Understanding Share-Based Compensation: From Restricted Shares to Share Options and Beyond, Schemes and Mind Maps of Business

Download Understanding Share-Based Compensation: From Restricted Shares to Share Options and Beyond and more Schemes and Mind Maps Business in PDF only on Docsity! 19 - 1 SHARE-BASED COMPENSATION AND EARNINGS PER SHARE Chapter 19 © 2013 The McGraw-Hill Companies, Inc. 19 - 2 Share-Based Compensation Compensation: • Salary • Share awards Share Award Plans Restricted share plans • Usually tied to continuing employment, • Compensation is market price at date of grant, • Compensation expense accrued over service period. 19 - 3 Share Option Plans Share option plans give employees the option to buy (a) a specified number of shares of the firm's share, (b) at a specified exercise price, (c) during a specified period of time. The fair value is accrued as compensation expense over the service period for which participants receive the options, usually from the date of grant to when the options become exercisable (the vesting date). 1 2 3 19 - 2 19 - 4 Expense – The Great Debate Historically, options have been measured at their intrinsic value – the simple difference between the market price of the shares and the option price at which they can be acquired. If the market and exercise price are equal on the date of grant, no compensation expense is recognized even if the options provide executives with substantial income. 19 - 5 Current Requirements Things changed in November 2002 when the IASB issued its exposure draft ED 2 on Share-based Payment . (This was followed by the standard IFRS No. 2 in February 2004.) The release of ED 2 came in the aftermath of the accounting scandals and the “dot-com” crisis, and the shell-shocked market were more willing to accept a higher level of discipline with regards to disclosures on management compensation. Thus the requirement for companies to measure options at their fair values at the time they are granted and to expense that amount over the appropriate service period became required under both IFRS and U.S. GAAP 19 - 6 Measurement Objectives The accounting objective is to report the fair value of compensation expense during the period of service for which the compensation is given. The objective is to measure the fair value of the services rendered by the share option recipients. IFRS No. 2 assumes that, typically, it is not possible to measure directly the fair value of services rendered – especially by employees. Thus, an indirect measure is allowed. The fair value of the share option granted is deemed the fair value of the services rendered 4 5 6 19 - 5 19 - 13 Earnings Per Share (EPS) Of the myriad facts and figures generated by accountants, the single accounting number that is reported most frequently in the media and receives by far the most attention by investors and creditors is earnings per share. 19 - 14 Simple Capital Structure (Basic EPS) Basic Earnings Per Share Net income (after tax) – preference dividends* Weighted average outstanding ordinary share *Current period’s cumulative preference bonus issues (whether or not declared) and noncumulative preference bonus issues (only if declared). Number of shares outstanding × Number of months outstanding ÷ 12 Weighted average shares outstanding 19 - 15 Issuance of New Shares Compute the weighted average number of shares of ordinary share outstanding. Date Description No. of Shares 1/1 Balance 100,000 4/1 Issued 50,000 10/1 Issued 10,000 13 14 15 19 - 6 19 - 16 Issuance of New Shares Compute the weighted average number of shares of ordinary share outstanding. 100,000 + [50,000 × (9/12)] + [10,000 × (3/12)] = 140,000 Shares at Jan. 1 New Shares New Shares Annual Weighting Annual Weighting 19 - 17 Bonus Issues and Share Splits Ordinary shares issued as part of bonus issues (also known as share or stock dividends) and share splits are treated retroactively as subdivisions of the shares already outstanding at the date of the split or dividend. 19 - 18 Bonus Issues and Share Splits Compute the weighted average number of shares of ordinary share outstanding. Date Description No. of Shares 1/1 Balance 100,000 4/1 Issued 50,000 5/1 Stock dividend(100%) 150,000 16 17 18 19 - 7 19 - 19 Bonus Issues and Share Splits Compute the weighted-average number of shares of ordinary share outstanding. 100,000 × (2.00) + [50,000 × (9/12) × 2.00] = 275,000 Shares at Jan. 1 New Shares bonus issue adjustment Annual Weighting 19 - 20 Bonus Issues and Share Splits Retroactive treatment: Bonus issue or split is treated as outstanding from the beginning of the period. Bonus issue or split is applied retroactively in proportion to the number of shares outstanding at the time of the dividend or split. New shares issued this period? Yes No 19 - 21 Share Buy-Back If shares were reacquired during the period, the weighted-average number of shares is reduced. The number of reacquired shares is time-weighted for the fraction of the year they were not outstanding. 