Stock appreciation rights (SARs)are one of the many stock-based compensation plans offered by employers. SARs and other stock-based plans are accounted for under ASC 718 guidelines.
Let us discuss what are stock appreciation rights and their accounting treatment.
What are Stock Appreciation Rights (SARs)?
Stock appreciation rights (SARs) are one of the several stock-based compensation plans for employees. Employers offer these plans to motivate employees and improve their performances.
SARs are linked with the share prices of the employer entity’s shares. An employer often offers SARs when the share prices reach a certain point in a specified period. The share appreciation directly links with the company’s performance. Thus, the SAR becomes a motive for employees to perform well.
SARs offer certain benefits to both sides; employers and employees.
For employers, the biggest advantage is to offer compensation and reward plans to their employees. Employers can link these compensation programs with performance and other metrics such as achieving a certain share price.
Employees do not need to invest money to receive stock appreciation rights (SARs). They receive cash by simply exercising their rights upon eligibility.
How Do the Stock Appreciation Rights Work?
Essentially, an employer awards its employees in the form of share rights through an SAR program. The SAR plan is linked with certain performance conditions of employees. The employer can set other vesting conditions such as specific period, minimum share price appreciation, and the value of rights accordingly.
Employers issue stock appreciation rights with employee share options as well. Such arrangements are called tandem stock appreciation rights (SARs).
Most of the time, stock appreciation rights are settled in cash by an employer. However, an employer has the choice of issuing stocks as compensation to the vested rights as well.
Public entities must record the fair value of the share appreciation rights liability at the end of each accounting period. Non-public entities should also evaluate the fair value of the liability preferably. However, these entities can record the SAR liability using the intrinsic value of the stocks as well.
Depending on the employer’s choice, stock appreciation rights can be of two types.
Stand-alone SARs that are issued separately from other stock-based compensation plans.
Tandem SARs that are issued in conjunction with other stock-based compensation plans such as employee stock options (ESOs).
Accounting for Stock Appreciation Rights
The stock appreciation rights (SARs) are accounted for under ASC 718 generally. The accounting standard ASC 718 applies to most stock-based employee compensation plans.
Generally, ASC 718 would apply to all employee stock-based compensations when an entity:
- Issues stocks, stock options, or any other form of equity options plans
- Incurs a liability to pay an employee in cash that is based partly or fully on the price of the entity’s stock price
- Incurs a liability against services or goods received from employees that can be settled in the form of an entity’s stocks or equity instruments.
The stock-based compensation can be awarded to an employee or a non-employee of the entity. The entity must analyze the circumstances to account for the equity or stock-based compensation that falls under the scope of ASC 718.
Some common forms of stock compensation plans that fall under ASC 718 include the following.
- Stock Appreciation Rights – SARs
- Employee Stock Purchase Plans – ESPPs
- Employee Stock Options Plans – ESOPs
- Long-Term Incentive Plans
- Stock Options
- Restricted Stock and Restricted Stock Units
ASC 718 applies to public and non-public entities equally. However, non-public entities can use some alternative measurement and recognition options that do not apply to public entities.
ASC 718 defines a public entity as:
“(a) with equity securities that trade in a public market, which may be either a stock exchange (domestic or foreign) or an over-the-counter market, including securities quoted only locally or regionally, (b) that makes a filing with a regulatory agency in preparation for the sale of any class of equity securities in a public market, or (c) that is controlled by an entity covered by (a) or (b).”
Subsidiaries of a public entity also fall under the same definition of a public entity as defined above under ASC 718.
Definition of an Employee Under ASC 718
ASC 718 applies to employees and non-employees of an entity. An entity can define different employee categories and stock-based compensation plans including SARs to account for under ASC 718.
ASC 71810-20 defines an employee as someone over whom the grantor of the stock-based compensation exercises or has the right to exercise control that establishes an employee-employer relationship.
