Equitycompensation: A comparative analysis of financial statements
Objectives of the research project
Itbecomes pretty hard for new entrepreneurial ventures to pay off theiremployees especially the experts. Most of these start-ups incorporatethe use of share-based compensation as a way to remunerate theiremployees (Bernstein, 2012). Share-based payment is a non-cash modeof remuneration that represents a type of ownership credit in anorganization. The use of equity compensation focuses on attractingand retaining expertise. New business entities are cash-strapped, andthey need to preserve and re-invest any profit made. At the sametime, they need to employ skilled labor and still pay them below themarket price. Share-based compensation schemes tie the fortunes ofthe employees to the fortunes of the firm which make experts stick tothe company for a long time.
Variousstandards govern stock- based payment arrangements. However, the USGAAP and the IFRS are the most popular accounting principles. Thisproject aims at analyzing these guidelines and pointing out anydifferences and similarities that exist between them. The paper alsoaims at describing the efforts that have been undertaken to convergethe two accounting standards. Lastly, expectations for greaterconvergence of the equity-based compensation standards will also beestablished.
Organization of text
IntegratedMedia Solutions is among the many growing private organizations thathave invented their versions of equity compensation schemes. TheC.E.O and president of this firm assert that, companies that plan tofail, resist from using equity compensation. Survival is the firstorder of any start-up organization. Nonetheless, there is asignificant risk associated with incentive compensation. There is noguarantee that the firm will do well in future and one will gain fromequity’s appreciation. However, taking the risk is worthwhile.
Equity compensation U.S GAAP standards
Accountingprinciples vary from one country to another. The U.S GAAP standardsoutline the rules and guidelines that the US publicly tradedcompanies should adhere to while compiling their financial reports.They cover several fields such as turn over cognition, incomestatement, item grouping and equity estimations among others.
ASC 718- Stock Compensation
Asopposed to the ASC 505-50, the U.S GAAP ASC 718, outlines the generalstandards related to share-based payment agreements with anyorganization’s internal public (employees). It states that any firmthat incorporates the use of equity as compensation should include alist of compensation expenses on its income statement that areequivalent to the appraised cost those equity grants (Bonham, 2013).This standard also requires companies to use a fair-value-basedapproach in the process of accounting for their share-basedtransactions.
ASC 505- Equity- based payments to non-employees
TheGAAP Accounting Standards Codification 505 section 50, require allprivate firms to account for the external public (non-employees)stock transactions based on the equitable value of the servicesissued or the just value of the stock instrument given. Auditingfirms advise that the private organizations should measure equityinstruments by their fair value. This sections also develops acritical guidance on how the measurement date should be established.It is as at the earlier of the date that commitment to perform hasbeen settled or as at the earlier of the actual date that theperformance has been completed (Beyersdorff, 2014).
Equity compensation IFRS
TheInternational Accounting Standard Board (IASB) is the right developerand custodian of the International Financial Reporting Standards(IFRS). These are accounting rules and guidelines that govern allpublicly stated organizations across the globe in their process ofdeveloping financial statements. They apply to more than 100countries around the world. They focus on uniformity in financialreporting among companies and from one country to another.
IFRS-2 – Share-based payment
Theseaccounting principles govern transactions in which an entity receivesgoods and services in exchange for equity- based compensation. Itstates that the reporting organization should recognize allshare-based payment transactions in their financial analysis as perthe fair value of that activity. Some of these arrangements thatwould be captured under IFRS 2 include share appreciation rights,share options and granted shares among others (Epstein, 2011).
Related standards for equity compensation
Variousrestrictions and rules govern equity-based compensation. The IASBboard require all companies to measure payment costs related toemployee stock awards using the fair value of the equity instrument.At the same time, equity compensation is subject to vesting. Theaccounting standards also require payment to be made if the workerhits certain performance target. It is until then that the employeescan gain a full possession of the stocks (Epstein, 2011).
History of convergence of U.S GAAP and IFRS
Since2002, the International Accounting Standards Board and the UnitedStates Financial Accounting Standards Board have been working so hardto harmonize the US GAAP and the IFRS accounting principles. Themajor goal of this convergence was to come up with a lone set oftranscendent global regulatory guidelines accepted by both the IASBand the FASB. In September of 2002, the two regulatory bodies accededto work jointly, in consultation with other national and regionalorganizations to put aside the differences that existed between theUS GAAP and the international accounting principles. The consent wasincarnated in a memorandum of association known as Norwalk Agreement.In 2006, the two bodies had a chance to meet and further strengthentheir agreement. In this occasion, the IASB and the FASB set someexplicit goals to be implemented by 2008. Following this progressbetween the two boards, in 2007 the US Security Exchange Commission,dismissed the requirement that all foreign companies registered inthe US should reconcile their financial statements with GAAPstandards if they were compiled following IFRS standards. At the sametime, the commission allowed US companies to prepare their financialrecords following IASB guidelines.
In2008, the two regulatory bodies were able to revise and update theMOU developed in 2002. At this meeting, a group of 20 leaders (G20)known as standard-setters were selected to intensify the efforts tocomplete the convergence exercise. In 2009, the IASB and FASB wereable to publish a joint report of their board meetings describing theprogress of their harmonization activities. By the year 2013, theFASB and IASB were able to produce a report stating the remainingconvergence projects. Today most of the convergence projects havebeen settled as envisioned in the 2002 MOU. Nonetheless, some arestill incomplete while others were discontinued since FASB and theIASB could not come to a consensus.
