How Do You Book Stock Compensation Expense Journal Entry?

The accounting treatment of stock-based compensation varies between stock options and restricted stock and between different types of stock. ShareOnTwitterShareOnFacebookShareOnLinkedIn AccountingReconciliation HowDoYouBookStockCompensationExpenseJournalEntry? Aug02,2022|ByChrisSluty Stock-basedcompensationisacommonwaytoattract,incentivize,andretaingreatemployees. Butrecordingstockcompensationexpenseaccountingcanbedaunting! Thisblogisaboutgoingbacktothebasicsinaccounting,andtheobjectiveofthepostistowalkyouthroughthecorrectwaytobookstockcompensationjournalentry.Butfirst,let’stalkaboutstock-basedcompensation.  WhatisStock-BasedCompensation? Theintentionofofferingstock-basedcompensationistoaligntheinterestsofemployeeswithcompanyperformance.Ifthecompanydoeswelloverthelong-term,employeesprofit.Corporationsloveitbecauseitdoesn’trequiredippingintocashflow,andcanbemuchmorevaluabletoemployeesandkeyexecutivesoverthelongrunthanjustafatterpaycheck.  Therearetwomaintypes:restrictedstockandstockoptions.Restrictedstockisagrantofstockinthecompanythatisrestrictedinsomewaytoprovideanincentiveforcontinuedemploymentorservice.Stockoptionsgivetherecipientanoptiontopurchasestockinthecompanyataspecificpriceatafuturedate.Bothofthesecanbeusedtocompensatenon-employeesaswellasemployees. BenefitsofStock-BasedCompensation Aswementioned,thereareseveralbenefitstostock-basedcompensationthatcanmakeitbeneficialforbothcompaniesandemployees.Anemployeestockoptionplanorrestrictedstockissuanceallowsyoutoincreasethetotalcompensationwhilereducingcompensationcost,atleastintermsofcashflow.Forayoungcompany,thiscanbeespeciallyattractive.Inthoseearlydays,cashisoftenhardtocomebyandstock-basedcompensationisawayofrewardingemployeeswithfuturevaluefortheirpresentwork. Again,stock-basedcompensationalsohelpskeepemployeesonboardandinvestedinthesuccessofthecompany—becausethey’reliterallyinvestedinthecompany.Receivingsharesofstockorstockoptionsratherthanahighercashsalarycanalsohavetaxbenefitsforemployees,whomaynothavetopaytaxesonthevalueoftheunderlyingstockuntilitvestsoruntiltheyexercisetheiroptions. Whilestock-basedcompensationmayhavelessofanimpactonthecashflowstatementupfront,it’simportanttorememberthatitisstilldilutive.Whenthoseoptionsareexercised,theincreaseinoutstandingshareswilldecreaseEarningsPerShare(EPS)byslicingtheNetIncomepieintomorepieces. HowDoYouAccountforStock-BasedCompensationonaBalanceSheet? Theaccountingtreatmentofstock-basedcompensationvariesbetweenstockoptionsandrestrictedstockandbetweendifferenttypesofstock.Let’stakeaquicklookathowstockoptionsimpactthebalancesheet. First,inaccordancewithGenerallyAcceptedAccountingPrinciples,expensesneedtoberecordedfortheperiodoftimethey’reusedformoreaccuratefinancialreporting.Forinstance,astockoptionthatvestsinfiveyearsshouldbespreadoutoverthoseyears,notrecordedasonelumpsumexpense.Inthatcase,youwoulddebitCompensationExpenseandcreditaStockOptionsEquityaccounteachofthefiveyearsforone-fifthofthevalueofthestock.Accountingstandardsrequirethistoberecordedbasedonthecompany’sfairvaluecalculationoftheirshares. Whenanemployeeexercisesstockoptions,you’llcreditCommonStockforthenumberofsharesxparvalue,debitCashforthenumberofsharesxtheexerciseprice,thendebitAdditionalPaid-InCapitalforthedifference,representingtheincreaseinvalueofthesharesduringtheserviceperiod.Byfollowingthisprocess,yourfinancialstatementsalwaysaccuratelyreflectnotonlythestockissuedandtherelatedcompensationexpensesbutalsohowmanystockoptionsareoutstanding. HowDoesRestrictedStockWork? Whenanemployeereceivesagrantofrestrictedstock,theyarenotallowedtosellituntilitvests,usuallyoverseveralyears.Iftheemployeeleavesbeforetheendofthevestingperiod,theyforfeittheirshares.Reasonablevestingperiodsencourageteammemberstostickaroundandhelpbuildastrongcompany.  