise price on the date of subsequent sale.date of subsequent sale.


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Intrinsic Value of Options

Many companies refuse to recognize the fair value of Many companies refuse to recognize the fair value of options. In this case, the value of options is options. In this case, the value of options is

measured at the grant date in an amount equal to the measured at the grant date in an amount equal to the intrinsic value, which is the difference between the intrinsic value, which is the difference between the market price of the shares and the exercise price at market price of the shares and the exercise price at

which they can be acquired.which they can be acquired.

Many companies refuse to recognize the fair value of Many companies refuse to recognize the fair value of options. In this case, the value of options is options. In this case, the value of options is

measured at the grant date in an amount equal to the measured at the grant date in an amount equal to the intrinsic value, which is the difference between the intrinsic value, which is the difference between the market price of the shares and the exercise price at market price of the shares and the exercise price at

which they can be acquired.which they can be acquired.

Market price at grant date 45.00$ Exercise price at grant date 38.50 Compensation per option 6.50$ Total shares issuable 200,000 Total compensation 1,300,000$

Market price at grant date 45.00$ Exercise price at grant date 38.50 Compensation per option 6.50$ Total shares issuable 200,000 Total compensation 1,300,000$


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Prior to 2002, only two companies—Boeing & Winn-Dixie—reported

stock option compensation expense at fair

value.

Reporting Update

2002

Public outrage in 2002 surrounding accounting scandals at Enron, WorldCom, Tyco and others pointed to the proliferation of stock options as a

primary form of compensation as a culprit in fueling greed.

The FASB issued an exposure draft in March 2004 that proposed a

standard that would require fair value accounting for employee stock options and eliminate the

intrinsic value approach.


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Performance Stock Option Plans

In some cases, option plans are structured so In some cases, option plans are structured so that the number of options received and/or the that the number of options received and/or the exercise price per share may be based on the exercise price per share may be based on the

occurrence of some future event.occurrence of some future event.

For example, the CEO may receive options to For example, the CEO may receive options to purchase 100,000 common shares at $10 per purchase 100,000 common shares at $10 per share only if the market price of the company’s share only if the market price of the company’s stock reaches $50 or more per share. This is stock reaches $50 or more per share. This is

known as a variable option plan.known as a variable option plan.

For example, the CEO may receive options to For example, the CEO may receive options to purchase 100,000 common shares at $10 per purchase 100,000 common shares at $10 per share only if the market price of the company’s share only if the market price of the company’s stock reaches $50 or more per share. This is stock reaches $50 or more per share. This is

known as a variable option plan.known as a variable option plan.


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Stock Appreciation Rights

The recipient is awarded the The recipient is awarded the share share appreciationappreciation which is the amount by which is the amount by

which the market price on the exercise which the market price on the exercise date exceeds the option price.date exceeds the option price.

$ $ $$ $ $


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Stock Appreciation Rights Payable in SharesStock Appreciation Rights Payable in Shares

Elective Fair Value ApproachElective Fair Value Approach: The fair value of : The fair value of the SARs is estimated at the date of grant and the SARs is estimated at the date of grant and accrued to expense over the service period.accrued to expense over the service period.

Alternative Intrinsic Value ApproachAlternative Intrinsic Value Approach: The : The compensation may be measured at the end of compensation may be measured at the end of the accounting period.the accounting period. (The FASB’s 2004 Exposure Draft (The FASB’s 2004 Exposure Draft eliminates this approach, except for nonpublic companies and public eliminates this approach, except for nonpublic companies and public companies for which fair value estimates are not reasonably possible.)companies for which fair value estimates are not reasonably possible.)

Stock Appreciation Rights Payable in SharesStock Appreciation Rights Payable in Shares

Elective Fair Value ApproachElective Fair Value Approach: The fair value of : The fair value of the SARs is estimated at the date of grant and the SARs is estimated at the date of grant and accrued to expense over the service period.accrued to expense over the service period.

Alternative Intrinsic Value ApproachAlternative Intrinsic Value Approach: The : The compensation may be measured at the end of compensation may be measured at the end of the accounting period.the accounting period. (The FASB’s 2004 Exposure Draft (The FASB’s 2004 Exposure Draft eliminates this approach, except for nonpublic companies and public eliminates this approach, except for nonpublic companies and public companies for which fair value estimates are not reasonably possible.)companies for which fair value estimates are not reasonably possible.)


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Stock Appreciation Rights Payable in Cash Stock Appreciation Rights Payable in Cash (Liability)(Liability)

The compensation, and related liability, The compensation, and related liability, is estimated each period and is estimated each period and

continually adjusted to reflect changes continually adjusted to reflect changes in the market price of stock until the in the market price of stock until the

compensation is finally paid.compensation is finally paid.

