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Reporting reset – Stock-based compensation · PwC's accounting podcast

0:00
SPEAKER_00: Thought Leadership from PWC's National Office.
0:07
SPEAKER_01: Hello, and welcome to PWC's Accounting Podcast.
0:10
SPEAKER_01: I'm Heather Horn, and I'll be your host today.
0:13
SPEAKER_01: As our regular listeners know, in this series, we're making our way through the financial statements, talking all about presentation and disclosure.
0:22
SPEAKER_01: For today's episode, I'm excited to dive into compensation-related topics focusing on stock-based compensation.
0:31
SPEAKER_01: For this conversation, I'm joined by Ken Soler, a partner in PWC's national office who specializes in financial reporting and plan design issues related to equity compensation arrangements, retirement and healthcare plans, and other benefits.
0:46
SPEAKER_01: So, Ken, I know you have a lot of experience in this area, and I probably understated your expertise there, but welcome.
0:52
SPEAKER_01: It's very nice to have you on today.
0:53
SPEAKER_02: Thank you.
0:54
SPEAKER_02: Nice to be back.
0:54
SPEAKER_02: Excellent.
0:55
SPEAKER_01: All right.
0:55
SPEAKER_01: So, Ken, let's just kick things off.
0:57
SPEAKER_01: And just as again, as a reminder to listeners, we're really focusing in on some of the presentation and disclosure requirements today.
1:05
SPEAKER_01: Not as much about accounting, although maybe we'll straighten into that a teeny bit.
1:09
SPEAKER_01: But why don't we start off with some of the basic presentation requirements or issues as we look at the balance sheet?
1:15
SPEAKER_02: Right.
1:16
SPEAKER_02: So when we're first analyzing a stock comp award, one of the things we do is think about classification.
1:22
SPEAKER_02: Is it equity classified or is it liability classified?
1:26
SPEAKER_02: If it is liability classified, obviously it's going to be shown as a liability on the balance sheet.
1:31
SPEAKER_02: One of the things to consider then is should it be non-current or should it be current?
1:37
SPEAKER_02: So generally, I would say all of our stock comp liabilities are going to be non-current unless it is scheduled to vest and pay out in the next 12 months or operating cycle, in which case it would be current because we're going to have cash going out the door in the next 12 months.
1:55
SPEAKER_02: Or if we've got an instrument that the employee controls when the settlement is going to happen and it is already exercisable.
2:04
SPEAKER_02: So think a stock option that an employee holds, it's already vested.
2:09
SPEAKER_02: So now the employee can choose when to exercise.
2:12
SPEAKER_02: And when they do exercise, it's going to be settled in cash.
2:14
SPEAKER_02: That should be current as well.
2:17
SPEAKER_01: So before you move on to equity classification, then just to confirm, this current first non-current obviously applies to liability classified, not equity classified.
2:26
SPEAKER_01: But on the first point that it would move to current if it's payable on demand, that's fine.
2:32
SPEAKER_01: Or if vesting is expected to occur within a year.
2:35
SPEAKER_01: So that means you actually are having to update the classification on a regular basis.
2:40
SPEAKER_01: And my guess is people do not always get this exactly right.
2:44
SPEAKER_02: Well, we we hope people are monitoring it in that way.
2:47
SPEAKER_02: And yes, that is what we would expect to happen is that over the life cycle of the instrument, it will start as non-current.
2:54
SPEAKER_02: And then at some point along the way, now that it is going to be settlable within the next 12 months, it would flip over into current.
3:01
SPEAKER_02: And that is probably one of the things that companies should make sure they've got control over so that they're getting it right.
3:05
SPEAKER_01: Yes, excellent controls in that area.
3:07
SPEAKER_01: All right, then let's move on then to the equity classification.
3:09
SPEAKER_01: Yeah.
3:10
SPEAKER_02: So as you point out, we don't have to worry about current versus non-current when we're dealing with equity.
3:16
SPEAKER_02: Uh, and by the way, as listeners would probably expect, uh, we're equity classified much more of the time than we are liability classified when we're dealing with stock comp.
3:25
SPEAKER_02: Uh, we do need to consider whether it is permanent equity or mezzanine or temporary equity.
3:32
SPEAKER_02: So I think I think that's uh a concept that's temporary equity that you and I have talked about on a previous podcast.
3:38
SPEAKER_02: I know you've talked about it with some of our financial instruments folks on previous podcasts.
3:41
SPEAKER_02: Won't do a deep dive into what and how uh mezzanine works, but just at a very high level, if there is an instrument that the company potentially would be required to redeem for cash at some point, that would usually require it to be reflected as mezzanine or temporary equity.
4:03
SPEAKER_02: And the concept there, and this is this is SEC guidance that requires this, the concept is even though it is classified as equity, because there is uh the potential that the company will be required to shell out some cash at some point to redeem it, we want to let a reader of the financial statements understand that it's a little bit different than permanent equity.