19 20 21 19 - 10 19 - 28 Options, Rights, and Warrants Determine new shares from assumed exercise of share options. Compute shares purchased for the treasury. Compute the incremental shares assumed outstanding. New shares from assumed exercise (1) Less: Treasury shares assumed purchased (2) Net increase in shares outstanding (3) 19 - 29 Options and Warrants When the exercise price exceeds the market price, the securities are antidilutive and are excluded from the calculation of diluted EPS. 19 - 30 Anti-Dilutive Securities The sequence in which we include a potential ordinary share matters. We have to include the most dilutive security first and stop at the point when the diluted EPS is at the lowest point. We rank the dilutive effects of each potential ordinary share by calculating their earnings per incremental share (EPIS). The EPIS is the after-tax earnings saved from the assumed conversion or exercise of the potential ordinary shares divided by the increase in number of ordinary shares. The higher the EPIS, the lower the dilutive impact When all the dilutive securities are included in the calculation of diluted EPS, at the same time, we may not arrive at a diluted EPS that is the lowest possible figure or the “worst case” EPS. 28 29 30 19 - 11 19 - 31 Anti-Dilutive Securities In-the-money” option or warrant is the most dilutive security among potential ordinary shares. Options or warrants may be relatively more dilutive than other potential ordinary shares, but there may be times when options or warrants may be anti- dilutive. For example when the options are" out-of- the-money". After applying the treasury stock method, there is a zero effect on the numerator and a positive effect on the denominator. 19 - 32 Convertible Securities The if-converted method is used for convertible debt and equity securities. The method assumes conversion occurs as of the beginning of the period or date of issuance, if later. 19 - 33 Convertible Securities The assumed conversion of convertible bonds or preference shares has two effects on dilutive earnings per share: increases the denominator by the number of ordinary shares issuable upon conversion, increases the numerator by decreasing after-tax interest expense on convertible bonds, and dividends on convertible preference shares. 31 32 33 19 - 12 19 - 34 Anti-Dilutive Securities For convertible securities (convertible bonds and convertible preference shares), we determine whether convertible securities are dilutive by comparing the “incremental effect” on EPS from the assumed conversion. If the incremental effect is higher than the basic EPS, then it is anti-dilutive. The incremental effect (of conversion) of the preference shares is the dividends that wouldn’t be paid divided by the additional ordinary shares from conversion. The incremental effect (of conversion) of the bonds is the after-tax interest saved divided by the additional ordinary shares from conversion. 19 - 35 Additional EPS Issues Contingent shares are issuable in the future for little or no cash consideration upon the satisfaction of certain conditions. Contingently issuable shares are considered to be outstanding in the computation of EPS if the target performance level already is being met. Contingently Issuable Shares 19 - 36 Contingently Issuable Shares Shares are issued merely due to passage of time. Some target performance level has already been met and is expected to continue to the end of the contingency period. Contingent shares are included in dilutive EPS if: Example: Additional shares may be issued based on future earnings. 34 35 36 19 - 15 19 - 43  The SARs are considered to be equity if the employer can elect to settle in shares; – Unless the employer has a present obligation to the employee to settle in cash, or unless the employee has a valid expectation to receive cash  The amount of compensation is estimated at the grant date as the fair value of the SARs.  This amount is expensed over the service period. Appendix 19B - Share Appreciation Rights Usually the same as the fair value of a share option with similar terms. 19 - 44 Share Appreciation Rights  The SARs are considered to be a liability if the employee has the right to receive cash upon settlement. In that case, the amount of compensation (and related liability) is estimated each period and continuously adjusted to reflect changes in the fair value of the SARs until the compensation is finally paid.  The current expense (and adjustment to the liability) is the fraction of the total compensation earned to date by recipients of the SARs (based on the elapsed percentage of the service period), reduced by any amounts expensed in prior periods.  The employer may have to recognize the expense immediately if the services have already been received 19 - 45 Share Appreciation Rights If the employee has a right to choose between cash and equity, the employer has effectively granted a compound financial instrument comprising of a liability and an equity component. The fair value of the compound financial instrument is the sum of the fair values of the two components. • The employer first measures the fair value of the debt component and then measures the fair value of the equity component. • In most cases, the employee or a supplier (who has the choice of settlement) will structure the two components to be of equal value, thus recognizing only a liability. 43 44 45 19 - 16 End of Chapter 19 46