Stock Appreciation Rights Payable in Cash Stock Appreciation Rights Payable in Cash (Liability)(Liability)

The compensation, and related liability, The compensation, and related liability, is estimated each period and is estimated each period and

continually adjusted to reflect changes continually adjusted to reflect changes in the market price of stock until the in the market price of stock until the

compensation is finally paid.compensation is finally paid.

The FASB’s 2004 Exposure Draft changes the way we estimate total compensation. Rather than

basing the adjustment to the liability each year on the intrinsic value of the SARs, we would instead

estimate the fair value of the SARs using the pricing model. The procedure for allocating that

compensation is the same either way.


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Let’s see how to account for these SARs.Let’s see how to account for these SARs.

On January 1, 2005, Matrix, Inc. granted 10,000 On January 1, 2005, Matrix, Inc. granted 10,000 stock appreciation rights to 2 key executives. stock appreciation rights to 2 key executives.

Each is to receive cash for the difference between Each is to receive cash for the difference between a base price of $60 per share and the market a base price of $60 per share and the market

value of the stock on December 31 for each of the value of the stock on December 31 for each of the next 3 years. The first payment will be made on next 3 years. The first payment will be made on

December 31, 2006.December 31, 2006.

On January 1, 2005, Matrix, Inc. granted 10,000 On January 1, 2005, Matrix, Inc. granted 10,000 stock appreciation rights to 2 key executives. stock appreciation rights to 2 key executives.

Each is to receive cash for the difference between Each is to receive cash for the difference between a base price of $60 per share and the market a base price of $60 per share and the market

value of the stock on December 31 for each of the value of the stock on December 31 for each of the next 3 years. The first payment will be made on next 3 years. The first payment will be made on

December 31, 2006.December 31, 2006.


Slide18-46


On December 31, 2005, Matrix common On December 31, 2005, Matrix common shares closed at $64.50 per share.shares closed at $64.50 per share.

Let’s look at the entry to recognize the Let’s look at the entry to recognize the compensation expense for 2005.compensation expense for 2005.


Slide18-47

GENERAL JOURNAL


Dec 31 Compensation expense 30,000 Cash 30,000


$90,000 ÷ 3 years = $30,000$90,000 ÷ 3 years = $30,000

On December 31, 2005, Matrix common On December 31, 2005, Matrix common shares closed at $64.50 per share.shares closed at $64.50 per share.


Slide18-48

Stock Appreciation Rights On December 31, 2005, the stock closed at On December 31, 2005, the stock closed at

$75 per share.$75 per share.


Slide18-49


GENERAL JOURNAL


Dec 31 Compensation expense 180,000 Cash 180,000

On December 31, 2006, the stock closed at On December 31, 2006, the stock closed at $75 per share.$75 per share.


Slide18-50

Noncompensatory Plans

Broad-based plans offer stock options to all Broad-based plans offer stock options to all employees rather than a select few.employees rather than a select few.

No compensation involved if . . .No compensation involved if . . . All employees meeting employment qualifications All employees meeting employment qualifications

participate.participate. Equal offers of stock to all eligible employees.Equal offers of stock to all eligible employees. Exercise period is reasonable.Exercise period is reasonable. Only modest discount from the market price is Only modest discount from the market price is

available.available.

Broad-based plans offer stock options to all Broad-based plans offer stock options to all employees rather than a select few.employees rather than a select few.

No compensation involved if . . .No compensation involved if . . . All employees meeting employment qualifications All employees meeting employment qualifications

participate.participate. Equal offers of stock to all eligible employees.Equal offers of stock to all eligible employees. Exercise period is reasonable.Exercise period is reasonable. Only modest discount from the market price is Only modest discount from the market price is

available.available.


Slide18-51

Note: The intrinsic value approach would be eliminated by the FASB’s 2004 Exposure Draft.


Slide18-52

Note: The intrinsic value approach would be eliminated by the FASB’s 2004 Exposure Draft.


Slide18-53

Other Employee Compensation

Future paid absences should be accrued when:Future paid absences should be accrued when: The obligation is related to employee services The obligation is related to employee services

already performedalready performed,, The benefit The benefit vestsvests (is not contingent on future (is not contingent on future

employment) or employment) or accumulatesaccumulates (can be carried (can be carried forward to the next year),forward to the next year),

Payment is Payment is probableprobable, and, and The amount can be The amount can be reasonably estimatedreasonably estimated..

Future paid absences should be accrued when:Future paid absences should be accrued when: The obligation is related to employee services The obligation is related to employee services

already performedalready performed,, The benefit The benefit vestsvests (is not contingent on future (is not contingent on future

employment) or employment) or accumulatesaccumulates (can be carried (can be carried forward to the next year),forward to the next year),

Payment is Payment is probableprobable, and, and The amount can be The amount can be reasonably estimatedreasonably estimated..

Sick PayVacation


Slide18-54

End of Chapter 18

Chapter Eighteen Employee Benefit Plans

Documents

Transcript of Chapter Eighteen Employee Benefit Plans