Let’swalkthroughanexample.UnderABCCompany’srestrictedstockprogram,2,000shareswillvestonDecember31,2020.Onthedatethosesharesweregranted—thegrantdate—nothinghappensoneithertheincomestatementorthebalancesheet.Onthevestingdate,theshareshaveafairvalueof$25pershareandaparvalueof$1.Here’stheentrytorecordthat:  Date AccountName DR CR 12/31/20 Stock-basedcompensationexpense $50,000 CommonStock(parvalue) $2,000 EquityAPIC $48,000 Memo:TorecordrestrictedstockcompensationforFY20  Whenthesharesvest,theemployeehastaxableincomeatthemarketvalueofthoseshares.Ifthisisapubliccompany,thisisthecurrenttradingvalue.Butforprivatecompanies,anestimateofthefairvaluemustbemade.Somecompanieshireanoutsideconsultantwhospecializesinvaluation.AccordingtoIRSsection83,whichgovernsrestrictedstockawards,acompanymustdemonstrateagoodfaithefforttoestimatethefairmarketvalue,whichcouldbebasedonaformula.  Atsomecompanies,accountingpolicycallsforanentrytorecordrestrictedshareswhenthey’reissued,whichmakesthestock-basedcompensationjournalentriesalittledifferent.Let’ssaythatonDecember31,2019,ABCCompanyissued4,000sharesofrestrictedstocktoemployees.Theseshareswillvestoverthenexttwoyears,50%onDecember31,2020,and50%onDecember31,2021.Ifthesharepriceonthegrantdateis$25withaparvalueof$1,here’stheentrytorecordtheissuanceofthoseshares:  Date AccountName DR CR 12/31/19 Contra-equity— deferredcompensation $100,000 CommonStock(parvalue) $4,000 EquityAPIC $96,000 Memo:Torecordtheissuanceofrestrictedstockcompensation Herethedeferredcompensationisrecordedasacontra-equityaccount,withtheoffsettoadditionalpaid-incapital,resultinginanet-zeroeffectonthebalancesheetandincomestatement.Ignoringanychangestothevalueofthestock,thefollowingjournalentrywouldberecordedonDecember31,2020,andagainonDecember31,2021: Date AccountName DR CR 12/31/2X Stock-basedcompensationexpense $50,000 Contra-equity— deferredcompensation $50,000 Memo:TorecordrestrictedstockcompensationforFY2X  Thisaccomplishesthesameneteffectintheendasthefirstmethod.  HowDoStockOptionsWork? Stockoptionsareabitmorecomplexthanrestrictedstockawards.Thesegiverecipientstherighttopurchaseacertainnumberofsharesofcompanystockataspecifiedprice—theexerciseprice—onorafteraspecificdateinthefuture— theexercisedate.Toincentivizeemployeestostay,theycan’texercisetheoptionrightaway,butmustremainemployedoveravestingperiod.Atanytimebetweenthedatethattheoptionsvestandtheyexpire,theoptionholdercanpurchasestockattheexerciseprice.Thisbecomesanincrediblygreatdealiftheexercisepriceislessthanthemarketvaluebecausetheemployeemaybebuyingstockatasubstantialdiscount.  Stockoptionsclearlyhavevalueascompensation,butwhatisthatvalue?Let’ssayanemployeeisgranted1,000optionsatanexercisepriceof$20pershareonadaythatthemarketvalueis$30pershare.Inthatcase,theintrinsicvalueoftheoptionisthedifferencebetweenthetwo,or$10pershare.Iftheoptionsvestedimmediately,thecompanywouldrecordacompensationexpenseof$10,000($10persharex1,000shares).  