Apart from that definition, the stock-based compensation plans for the following categories also fall within the scope of ASC 718.
- Members of a Board of Director
- Leased or Part-Time Employees
- Employees of Pass-Through Entities and Subsidiaries
Vesting Conditions for Stock Appreciation Rights
Employers offer stock-based compensation plans to motivate employees and as performance bonuses. Generally, employers offer these plans against certain conditions to improve employee performance.
ASC 718 provides guidance on three types of vesting conditions that relate to the employee stock-based compensation plans including stock appreciation rights (SARs).
Market Conditions for a Stock-based Compensation Award
These are the awards that employers offer when certain market conditions are met. Stock appreciation rights are the most common example of such market conditions.
Employers offer stock option rights to employees as a performance bonus or reward. Employees receive compensation when stock prices appreciate above a certain price.
ASC 718 guides that:
“(a) a specified price of the issuer’s shares or a specified amount of intrinsic value indexed solely to the issuer’s shares or (b) a specified price of the issuer’s shares in terms of a similar (or index of similar) equity security”
An employer must account for a stock-based compensation even if the market condition is not fulfilled.
Performance and Service Conditions
Entities should not consider the performance condition to calculate the fair value of a stock-based award at the grant date. However, they should account for the estimation of forfeitures considering the service conditions when calculating the number of awards that will be vested.
An entity should include the compensation costs for such arrangements when it is probable that employees will vest the rights. In other words, when it is probable that performance or service conditions will be fulfilled by the employees.
For multiple performance outcomes, an entity must calculate the fair value of each outcome at the grant date.
Performance Conditions Satisfied After the Service Period
In some cases, an employer may put certain conditions for stock-based compensation plans that can be fulfilled after the service period of an employee.
For example, in stock appreciation rights, even when an employee has retired, the stocks prices may rise to fulfill the compensation plan criteria. Thus, the employee can be entitled to such compensation plans even after the completion of the normal service period.
An employer must account for the compensation plan costs over the service requisite period. An employer should not calculate the compensation costs at the grant date though.
Stock Appreciation Rights (SARs) Example
Suppose an entity issued a stock-based compensation for its employees. The compensation plan is categorized as a stock appreciation rights program that depends on the market share price of the entity.
Suppose the company has a total number of 10,000 employees and non-employees eligible for the stock appreciation rights plan.
We further assume that when the stock price hits the $40 mark, the stock appreciation rights plan conditions are fulfilled. The period is 3 years and the entity expects a forfeiture ratio of only 3%.
The fair value of the share appreciation right is calculated at $ 7 per share. Therefore, the expected vesting for three years will be:
10,000 × .97 ×.97 ×.97 = 9,127.
At the beginning of the first year, SARs will be valued as:
9,127 × 7 = $ 63,889
The SAR value at the end of first year will be:
$ 63,889 × 1/3 = $ 21,296
The journal entry for the first year will be:
|Stock Appreciation Rights Liability||$21,296|
Under ASC 718 requirements, the entity will assess the fair value of the SARs at the end of each accounting period.
Suppose the value of the SAR at the end of second year is $10 per right. Therefore, the SARs value and its corresponding liability value will be:
9,127 × $10 = $ 91,270 SARs liability = $ 91,270 × 2/3 = $ 60,846
The entity has recognized $ 21,296 so far, therefore the remaining value of the SARs liability will be
$ 60,846 – $ 21,296 = $ 39,550
Thus, the journal entry will be:
|Stock Appreciation Rights Liability||$39,550|
Suppose the value of rights falls to $8 for the third year. The fair value of the SARs liability and its cost can be calculated as:
9,127 × 8 = $ 73,016 The value of SARs liability will be the same as the amount is fully vested after three years.
Entity’s compensation cost for the third year is:
$ 73,016 – $ 39,550 – $ 21,296 = $ 12,170
Thus, the journal entry for the third year will be:
|Stock Appreciation Rights Liability||$12,170|