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Example SC 3-9 illustrates the accounting for a common liability-classified award. For the sake of simplicity, long-term versus short-term classification of balance sheet amounts is not considered; quarterly information is not presented; nor is any of the compensation cost subject to capitalization under other GAAP.
Refer to TX 17 for guidance on the tax-related aspects of the examples.
EXAMPLE SC 3-9
Cash-settled SARs with service and performance conditions
On January 1, 20X1, SC Corporation, a calendar year-end company, grants 100,000 cash-settled SARs with service and performance conditions to five vice presidents (20,000 SARs each). The cash-settled SARs will cliff vest if each vice president’s department achieves a cumulative revenue total of $3 million over a three-year period that ends on December 31, 20X3 and the vice president is still employed at that date (i.e., the SARs have a performance condition with a three-year requisite service period). Historical results lead management to believe that the targets will be achieved and that none of the vice presidents will cease working for SC Corporation before vesting. All five employees continue employment for the three-year requisite service period and achieve their targets for vesting in the SARs. SC Corporation’s common stock has a par value of $0.01 per share.
SC Corporation calculates cumulative compensation cost by taking the total number of SARs that it granted, multiplied by the percentage of the requisite service period that has been completed, multiplied by each SAR's fiscal year-end fair value. The cumulative compensation cost represents the ending liability balance of the outstanding SARs at the end of the fiscal year and expense is recognized or reversed each year to adjust the liability to the appropriate ending balance.
The following table summarizes the SARs activities. For simplicity, all SARs are assumed to be exercised at the beginning of the fiscal year.
(Abbreviations: O/S = Outstanding)
Fiscal year
Granted
SARs
O/S
Fair value per SAR at 12/31
% Requisite service provided
Ending liability balance
Annual compensation cost*
20X1
100,000
100,000
$12
33%
$400,000
$400,000
20X2
100,000
$14
67%
$933,333
$533,333
20X3
100,000
$17
100%
$1,700,000
$766,667
* Ending liability balance (i.e., the cumulative compensation cost) = the number of SARs outstanding × percentage of requisite service provided × the fair value per SAR at the end of the fiscal year. Annual compensation cost is the change in the liability balance during the year.
Fiscal year
SARs exercised
SARs
O/S
Fair value per SAR
Exercised SARs: cash settlement
Liability balance**
Annual compensation cost
At
1/1
At
12/31
20X4
60,000
40,000
$17
$21
$(1,020,000)
$840,000
$160,000
20X5
20,000
20,000
$21
$18
$(420,000)
$360,000
$(60,000)
20X6
20,000
$18
$(360,000)
$0
$0
** Liability balance is the beginning balance less cash payouts for exercised SARs of $1,020,000 (60,000 * $17), $420,000 (20,000 * $21), and $360,000 (20,000 * $18) in 20X4, 20X5, and 20X6, respectively, plus or minus changes in the stock price for SARs that remain outstanding of $160,000, ($30,000), and nil for 20X4, 20X5, and 20X6 respectively. Since the awards are fully vested, the ending liability for each year equals the number of SAR's outstanding at the end of each year multiplied by the fair value per SAR at the end of the year.
How should SC Corporation account for cash-settled SARs with service and performance conditions?
Analysis
SC Corporation records the following journal entries:
Dr. Compensation expense
$400,000
Cr. SBC liability
$400,000
To recognize compensation expense in 20X1 for the 20X1 award
Dr. Compensation expense
$533,333
Cr. SBC liability
$533,333
To recognize compensation expense in 20X2 for the 20X1 award
Dr. Compensation expense
$766,667
Cr. SBC liability
$766,667
To recognize compensation expense in 20X3 for the 20X1 awards
On January 1, 20X4, 60,000 SARs are exercised at a fair value of $17 per SAR, resulting in a cash payment of $1,020,000 (60,000 × $17).
Dr. SBC liability
$1,020,000
Cr. Cash
$1,020,000
To recognize exercise of 60,000 SARs at a fair value of $17 in 20X4
On December 31, 20X4, the fair value of each SAR is $21 for the 40,000 SARs that are outstanding. SC Corporation should recognize additional compensation expense for the $4 increase in the fair value.
Dr. Compensation expense
$160,000
Cr. SBC liability
$160,000
To recognize compensation expense in 20X4 for the 20X1 awards
On January 1, 20X5, 20,000 SARs are exercised at a fair value of $21 per SAR, resulting in a cash payment of $420,000 (20,000 × $21).
Dr. SBC liability
$420,000
Cr. Cash
$420,000
To recognize exercise of 20,000 SARs at a fair value of $21 in 20X5
On December 31, 20X5, the fair value of the 20,000 SARs that remain outstanding is $18 each. SC Corporation adjusts its compensation expense to reflect the $3 decrease in the fair value. Therefore, an adjustment of $60,000 reduces the SBC liability to $360,000.
Dr. SBC liability
$60,000
Cr. Compensation expense
$60,000
To adjust the SBC liability to its fair-value amount at the end of 20X5
On January 1, 20X6, the final 20,000 SARs are exercised at a fair value of $18 per SAR, resulting in a cash payment of $360,000 (20,000 × $18).
Dr. SBC liability
$360,000
Cr. Cash
$360,000
To recognize exercise of 20,000 SARs at a fair value of $18 in 20X6
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