Butwhathappensoftenisthattheexercisepriceissetatthemarketpriceonthegrantdate.Inthiscase,theintrinsicvalueofthoseoptionsisnowzero,sothecompanywouldn’trecordanycompensationexpense.Becausethisdistortstheactualvalueofcompensationthatemployeesreceive,companiesarerequiredtocalculatethefairvalueoftheoptionsatthegrantdateandrecordthatinthefinancials.ThemostcommonlyusedmethodistheBlackScholesoptionpricingmodel.  SomecompaniesoutsourcethisworktoaconsultantwhospecializesinBlackScholesvaluation,othercompaniesusecaptablesoftwarewiththefunctionalitytocalculatetheBlackScholesmodel,andothercompaniesdoitallinexcel. TheinputstoBlackScholesarethecurrentstockprice,USTreasuryrisk-freerate,thevolatilityofcomparablecompanies’stockprices,andexpectedtermoftheoptions. Hereagain,werunintotroublefornon-publiccompanies— whatisthecurrentstockprice?Currently,FASBisworkingonapracticalexpedientforprivatecompaniesthatwouldalignU.S.GAAPtreatmenttotheIRStreatmentundersection409A.ThisisthesectionoftheIRScodethatprovidesvaluationrulesforstockoptionsfortaxpurposes.  Let’sworkthroughasimpleexampletoseehowthatworks.OnJanuary1,2021,ABCCompanygrantsanemployee1,000optionsthatvestintwoyearsandexpirein10years.Basedonvaluations,thecompanydeterminesthatthemarketvalueofcompanystockis$20pershareandthefairvalueofanoptionis$8.Theparvalueofthestockis$1.Theexercisepriceissetatthecurrentmarketvalueof$20pershare.Multiplyingtheoptionvaluebythenumberofsharesintheoptiongrant,wegetatotalvalueforthestockoptionsof$8,000.ABCCompanywillexpensethecompensationonastraight-linebasisoverthetwo-yearvestingperiod.SoonJanuary1,2022,ABCCompanywillrecordthisasastockoptionexpensejournalentryforhalfoftheoptions:  Date AccountName DR CR 1/1/21 Stockoptioncompensationexpense $4,000 EquityAPIC-stockoptions $4,000 Memo:Torecordstockoptioncompensation  Thesamejournalentrywillalsoberecordedayearlater.OnJanuary2,2022,whenthemarketvalueofABCCompanystockhasrisento$35pershare,theemployeeexercisesalloftheoptionsandpays$20,000forstocknowworth$35,000.Here’sthejournalentrytorecordthattransaction:  Date AccountName DR CR 1/2/22 Cash $20,000 EquityAPIC-StockOptions $8,000 CommonStock(parvalue) $1,000 EquityAPIC $27,000 Memo:Torecordexerciseofstockoptions Oneofthebiggestchallengesofofferingstock-basedcompensationforprivatecompaniesisfiguringoutthevalueofthestockandoptions. Outsourcingthistoaconsultantwhospecializesin409Avaluationscanbepricey,butit’sthebestwaytoensureanobjectiveandfairvalue.  Reconciliation(CLICKHEREFOR3BESTPRACTICEEXCELRECONCILIATIONTEMPLATES) Alwaysmakesureretainedearningsrollforwardyearoveryear! Thereshouldbelineitemsinyourequityreconforallofthestockoptionexpenseovertime. Commonpitfalls Notgettingtimely409Avaluationsdone.Thisgivesyouyourstrikepriceifyou’renotapublicly-tradedcompany. Optionstrikepricesshouldbeissuedinaccordancewiththe409Afindings. Nonstandardoptiongranttermslikedifferentvestingperiodsforemployeescanmakeadministrationdifficultandmayevencreateproblemsforthecompanyoremployeeswhenitcomestimetopayincometax. HowAuditorsAudit Auditorswillspendalotoftimeonequity,especiallyifit’safirst-yearaudit. It’sadvisabletoworkwithacorporateattorneyorataxCPApriortoissuingstockascompensation. They’llcheckthetermsandlookouttopreventfutureheadaches. ChrisSluty NextPost Followus FeaturedPosts 2022Month-EndCloseChecklistExcelTemplate WhatistheMonth-EndCloseProcess? HowtoBookaFixedAssetJournalEntry HowDoYouBookaRevenueRecognitionJournalEntryUnderASC606? HowDoYouBookaDeferredCommissionJournalEntryunderASC606? WhatIsCostofGoodsSold(COGS)inAccounting? 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