4:24
SPEAKER_02: So if you're looking at a balance sheet of a company that's got mezzanine equity, we would have our liabilities, then we would have our mezzanine equity instruments, and then we would have our permanent equity.
4:36
SPEAKER_02: So an example in the stock comp world where we would have this mezzanine equity classification, you could have, let's say, a stock award, which the employee is able to put back to the company for cash at their choosing, the employees choosing after they vest, of course.
4:56
SPEAKER_02: Right?
4:56
SPEAKER_02: So the employee controls it, so it's outside the control of the company to have to pay out some cash to buy this instrument back.
5:04
SPEAKER_02: As we already talked about, the first step would be to determine whether this thing is a liability or equity.
5:10
SPEAKER_02: We go through those traps first, and we won't describe what cause it can be a liability, but we'll assume for now that that puttable share is not liability classified.
5:19
SPEAKER_02: Then we would have to run it through this mezzanine guidance.
5:22
SPEAKER_02: And because it is putable back to the company for cash, we would have to show that stock comp award as mezzanine equity.
5:28
SPEAKER_02: Now, as I mentioned, it's SEC guidance, so it only applies technically to public companies.
5:35
SPEAKER_02: Um, most public companies don't have stock awards that are redeemable like this, usually because their shares are publicly traded.
5:43
SPEAKER_02: So they're so you don't need this.
5:45
SPEAKER_02: They don't need it.
5:45
SPEAKER_02: If the employee wants to get some cash for their shares, they can go sell them in the market.
5:48
SPEAKER_02: With private companies, we see these types of provisions a lot because they don't have publicly traded shares and they need some types of redemption features so that the employee at some point can get some cash for their shares.
6:00
SPEAKER_02: Um, but the guidance is SEC guidance, so it doesn't apply to private companies.
6:05
SPEAKER_02: And so what we say is uh a private company is not required to apply it.
6:10
SPEAKER_02: We do think it's a best practice because it does provide a good presentation of these types of instruments.
6:16
SPEAKER_02: Uh, but again, not required.
6:18
SPEAKER_02: But private companies who are considering going public at some point might want to consider applying it now because they're otherwise going to have to kind of rejigger the financials when they're filing the registration statement and getting ready to go public.
6:30
SPEAKER_01: And from a practical point of view, then do you see most or many private companies applying this guidance, or it's it's a mixed?
6:38
SPEAKER_01: Yeah.
6:38
SPEAKER_02: Not as much.
6:39
SPEAKER_02: Usually I'll see that they continue to just call it all permanent equity until they're actually putting the registration statement together and then they start reading that.
6:45
SPEAKER_01: It actually doesn't seem that much more complicated, although I'm sure there's complications for not talking about that.
6:50
SPEAKER_01: There's some stuff.
6:51
SPEAKER_01: Yes.
6:51
SPEAKER_01: All right, that's helpful.
6:53
SPEAKER_01: How about then let's talk about?
6:54
SPEAKER_01: I know sometimes there can be cases then when you can actually capitalize some of your stock comp.
6:59
SPEAKER_01: So, what are those circumstances and what are some of the considerations?
7:02
SPEAKER_02: Yeah, yeah, maybe just rounding out the balance sheet.
7:04
SPEAKER_02: You know, we've talked about liabilities, we've talked about equity.
7:07
SPEAKER_02: There are situations when stock comp could show up in an asset because stock comp is just another element of employee compensation like salaries and bonuses, et cetera.
7:17
SPEAKER_02: And some employees' compensation is capitalized maybe into software cost, maybe into inventory, maybe into PPE.
7:26
SPEAKER_02: So just follow whatever we're already doing for normal compensation for that employee.
7:31
SPEAKER_02: And if stock comp is part of it, we would be capitalizing it into those assets.
7:35
SPEAKER_01: All right.
7:36
SPEAKER_01: That's helpful to know.
7:37
SPEAKER_01: And then I know another nuance may come up when our companies are issuing shares.
7:42
SPEAKER_01: However, they are actually loaning the employee the money.
7:46
SPEAKER_01: So then what happens on the balance sheet?
7:48
SPEAKER_02: Yeah, these um not as common, but they can get complicated.
7:53
SPEAKER_02: And in fact, you and I talked about these in a podcast we did last year on stock comp issues in private companies, where these are pretty common.
7:59
SPEAKER_02: Maybe it's just a couple things I'll point out as it relates to the balance sheet.
8:02
SPEAKER_02: So picture you're loaning an employee the money to buy some of your shares.
8:07
SPEAKER_02: So the employee hasn't actually paid you yet.
8:09
SPEAKER_02: So you have you, the company, have a receivable from the employee.
