CEP Financial Analysis & Reporting 3 — Questions and Answers
Question 1: A company modifies a stock option by extending its expiration date. Under ASC 718, how is the incremental fair value treated?
- Recognized immediately as a one-time charge
- Recognized over the remaining requisite service period of the modified award (Correct answer)
- No additional expense is required if the original award was fully vested
- Credited to additional paid-in capital with no income statement impact
Correct answer: Recognized over the remaining requisite service period of the modified award
Incremental fair value from a modification is recognized over the new requisite service period; for vested awards it is recognized immediately.
Question 2: Which financial statement disclosure is required by ASC 718 regarding the weighted-average grant-date fair value of options granted during the period?
- It must be disclosed in the balance sheet footnotes only
- It must be disclosed in the notes to financial statements (Correct answer)
- It is optional for non-public companies
- It is included only in the proxy statement
Correct answer: It must be disclosed in the notes to financial statements
ASC 718 requires disclosure of the weighted-average grant-date fair value of options granted during the period in the notes to financial statements.
Question 3: How is the tax benefit from the exercise of NQSOs recorded on the company's books under current U.S. GAAP?
- As a reduction of income tax expense in the period of exercise (Correct answer)
- As an addition to additional paid-in capital
- As a deferred tax asset until the option is sold
- As a reduction of goodwill
Correct answer: As a reduction of income tax expense in the period of exercise
Under ASC 718, excess tax benefits from NQSO exercises are recorded as a reduction of current income tax expense (through the income statement) in the period of exercise.
Question 4: What is the primary purpose of the diluted EPS calculation in the context of equity compensation?
- To report earnings excluding all stock-based compensation expense
- To reflect the potential dilutive effect of outstanding stock options, RSUs, and other equity awards (Correct answer)
- To calculate the intrinsic value of all outstanding awards
- To reconcile shares outstanding with shares authorized
Correct answer: To reflect the potential dilutive effect of outstanding stock options, RSUs, and other equity awards
Diluted EPS incorporates the potential dilutive impact of equity awards (options, RSUs, etc.) on the weighted-average shares outstanding using the treasury stock method.
Question 5: Under the treasury stock method for diluted EPS, proceeds assumed from option exercises are used to:
- Pay dividends to shareholders
- Repurchase shares at the average market price during the period (Correct answer)
- Retire outstanding debt
- Fund share repurchase programs at the grant price
Correct answer: Repurchase shares at the average market price during the period
The treasury stock method assumes proceeds from option exercises are used to repurchase shares at the average market price, with only the net incremental shares included in diluted EPS.
Question 6: When a performance share unit (PSU) has a market condition (e.g., relative TSR), how is the compensation expense treated if the market condition is not achieved?
- All previously recognized expense is reversed
- Expense is recognized over the service period regardless of whether the market condition is met (Correct answer)
- Expense is deferred until the market condition outcome is known
- No expense is recognized until vesting is confirmed
Correct answer: Expense is recognized over the service period regardless of whether the market condition is met
Unlike performance conditions, market conditions are reflected in the grant-date fair value, and expense is recognized regardless of whether the market condition is achieved.
Question 7: What does a company disclose as 'unrecognized compensation cost' in its equity award footnote?
- The total intrinsic value of all outstanding awards
- The remaining stock-based compensation expense for unvested awards not yet recognized (Correct answer)
- The cumulative expense recognized to date for all equity awards
- The fair value of shares repurchased under buyback programs
Correct answer: The remaining stock-based compensation expense for unvested awards not yet recognized
Unrecognized compensation cost represents the grant-date fair value of unvested awards that has not yet been expensed, typically disclosed with the weighted-average period over which it will be recognized.
CEP Financial Analysis & Reporting 3
A company modifies a stock option by extending its expiration date.
Under ASC 718, how is the incremental fair value treated?