Equity compensation similarities between U.S GAAP and IFRS
i.Grant date fair value
TheUS GAAP (ASC 718 and ASC 505-50) standards for equity compensationlargely converge with the IFRS 2 guidelines for share-based payments.Both principles advocate for the use of fair -value based approachwhen analyzing their equity-based payment transactions. This applieswhen a company procures goods or services in return for shareinstruments or incur costs that are wholly or partly share- based.These rules in both cases apply to the external and the internalpublic (Shamrock, 2012).
ii.Revenue recognition period
Underboth the US GAAP and the international accounting standards, turnover cognition is tied to the earning process and the actualizationof assets from completion of the commitment period. Income cannot becognized until it has been both actualized and earned. That impliesthe period of the agreement must come to a conclusion (Shamrock,2012).
Equity Compensation differences between U.S. GAAP and IFRS
Companiesthat compile their financial statements using IFRS make use of a soleguideline for all share-based compensation transactions irrespectiveof if the individuals involved are employees or not (IFRS 2standard). On the other hand, with the US GAAP, there are twoseparate principles that govern shared-based compensations for eachparty. We have ASC 718-stock compensation standards for the employeesand ASC 505-50 principles for the non-employees (Porter & Norton,2014). At the same time some awards stated as employee instrumentsunder IFRS might not be considered as worker awards under the USGAAP.
b)Valuation- guidance on expected volatility and expected term
Organizationswhich prepare their financial records under GAAP rules rely on SABTopic 14 that provides guidelines on anticipated volatility andexpected term. They include directions for dependence on the alludedvolatility and the simplified tactic for computing the anticipatedterms for qualifying instruments. Firms that follow IFRS guidelineslack the opportunity for employing the simplified way of reckoninganticipated conditions (Shamrock, 2012).
c)Balance sheet classification
Firmsthat report under IFRS do not follow and particular order orclassification of accounts on their balance sheet. In simple terms,there are no stringent rules on the format of the statement offinancial position. However, with the US GAAP standards, there is aparticular principle that requires accounts to be ranked in theirorder of liquidity (Shamrock, 2012). This implies that highly liquidassets such as operating cash will appear first on the balance sheetand so on.
Withthe US GAAP standards, business entities are granted the opportunityto choose the acknowledgement strategy to employ for awards withservice-only prerequisites and graded-vesting attributes. At the sametime, there is no linkage between the attribution method selected andthe valuation method the firm employs. With IFRS, corporations arenot given the opportunity to make a choice on which attribution orvaluation method to use for awards with graded vesting features(Porter & Norton, 2014).
UnderUS GAAP improbable to probable adjustments are known to lead torecognition of payment expenses that might be greater or lower thanthe equitable value of the equity instrument at the initial issuancedate. With IFRS, vesting terms of shares are revamped in a way thatis beneficial to the employee when compared to the original grantconditions.
f)Deferred Tax Accounting
TheUS GAAP accounting standards require firms to treat deferred leviesas remuneration expenses so long as there is a levy subtractionaccorded for any discrete class of financial award. The estimation ofthe delayed levy asset is founded on the amount of remunerationexpense cognized for book reasons. On the other hand, with IFRS, thecalculation of the postponed levy asset in every period depends on anappraisal of the future levy subtractions, in case there are any, forthe award estimated at the terminal of the reporting duration.
IFRSstandards have a timing of recognition for social taxes such aspayroll charges that is earlier than that for the US GAAP. With IFRS,social taxes imposed in relation to share-based payment plans, areoutlined in the balance sheet at the time when the relatedequity-based payment cost is cognized. Under the US GAAP, socialcharges on equity- based payment plans should be cognized at the dateof the event commencement and the computation of tax.
Expectations of greater convergence for equity compensation
Therehave been proposals to converge the US GAAP and IFRS principlesregarding stock-based compensations. Both the FASB and the IASB adoptthe same system for recognizing equity-based payments. That is theequitable value of the share instrument. Even if the computations ofbasic and diluted returns are the same per share, the two regulatorybodies are jointly working to put aside some minor differences in EPSreporting (Tracy, 2014).
TheFASB has raised a concern how its principles treat contracts that canbe settled by cash or by equity. Under IFRS standards, only sharesshould be used as a mode of payment in such transactions. However,under US GAAP, the firm in question is given an opportunity to chooseits preferred remuneration strategy. FASB has made a proposal toadopt the IFRS approach thus converging the US GAAP and the IFRSprinciples in that perspective.
TheUS Security Exchange Commission is among the great supporters of theconvergence process (Tracy, 2014). The commission had always wantedto adopt the IFRS standards and divert from the US GAAP. With theconvergence exercise in progress, the commission has been able toallow US companies to report under any of the two principles.Harmonizing the regulatory standards is paramount in the world today.This is because most companies prefer to operate on a global basis totap more competitive grounds. Unified accounting standards make iteasy for such organizations to work in any country without having tochange their accounting procedures.
Bernstein,R. (2012). Theentrepreneur`s guide to equity compensation.La Jolla, CA: Beyster Institute at the Rady School, University ofCalifornia, San Diego.
Beyersdorff,M. (2014). TheU.S GAAP Standards.New York: McGraw Hill.
Bonham,M. (2013). TheU.S GAAP Standards.England: Wiley.
Epstein,B. (2011).IFRS policies and procedures.Hoboken, N.J.: John Wiley & Sons.
Porter,G. & Norton, C. (2014). Financialaccounting.Fort Worth: Dryden Press.
Shamrock,S. (2012). IFRSand US GAAP:A comprehensive comparison.Hoboken, New Jersey: Wiley.
Tracy,J. (2014). Fundamentalsof financial accounting.Santa Barbara: Wiley.