8:13
SPEAKER_02: If the loan is a full recourse loan, and again, won't go into the details on what full recourse is.
8:18
SPEAKER_02: We can I encourage listeners to check out the other podcast on that.
8:22
SPEAKER_02: But if it's a full recourse loan, it is a receivable that the company has, but it should not be recognized as an asset.
8:29
SPEAKER_02: That receivable should be set up as contra equity if the receivable is related to selling shares to your employee.
8:35
SPEAKER_02: So that's a bit of a reminder there.
8:38
SPEAKER_02: And then it gets even more complicated if we've got a non-recourse loan, which means we've loaned you the money to buy the share.
8:45
SPEAKER_02: Uh, but if you don't end up paying the loan off, we can't go after your other assets.
8:52
SPEAKER_02: We can just take the share back.
8:54
SPEAKER_02: In those situations, the literature is clear.
8:57
SPEAKER_02: We don't even treat that as a real loan in the first place.
9:00
SPEAKER_02: That is treated as a stock option.
9:02
SPEAKER_02: Um, and this is a bit of a sleeper issue because I will often see companies who have made these non-recourse loans, and it is technically a loan, and so they will set up a receivable on their balance sheet, and that is not appropriate.
9:13
SPEAKER_02: This should only be treated as a stock option, and there is no loan receivable to recognize.
9:18
SPEAKER_01: All right.
9:18
SPEAKER_01: Well, I think a good reminder for all of these issues is really understanding your arrangements.
9:23
SPEAKER_01: And then definitely, we've mentioned a few podcasts now.
9:26
SPEAKER_01: We'll make sure those are in the show notes if people want to go and hear more on some of these.
9:30
SPEAKER_01: All right, so lots of places on the balance sheet actually you can be impacted more than it may seem on the surface.
9:36
SPEAKER_01: Why don't we talk about the income statement?
9:38
SPEAKER_02: So, income statement, I think, is actually a bit more straightforward.
9:41
SPEAKER_02: And as I was mentioning, stock comp is just another form of compensation to employees.
9:47
SPEAKER_02: And so wherever a particular employee's compensation expense is recognized on the income statement, that's where the stock comp should be as well.
9:57
SPEAKER_02: So one employee might be showing up in general and admin, that's where the stock comp would be.
10:02
SPEAKER_02: Another employee might be in cost of sales, that's where their stock comp would be.
10:05
SPEAKER_02: Someone else is in RD, et cetera.
10:07
SPEAKER_02: So it just follows.
10:09
SPEAKER_02: And maybe the most important reminder here is it is explicitly prohibited by the SEC to recognize on a separate line on the income statement all of the stock comp expenses and to show them separately.
10:24
SPEAKER_02: The SEC does not want us doing that.
10:25
SPEAKER_02: They need to be included wherever the other employee costs are.
10:29
SPEAKER_02: The one thing that the SEC is okay with on the income statement is if we wanted to highlight uh the amount of stock comp expense associated with an employee's compensation, you can include that in a parenthetical on whatever appropriate line.
10:44
SPEAKER_02: So you might have cost of sales and then a parenthetical that says like uh including stock comp of a million dollars.
10:51
SPEAKER_02: And then you would show the total cost of sales expense.
10:53
SPEAKER_02: Uh and so that would be appropriate if we wanted to highlight what the stock comp was in each line.
10:58
SPEAKER_01: And Ken, not to get too much into uh plan design and all those questions, but specifically for this, what is the incentive for companies, this desire to break it out separately or to include it parenthetically?
11:12
SPEAKER_02: I think it's to just to provide investors a better understanding of what portion of our costs are cash costs versus what are going to be equity settled.
11:21
SPEAKER_02: It's another reason why we often see, and I don't want to go off too much on a tangent, but in non-gap disclosures, we will often see companies adding back their non-cash stock expense charges for a similar reason.
11:34
SPEAKER_01: All right.
11:34
SPEAKER_01: Well, that's maybe a good lead into our next topic, then, which is the cash flow statements.
11:39
SPEAKER_01: So, what about presentation on the cash flow?
11:41
SPEAKER_01: And we just said this was non-cash, but go ahead.
11:43
SPEAKER_02: I know it's um I um as I was thinking through what we were going to talk about today, I was a little bit surprised because at first blush you would think the cash flow statement shouldn't be terribly impacted because we're talking about arrangements that are settled in equity.
11:58
SPEAKER_02: But there are actually quite a few things that could impact cash flow.
12:00
SPEAKER_02: So let's talk about it.
12:01
SPEAKER_02: Maybe I'll start with what is probably most pervasive and relevant to the majority of companies, where if you think majority of companies, at least that have stock compensation.
12:11
SPEAKER_02: If you think about how companies put their operating cash flow together, almost everybody uses the indirect method rather than direct method.
