Lesson 55 - Intermediate Accounting Course 

55. Stock-Based Compensation and Its Accounting Treatment

Stock-based compensation (SBC) is a method companies use to reward employees, executives, and other stakeholders by granting them shares or stock options instead of cash. This approach aligns the interests of employees with those of shareholders, as compensation is tied to the company's stock performance.

However, stock-based compensation creates accounting complexities, especially regarding valuation, expense recognition, and tax implications. Companies must properly account for SBC under financial reporting standards such as IFRS 2 (Share-Based Payment) and ASC 718 (Compensation—Stock Compensation, under US GAAP).

1️⃣ Types of Stock-Based Compensation

There are several forms of stock-based compensation, but the two most common are:

1. Stock Options

Employees receive the right to purchase company stock at a fixed price (exercise price) after a certain period (vesting period). If the stock price increases, employees can buy shares at a discount and make a profit.

🔹 Example: A company grants an employee 1,000 stock options at an exercise price of $50 per share. If the stock price rises to $80, the employee can buy shares at $50 and immediately sell them for a $30 profit per share.

2. Restricted Stock Units (RSUs)

RSUs are company shares awarded to employees but subject to a vesting schedule. Once vested, the shares are delivered to the employee, who can sell them at market value.

🔹 Example: A company grants 500 RSUs that vest over four years. Each year, the employee receives 125 shares.

Other stock-based compensation forms include:
✔ Employee Stock Purchase Plans (ESPPs)
✔ Performance Stock Units (PSUs)
✔ Stock Appreciation Rights (SARs)

2️⃣ Accounting for Stock-Based Compensation

Under both IFRS and US GAAP, companies must recognize SBC as an expense in the income statement over the vesting period.

Step 1: Determine the Fair Value

✔ For stock options, companies typically use the Black-Scholes Model or the Binomial Model to estimate fair value.
✔ For RSUs, fair value is simply the stock’s market price on the grant date.

Step 2: Expense Recognition

✔ The total stock-based compensation expense is spread over the vesting period.
✔ Companies record SBC as an expense in the income statement and increase equity in the balance sheet.

Example:
A company grants 1,000 stock options to an employee with a fair value of $10 per option and a four-year vesting period.

✔ Total Compensation Cost = 1,000 × $10 = $10,000
✔ Annual Expense = $10,000 ÷ 4 = $2,500 per year

Journal Entry (Each Year During Vesting Period)

Dr. Compensation Expense $2,500
Cr. Additional Paid-in Capital (Equity) $2,500

3️⃣ Impact on Financial Statements 

4️⃣ Tax Implications of Stock-Based Compensation

✔ Stock options are typically not taxable at the grant date.
✔ Employees pay taxes when they exercise options or sell shares.
✔ Companies can claim a tax deduction when employees exercise stock options, reducing taxable income.

5️⃣ Key Takeaways

✔ Stock-based compensation includes stock options, RSUs, and other equity-based incentives.
✔ SBC is recognized as an expense over the vesting period, reducing net income.
✔ Stock options require valuation models like Black-Scholes, while RSUs use market price.
✔ Companies benefit from tax deductions when employees exercise options.