Impact of Accounting Standards Update
Impact of Accounting Standards Update
Accounting 5102 – Written Assignment
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The Main Question
The main issue is the impact of Accounting Standards Update 2016-09 on the financial reports of one of your clients, Edina Electronics. You can ignore any tax effects, and changes in accounting for the tax effects of share based compensation. Below are more details on your client and the purpose of the report.
The Setting
For this assignment, you will assume that you work for a consulting firm that advises clients on accounting issues. One of your clients, Edina Electronics, is a privately-held technology company. Your client has publicly traded debt, and thus has to register with the Securities and Exchange Commission. It does not have publicly traded equity, but expects to do an IPO in 3-4 years. It has not started this process yet. The CEO and operations staff of your client company are not accountants, but they are familiar with basic financial statements. The company is currently using US GAAP.
You have been retained by your client to summarize the appropriate financial statement presentation and disclosures, under generally accepted accounting principles, relating to the specific issues and information described below. You will be presenting your report to the CEO and other members of the operations staff.
Because of the diverse nature of this audience, the use of examples will be especially helpful. However, since your audience does not have an accounting background, technical jargon should be used sparingly, and when used, definitions should be provided. Also, since the audience does not have an accounting background, the use of notation such as debits and credits when presenting examples would be unhelpful.
However, since your audience does have some familiarity with the basic financial statements, your report should include some mention of how the income statement, balance sheet, and statement of cash flows will be impacted when the company changes its reporting to be in compliance with the new standard.
The Specifics
Your report should address how Accounting Standards Update 2016-09 affects the financial reports of Edina Electronics, with specific consideration of the following:
– Like many other private technology companies, Edina relies heavily on stock options to attract and retain employees.
– Edina regularly issues the following types of options to its employees:
o Stock options with service based vesting. All stock options are settled in equity.
o Share Appreciation Rights (SAR) with service based vesting. All SARs are settled exclusively in cash.
Accounting 5102 – Written Assignment
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– Since the number of employees is still relatively small, Edina has difficulty in estimating the expected likelihood of employees leaving and/or exercising their options and similar instruments. Historically, Edina has assumed that 5% of employees leave each year, and that the expected term of the options/SARs is one year less than the contractual term. However, these assumptions have not proven to be very accurate.
– If an employee leaves the firm any vested options need to be exercised within 30 days after departure.
– Edina uses the fair value method for all options and similar instruments.
– Edina uses the Black Scholes model to estimate the fair value of the options and similar instruments, so you can ignore statements in the codification about other valuation models (e.g. lattice models).
– You are encouraged to use simple numerical examples to illustrate your points. At a minimum you should discuss (the changes in) the accounting treatment for the following data. A typical annual grant consists of the following (all are issued at the beginning of the year):
o 10,000 stock options issued at the money. The options become exercisable after 4 years, and expire after 10 years.
o 10,000 share appreciation rights (SAR) issued at the money. The SARs become exercisable after 3 years, and expire after 9 years.
o Assume that the fair value of a share is $40 on the grant date, and that the Black-Scholes values per option/SAR are as follows (as a function of the expected life of the options/SARs):
Expected life
Fair value
3 years
9.68
4 years
11.33
5 years
12.80
6 years
14.12
7 years
15.33
8 years
16.45
9 years
17.49
10 years
18.46
o Assume that by the end of the first year, the share price has gone up by $5 per share, and the option/SAR price has gone up by $3 (relative to the table above). Forfeitures were 5% in the first year, but Edina now expects that it will be 8% in each of the remaining years.
– Show the impact on the compensation expense under each of the allowable methods for the first year of these grants.
Accounting 5102 – Written Assignment
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Helpful hints
– The treatment in Chapter 16 is simplified and incomplete. Do not assume that this exactly matches current GAAP. Instead, study the codification. Feel free to search for other sources as well.
– Feel free to check finance textbooks or online sources to learn more about the Black Scholes model.
– When describing the impact of the standard, don’t just focus on the facts (e.g. Edina should switch from method A to method B) but also consider the implications (e.g., earnings go up/down, become more/less volatile) and practical considerations (what needs to be estimated and how often). When the GAAP allows for multiple methods discuss some considerations for the choice amongst the methods.
– Keep in mind that the audience is not an accounting expert, so don’t assume too much knowledge and don’t be afraid to state the obvious, e.g. “provision X applies/does not apply to Edina, because …”
– Make sure to clearly describe what you are doing in the numerical example. That way we can assign partial credit even if you didn’t get everything right. Don’t just paste in the output of an Excel spreadsheet.
Sources and Citations
In writing your paper, you may certainly use secondary sources other than those provided by the FASB. However, please be sure that any outside sources are properly cited. Whenever possible, it is preferred to cite primary sources rather than secondary sources, e.g., cite US GAAP from the codification directly rather than from what others (e.g. textbooks or accounting firms) claim about US GAAP.
Format:
The paper should include a cover page, with your name presented in the upper right corner, as well as the course number (Accounting 5102) and the semester (Fall 2016).