12:19
SPEAKER_02: And in the indirect method, they'll start with their net income, their gap net income, and then they will add back a variety of things that are non-cash to get back to the operating cash flow.
12:30
SPEAKER_02: Stock compensation is usually one of the main elements there because we had a big expense charge, which was reducing net income, but it's non-cash, and so we're adding it back.
12:39
SPEAKER_02: So that is clearly relevant to cash flow statement.
12:43
SPEAKER_02: Beyond that, maybe I'll describe some uh issues that are not usually relevant to everybody, but that uh that we are we still see relatively regularly.
12:55
SPEAKER_02: Um so one is uh some companies will repurchase their shares, as we were talking about a little bit earlier.
13:03
SPEAKER_02: So if you picture an employee is vested in some shares, and now the company is buying them back, so we've got a cash outlay.
13:12
SPEAKER_02: So because we're buying back shares, that's basically like a treasury stock transaction.
13:17
SPEAKER_02: So there we would show that as a financing outflow on the statement of cash flows.
13:22
SPEAKER_02: But what also happens sometimes, and this is another one you and I talked about on our uh private company stock comp uh podcast, for various reasons, some companies will pay the employee more than what the share is worth when they buy it back.
13:37
SPEAKER_02: So the share is worth a hundred bucks, but we're paying the employee 120.
13:42
SPEAKER_02: And typically we'll kind of do a little bit of an analysis on why that's happening, but usually what we'll end up saying is that incremental$20 is an additional compensation charge that needs to be recognized on the income statement.
13:55
SPEAKER_02: It's an additional expense.
13:56
SPEAKER_02: It's like we're we're buying the share for$100, it's fair value, and then we're just making a bonus payment of$20.
14:04
SPEAKER_02: So when we see one of these, uh, we will have we'll basically split out the cash outflow into those two components as well.
14:10
SPEAKER_02: So we'd have a cash outflow of$100 through financing, because that's buying the share back, and then we'll have a$20 operating outflow, which is basically that bonus payment.
14:20
SPEAKER_01: Oh, this is very important then to get the split correctly because you're in two different places in the cash thus statement, then.
14:27
SPEAKER_01: Okay.
14:27
SPEAKER_02: Exactly.
14:28
SPEAKER_02: Exactly.
14:29
SPEAKER_02: Um, we talked earlier when we're talking balance sheet about some awards that are liability classified in the first place.
14:34
SPEAKER_02: So when we're settling one of those liability classified awards, those would be operating outflows.
14:41
SPEAKER_02: It's just an employee compensation liability that we're settling.
14:44
SPEAKER_02: So that's an important one to be aware of if you have liability awards.
14:49
SPEAKER_02: Companies that have stock options, if you picture an employee holding a stock option, maybe it's got a$10 exercise price.
14:57
SPEAKER_02: When the employee exercises their option, they're actually paying the company$10 to buy the share.
15:04
SPEAKER_02: So now we've got a cash inflow.
15:07
SPEAKER_02: And because it's a cash inflow in exchange for issuing our shares, that would be a financing inflow for option exercises.
15:15
SPEAKER_02: Uh any cash related to uh taxes of one form or another, whether it's income tax benefits that the company gets associated with Stock Comp awards, payroll taxes that we are paying to jurisdictions associated with Stockcomp, all of those tax impacts are going to be flowing through operating.
15:35
SPEAKER_02: And maybe the last one I'll mention, and this one is relatively common, um, employers have a withholding obligation when an employee vests in an award and the tax is due by the employee.
15:48
SPEAKER_02: The company might have a tax withholding obligation.
15:51
SPEAKER_02: Some companies, rather than let's say it was 100 RSUs that the person just vested in, we could just deliver the full 100 RSUs to the employee, and then we'd still have an obligation to withhold some cash from somewhere to pay the government.
16:04
SPEAKER_02: Uh instead, some companies will net settle the arrangement.
16:09
SPEAKER_02: So in uh instead of issuing the 100 shares to the employee, maybe we'll just issue the net 70 shares, hold 30 of them back to cover the employee's tax bill, and then the company will use its own cash to pay the government.
16:23
SPEAKER_02: But it's not on behalf of the employee.
16:26
SPEAKER_02: The way that 718 requires us to think about these arrangements is that it's kind of a two-step process where even though it was a net settlement for only 70, we are first issuing the full hundred shares to the employee to settle the arrangement, and then we are buying back 30 of those shares.
16:44
SPEAKER_02: So the cash outflow, even though we're sending it directly to the government, in substance, the cash outflow is to buy back those 30 shares, and therefore it is a financing cash outflow.
16:56
SPEAKER_01: All right.
16:56
SPEAKER_01: So definitely then, if I was keeping track of all that, lots of different types of transactions.
17:02
SPEAKER_01: I I think only in operating and financing.
17:04
SPEAKER_01: I don't think you said it on stage.
