How come there is an adjustment to compensation expense for awards that awards that do not vest. If they do not vest I would assume no adjustment is neccessary. That’s the case for performance based awards.
Haven’t looked at FSA in forever, but it is probably becuase compensation expense was booked with the anticipation that the awareds would vest (not probability based). So if the don’t vest you have to make an adjustment to get back to what really happened. You are bringing your ex-ante guess to ex-post reality.
OKay that makes sense. When I here the phrase “true up” I think an upward adjustment but this can just as likely mean downward.
dancingqueen Wrote: ------------------------------------------------------- > OKay that makes sense. When I here the phrase > “true up” I think an upward adjustment but this > can just as likely mean downward. Yeah I think. I had this conversation with JDV awhile back concerning this same topic. I will look for the thread. Stay tuned…
dancin, Here is the thread I had on a similar line. Hope this helps. http://www.analystforum.com/phorums/read.php?12,674308,674459#msg-674459
That thread just confused me!
Oops.
What JDV was saying is (contrary to my first post) that the probability of the awards vesting was originally taken into account when the expense was booked. The “true-up” comes when the awards actually come to pass and you know for sure what your compensation expense SHOULD have been. To get it back to where it should have been you “true up”. This could be an upward or downward adjustment. That is my understanding.
Okay. I revisted this issue today and I think I have the answer (schweser 229). Compensation expense under 123® is based on the fair value of the option at the GRANT date. In order the find the fair value of the grant date a model is usually used. There are six inputs into the model: 1) Exercise Price 2) Stock price at the grant date 3) Expected term *(this is where the true up will come in…keep this in mind) 4) Expected volatility 5) Expected dividends 6) Risk-free rate Again, these six inputs are used to determine the fair value of the model. The EXPECTED term of the model is not the length of the option (contractual term). You must look at past exercise patterns and then estimate the likelihood of exercise and timing of exercise to determine the expected term. One acceptable method for determining the EXPECTED term is the simple method. In this method the expected term is equal to the average of the VESTING period and the original contractual term of the option. For example, a seven year option that vests over 5 years would be [(7+5)/2]= 6. Now if we back up and say the options fair value was $1,000 at the grant date, then you would book compensation expense in the amount of $200 (1000/5 year vesting) per year. So now here comes the answer to the question that you asked about. Let’s say that the employee leaves after only 4 years (instead of the full five years required to vest)? When the employee leaves after four years you have to go back to your model and adjust the expected term above. In this case it would be [(7+4)/2]=5.5. This means that compensation expense will not be $1,000 ($200/per year) but some lower number because of the lower expected term. It will always be a downward adjustment (at least in the simple model shown above), because the full vesting period is always used in the orignal expected term calculation (and you ever “over vest”). So there will be less compensation expense. You have to make this adjustment through the true up. This will only happens for option that have vesting schedules. Also remember that for options that expire worthless there is no adjustment to compensation expense. Edit: This contradicts what JDV said in the post I gave above, but this is how I understand it. Keep in mind that this is almost certainly way deeper than the exam will ask us to go. I just happened to be with a CPA today and we broke out the books and based the decision off what Schweser said. JDV’s opinion came straight from the horses mouth- FASB.