17:06
SPEAKER_01: Okay, that's good.
17:06
SPEAKER_01: I thought it was gonna be the proper track.
17:09
SPEAKER_01: But so one overall question then.
17:11
SPEAKER_01: So let's assume you're a company that's very active and you have all of these different programs.
17:16
SPEAKER_01: So maybe you have multiple of these.
17:18
SPEAKER_01: Then do you sort of net the financing ones can go in one row and the operating, or how what's the sort of requirement if there's different types of transactions?
17:28
SPEAKER_02: Yeah, I think absent materiality considerations.
17:32
SPEAKER_02: Um, different types of situations should be broken out, gross.
17:36
SPEAKER_02: So, for example, I mentioned these net settlements in financing as financing outflows.
17:41
SPEAKER_02: Those should be shown separately from, for example, if we've got option exercises that are have are showing up as cash inflows, I would expect generally as a separate line in the financing cash flow section.
17:54
SPEAKER_01: All right.
17:54
SPEAKER_01: And then in the operating cash flow section, at least simplistically, and I think you may have said this, just your non-cash starting point, that you can all clump into one line, even if it's in different lines than the income statement?
18:07
SPEAKER_02: Well, yeah, I would say I would I would have one line for our compensation, our non-cash compensation expense.
18:12
SPEAKER_02: But then if we have other operating cash flows, like an actual payment to the employee for that bonus,$20 bonus that we were talking about, we should be showing that separately.
18:21
SPEAKER_01: All right.
18:21
SPEAKER_01: So definitely a lot to keep track of then.
18:24
SPEAKER_01: And then this is probably a good lead-in because there's more to keep track of uh on to the statement of stockholders equity.
18:31
SPEAKER_01: So lots there as well.
18:33
SPEAKER_01: So what can you share?
18:34
SPEAKER_02: Yeah, so this is where you would expect to have a uh a bunch of things happening related to stock comp because it's not the cash flow statement, but that's fine.
18:41
SPEAKER_02: So uh so obviously we've got statement of shareholder equity impact related to stock comp.
18:48
SPEAKER_02: Uh, I would say the one that is most common is as we're recognizing our stock compensation expense over the year, the credit entry there is to APIC.
18:57
SPEAKER_02: And so if now if you think about the statement of shareholders equity, I would expect to see a line related to our stock comp expense recognized over the course of the year because it is increasing APIC by that amount.
19:09
SPEAKER_02: So that one would be very common.
19:12
SPEAKER_02: Uh, and then the others are any increases or decreases, usually in APIC related to stock comp.
19:17
SPEAKER_02: So we talked about one uh on cash flow where the option gets exercised.
19:23
SPEAKER_02: You've got cash coming in, the other side of that entry is an increase to APIC, so we would expect that.
19:29
SPEAKER_02: Uh, you can have modifications of certain awards that change their classification from equity to liability, or vice versa.
19:37
SPEAKER_02: So that's going to roll through the equity statement.
19:39
SPEAKER_02: Say you've got uh something that was originally classified as a liability, so there's a liability showing up on the balance sheet.
19:45
SPEAKER_02: Now we modify it, we change its classification.
19:48
SPEAKER_02: So we're going to reduce the liability and increase APIC.
19:52
SPEAKER_02: So we would expect to see that modification impact showing up on the statement of shareholders equity.
19:57
SPEAKER_02: Uh share repurchases are going to decrease APIC, usually, sometimes if a company's recording them in the treasury, maybe it'll show up in treasury stock, but it's going to be a decrease in equity.
20:08
SPEAKER_02: Uh, and then maybe just a reminder when we're recognizing our stock comp expense, the credits are going to APIC.
20:16
SPEAKER_02: Usually a company will also have a common stock at par account.
20:20
SPEAKER_02: We're not touching that as we're recognizing the expense.
20:23
SPEAKER_02: We only touch the par value account when the shares are actually earned issued.
20:28
SPEAKER_02: So we would have, you know, these are usually small dollars, but we would have some reclassification from the APIC balance over to the common stock at whatever its par value is.
20:37
SPEAKER_01: All right, good reminder.
20:38
SPEAKER_01: And then I think I know the answer, but again, assuming everything's material, all of these different types of transactions also you would expect to see in different lines.
20:49
SPEAKER_01: Broken out separately.
20:50
SPEAKER_01: Yes, yes, that which somehow makes a lot of sense with the uh statement of stockholders' equity since everything to do with what's going on there.
20:58
SPEAKER_01: So all right.
20:59
SPEAKER_01: So then let's move on to disclosure because I think this is also an area where sometimes I feel like there can be pages of disclosure and lots of places that it's it may be difficult to make sure you're getting all the details in that you need.
21:12
SPEAKER_01: So, what are some of the key reminders that you would give?
21:14
SPEAKER_02: Well, you're right that these things can run on for pages for sure, um, which which is kind of funny because the the disclosure rules in 718 start with just four overarching objectives.
21:28
SPEAKER_02: So they say the disclosure should cover the nature and the general terms of any of your stock comp arrangements, uh, the method that is used to estimate the fair value of the arrangements, any of the income statement effects, and any of the cash flow effects.
21:47
SPEAKER_02: Those are the objectives.
21:49
SPEAKER_01: All right.
21:50
SPEAKER_01: So definitely easy from an objective point of view, but nonetheless that translates to multiple pages.
21:56
SPEAKER_01: So when you talk about uh sorry, but Before we get into these multiple pages, maybe just to level set, are we going to focus on annual, interim, both?
22:06
SPEAKER_01: What would you say?
22:07
SPEAKER_02: Yeah.
22:07
SPEAKER_02: So so all of these disclosures that we're going to walk through are annual disclosures.
22:13
SPEAKER_02: 718 doesn't have any specific interim disclosure requirements.
22:18
SPEAKER_02: So what I would say is we, of course, have general interim disclosure requirements in 270.
22:24
SPEAKER_02: And so we need to be thinking about those.
22:25
SPEAKER_02: So if there was something significant that happened over the course of the year related to our stock comp plan, then we should probably be disclosing that.
22:32
SPEAKER_02: And that's not uncommon.
22:34
SPEAKER_02: We might have a big grant that happens in one quarter.
22:37
SPEAKER_02: And so maybe we'll have some disclosure there.
22:39
SPEAKER_02: Maybe we make a big modification during one quarter.
22:42
SPEAKER_02: Maybe we do a big buyback during one quarter.
22:45
SPEAKER_02: So that's where we would want to be thinking about interim.
22:48
SPEAKER_02: And then some companies, just because their stock compensation is so significant to the overall company, some uh choose to include additional interim disclosures, even if it's kind of repeating what's in the annuals, but that's uh on a case-by-case basis, company judgment.
23:03
SPEAKER_01: All right.
23:04
SPEAKER_01: So then sticking, let's assume for this purpose, we're only talking about the annual statements.
23:08
SPEAKER_01: And I I liked the overview, there are these four parts.
23:11
SPEAKER_01: It seems so simple.
23:12
SPEAKER_01: And then yet when you start to get into it, it's sometimes overwhelming detail and to the point where you're you're meeting the individual disclosure requirements, but yeah, it's very difficult to actually understand what's going on.
23:26
SPEAKER_01: And so, how do you advise companies in terms of sort of meeting all the requirements and yet finding the balance of detail?
23:33
SPEAKER_02: Yeah.
23:34
SPEAKER_02: Well, first of all, you're right.
23:36
SPEAKER_02: There are it's funny because as we mentioned, there are the four key objectives that are listed.
23:43
SPEAKER_02: And then 718 goes on to list a couple of pages worth of what is referred to as the minimum required information to achieve those objectives.
23:54
SPEAKER_02: Uh and actually one of the questions, because it's kind of getting what you were getting at, one of the questions that we sometimes get is we have a company where our stock comp is not terribly material, but this says these are the minimum required uh disclosures.
24:09
SPEAKER_02: So do we have to list all of these three multiple pages worth of stuff?
24:13
SPEAKER_02: Uh I would say the general materiality considerations that apply to all of the codification apply to these disclosures as well, notwithstanding the fact that they're called minimum required disclosures.
24:26
SPEAKER_02: So if you believe that any of these disclosures are truly not material, then it is not required to include them.
24:33
SPEAKER_02: So there's some judgment that should be applied.
24:35
SPEAKER_02: But assuming the stock comp is material to the company, then we should do as good a job as possible in making sure that we're ticking off all of these minimum required disclosures that are listed in 718.
24:48
SPEAKER_02: We'll talk through some of the concepts here.
24:51
SPEAKER_02: I don't want to list the entire three pages worth of minimum required disclosures, but uh I think just good to good to remember that there's some judgment to apply here.
24:59
SPEAKER_01: Well, and I guess Ken as well, if a company has multiple plans, then they need to make sure they're laying out the information with respect to the plans so it's clear which is which.
25:08
SPEAKER_01: And then again, you may have some plans that are not material, in which case maybe you have much less disclosure on those.
25:17
SPEAKER_02: For sure.
25:17
SPEAKER_02: Yeah, I think the the disclosure objectives clearly want us to be describing each of our material plans separately, because they can work very differently.
25:26
SPEAKER_02: And and ultimately, I encourage listeners to think about the kind of the overarching objective, which is to provide our investors or other readers of our financial statements enough information to be able to understand what is the economic impact of all these plans on the company and what are the potential dilutive impacts to all of our investors, because that ultimately is probably one of the most significant elements of stock comp is that it's ultimately going to be diluting our investors as the stock continues to best.
25:57
SPEAKER_01: Yeah, and it's interesting because if I reflect on all of those disclosures we talked about that can you may need to make, you know, particularly with the cash flow statement and the statement of stockholders equity, but even the income statement balance sheet, you need to also have enough disclosure so people can understand what they're seeing on those statements.
26:15
SPEAKER_01: So then with that in mind, I know roll forward is one of the big things, and again, ties in well to what's on the face of the statements.
26:23
SPEAKER_01: So, what are some of the things you think about when you're talking about the roll forward requirements?
26:27
SPEAKER_02: Yeah, there's a lot of requirements on what should be included in all these roll forwards and uh maybe just at a at a high level, if you think about a roll forward.
26:36
SPEAKER_02: So we would be starting with whatever the earliest period presented, start with the opening balance of one, let's take one of the company's plans.
26:44
SPEAKER_02: Maybe they have a stock option plan.
26:45
SPEAKER_02: So, what were the total stock options outstanding at the beginning of the year?
26:50
SPEAKER_02: And then what were all the things that increased or decreased that balance over the course of the year?
26:54
SPEAKER_02: So maybe it increased because we had new grants that were made, maybe it decreased because some of those options were exercised, it decreased because some were forfeited, it decreased because some were canceled.
27:06
SPEAKER_02: So we'll have each of those lines showing the increases or decreases over the course of the year, uh, and then for each year that uh is presented to get us to like the total outstanding today.
27:17
SPEAKER_02: And then in addition to just the quantity roll forward, we would also be showing a variety of things, won't go through them all, but things like what is the weighted average exercise price of all of these options, uh, what is the weighted average grant date fair value of the instruments that were granted during the year, how much unrecognized compensation for the plan still exists that's going to be recognized over the in in the future, and over what period are we expecting to recognize that compensation?
27:46
SPEAKER_02: And we would have one of these roll forwards for each plan because each plan is different.
27:51
SPEAKER_02: So we might have an option roll forward, we might have an RSU roll forward, maybe a performance share roll forward, and uh kind of including all this information for each.
28:01
SPEAKER_01: All right.
28:01
SPEAKER_01: So that's where you start to get the pages because it's a lot of information, and if you have a lot of plans.
28:06
SPEAKER_01: And so one of the things when you were talking about those core principles of disclosure, you mentioned fair value, and obviously we've talked about fair value on other podcasts.
28:14
SPEAKER_01: Uh, but what are some of the granular requirements and in particular, maybe how this fits in with someone to the broader fair value disclosure requirements I think can be helpful?
28:24
SPEAKER_01: Yeah.
28:25
SPEAKER_02: Well, um, 718 does have different fair value rules than uh than what is required in 820.
28:34
SPEAKER_02: 820, thank you.
28:34
SPEAKER_02: Yes.
28:35
SPEAKER_01: Well, I really're the financial instrument.
28:37
SPEAKER_02: I remember that.
28:37
SPEAKER_01: Yes, I pulled that out.
28:39
SPEAKER_01: Yes, yes.
28:40
SPEAKER_02: Um and so you might get a a bit of a different fair value for a stock award than you would for what appears to be a similar instrument that is uh outside of Stockholm Land.
28:50
SPEAKER_02: Um but one of the things that we'd want to be disclosing is what is the approach or the method that we're using to come up with the fair value.
28:57
SPEAKER_02: So many listeners have probably heard of the Black Shoals model, which is one model for valuing stock options.
29:03
SPEAKER_02: So if that's what we're using, let's talk about that.
29:06
SPEAKER_02: Uh, in certain circumstances, because the award is a bit more complex, Black Shoals maybe can't be used.
29:11
SPEAKER_02: And so there's other models, maybe a Monte Carlo simulation that's used.
29:15
SPEAKER_02: So let's make sure we're talking about uh what model we're using.
29:19
SPEAKER_02: And then let's talk about how we developed the significant assumptions that went into the model to develop the fair value.
29:27
SPEAKER_02: So some of the more significant uh assumptions when it comes to stock awards.
29:33
SPEAKER_02: Uh one is the expected term.
29:36
SPEAKER_02: So this is if you have a stock option, it might have a 10-year term.
29:40
SPEAKER_02: The employee has to exercise it within 10 years.
29:43
SPEAKER_02: But we, for valuation purposes, we don't use that 10-year term.
29:48
SPEAKER_02: We come up with an expected term, which is how long do we think it's going to be until the employee actually exercises?
29:55
SPEAKER_02: Uh, and so in developing, so obviously there's a good bit of judgment in coming up with that expected term.
29:59
SPEAKER_02: So, how did we go about doing that?
30:01
SPEAKER_02: And some companies will use their historical exercise behavior.
30:06
SPEAKER_02: Employees have been exercising in the past.
30:07
SPEAKER_02: We've been tracking it, we use that historical behavior.
30:10
SPEAKER_02: That's one approach.
30:11
SPEAKER_02: Other companies, there's a simplified approach that is allowed for certain types of instruments.
30:16
SPEAKER_02: So some companies may be using this simplified method, and that would be something to disclose there.
30:21
SPEAKER_02: Uh, another significant assumption when it comes to stock comp is expected volatility.
30:27
SPEAKER_02: So, this is how much does our stock price change over time?
30:31
SPEAKER_02: Uh, and volatility can have a very significant impact on uh fair value.
30:36
SPEAKER_02: So it's important to make sure that we've got a good process in place to develop our expected volatility.
30:42
SPEAKER_02: Uh, some companies will use their historical uh stock price behavior, so they'll look back at the stock price movement over time and they'll use that to develop their volatility.
30:52
SPEAKER_02: Others will use something called implied volatility, which is based on uh options that are publicly traded in the company, and you can determine kind of the implied volatility coming from those publicly traded options.
31:05
SPEAKER_02: Some companies will use a combination of those things.
31:07
SPEAKER_02: Uh, so make sure we're describing what's used for expected volatility.
31:12
SPEAKER_02: Uh, and then maybe I'll I'll just mention because I've seen over the years the SEC does comment from time to time on this.
31:19
SPEAKER_02: When a company first goes public, they don't have their own historical stock price to look to because they're brand new.
31:28
SPEAKER_02: So they will look to the volatility of some of their peer companies and use that for some period of time until enough time has gone by that they can start looking at their own historical.
31:38
SPEAKER_02: And some companies maybe will start with uh looking at their peers at 100% level and then over time start to blend that.
31:45
SPEAKER_02: So maybe next year they're using 80% peer and 20% their own historical and kind of phase it out over time.
31:52
SPEAKER_02: So sometimes the SEC will ask, especially for a company that's been public for quite a few years, but is still relying on peer company, why are we still relying on peers?
32:01
SPEAKER_02: It seems like we've got enough of our own historical, so maybe that's something for listeners to watch out for.
32:06
SPEAKER_01: So a lot to think about there.
32:08
SPEAKER_01: I if you kind of take a step back for all of what we talked about then, are there any sort of pitfalls that you frequently see, you know, many companies falling into in terms of either classification or some of these disclosures or otherwise?
32:24
SPEAKER_02: I think it probably comes back to um this notion of having good control over all of this, as we were talking about.
32:29
SPEAKER_02: Like this is probably the most important thing because you know, we've been talking for half an hour about all of these various disclosure requirements, and it's easy for things to fall through the cracks.
32:39
SPEAKER_02: And so just to make sure that we've got good control over all elements of the presentation and disclosure process, not just the accounting recognition.
32:46
SPEAKER_02: I think that is what people are very focused on.
32:49
SPEAKER_02: Make sure we've got good control here.
32:50
SPEAKER_02: And then one um recommendation that I always have because StockComp touches so many parts of the organization, and to make sure we've got good communication between all of them to make sure nothing is falling through the cracks.
33:03
SPEAKER_02: We've got financial reporting is involved, tax is involved, the equity uh group that kind of maintains all of this information, legal is very involved, HR is involved, and sometimes when that communication isn't great, then we tend to miss things.
33:18
SPEAKER_01: Yeah, and actually that made me think.
33:20
SPEAKER_01: So one of the things then with disclosure is changes to the plans as well, is as plans or if there are significant changes made, then then obviously it's also an important thing that you would need to be disclosing.
33:32
SPEAKER_02: Yep, and that is uh an area where we sometimes see problems because maybe HR decides we're going to make a modification, but HR hasn't told accounting about it.
33:41
SPEAKER_02: So the modification gets pushed through, but accounting doesn't know about it, and that can be a problem.
33:46
SPEAKER_01: Yeah.
33:47
SPEAKER_01: So any final words of wisdom then for our audience?
33:51
SPEAKER_02: Uh good luck.
33:53
SPEAKER_01: Okay.
33:53
SPEAKER_01: I think and hopefully we have something beyond that.
33:57
SPEAKER_02: So again, it's uh it's a lot to keep your arms around.
34:00
SPEAKER_02: And so uh just make make sure that you're you're keeping an eye on it and uh and not leaving it to the last minute when it comes to presentation disclosure.
34:08
SPEAKER_01: Excellent advice.
34:09
SPEAKER_01: And it's always such a pleasure to talk to you.
34:10
SPEAKER_01: Thanks so much for joining me today.
34:12
SPEAKER_02: Thanks, Heather.
34:14
SPEAKER_01: That's our show for today.
34:16
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34:22
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34:26
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34:36
SPEAKER_01: From Thought Leadership at PwC, I'm Heather Horn.
34:40
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34:51
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34:53
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