CON 6 defines stockholder’s equity as the residual interest in the assets of an entity after deducting its liabilities. Stockholders’ equity is comprised of all capital contributed to the entity plus its accumulated earnings less any distributions that have been made.
There are three major categories within the equity section: paid-in capital, retained earnings, and other comprehensive income. Paid-in capital represents equity contributed by owners. Retained earnings represents the sum of all earnings less that not retained in the business (i.e., what has been paid out as dividends). Other comprehensive income represents changes in net assets, other than by means of transactions with owners, which have not been reported in earnings under applicable GAAP rules (e.g., accumulated translation gains or losses). What else?
This post outlines essential terms and definitions relate to stockholder’s equity. It does not meant to be all inclusive, but most essential terms are well defined, extracted from the IFRS, IAS, FASB, Accounting Concept Framework, and the latest GAAP Codification or well known as “Accounting Standard Codification [ASC]“. Enjoy!
Stock Holder’s Equity Terms and Definitions
Additional paid-in capital – Amounts received at issuance in excess of the par or stated value of capital stock and amounts received from other transactions involving the entity’s stock and/or stockholders. It is classified by source.
Allocated shares – ESOP shares assigned to individual participants. These shares are usually based on length of service, compensation or a combination of both.
Appropriation (of retained earnings) – A segregation of retained earnings to communicate the unavailability of a portion for dividend distributions.
Authorized shares – The maximum number of shares permitted to be issued by a corporation’s charter and bylaws.
Blackout period – A period of time during which exercise of an equity share option is contractually or legally prohibited.
Broker-assisted cashless exercise – The simultaneous exercise by an employee of a share option and sale of the shares through a broker.
Calculated value – A measure of the value of a share option or similar instrument determined by substituting the historical volatility of an appropriate industry sector index for the expected volatility of a nonpublic entity’s share price in an option-pricing model.
Callable – An optional characteristic of preferred stock allowing the corporation to redeem the stock at specified future dates and at specific prices. The call price is usually at or above the original issuance price.
Cliff vesting – A condition of an option or other stock award plan which provides that the employee becomes fully vested at a single point in time.
Closed-form model – A valuation model that uses an equation to produce an estimated fair value. The Black-Scholes-Merton formula is a closed-form model.
Combination plans – Awards consisting of two or more separate components, such as options and stock appreciation rights, each of which can be exercised. Each component is actually a separate plan and is accounted for as such.
Committed-to-be-released shares – ESOP shares that will be allocated to employees for service performed currently. They are usually released by payment of debt service.
Compensatory plan – A stock option or similar plan including elements of compensation which are recognized over the service period.
Comprehensive income – The change in equity of a business enterprise during a period from transactions and other events and circumstances from nonowner sources. It includes all changes in equity during a period, except those resulting from investments by and distributions to owners.
Constructive retirement method – Method of accounting for treasury shares which treats the shares as having been retired. The shares revert to authorized but un-issued status. The stock and additional paid-in capital accounts are reduced, with a debit to retained earnings or a credit to a paid-in capital account for the excess or deficiency of the purchase cost over or under the original issuance proceeds.
Contributed capital – The amount of equity contributed by the corporation’s shareholders. It consists of capital stock plus additional paid-in capital.
Convertible – An optional characteristic of preferred stock allowing the stockholders to exchange their preferred shares for common shares at a specified ratio.
Cost method – Method of accounting for treasury shares which presents aggregate cost of reacquired shares as a deduction from the total of paid-in capital and retained earnings.
Cross-volatility – A measure of the relationship between the volatilities of the prices of two assets taking into account the correlation between movements in the prices of the assets. (Refer to the definition of volatility.)
Cumulative – An optional characteristic of preferred stock. Any dividends of prior years not paid to the preferred shareholders must be paid before any dividends can be distributed to the common shareholders.
Date of declaration – The date on which the board of directors votes that a dividend shall be paid. A legal liability (usually current) is created on this date in the case of cash, property, and scrip dividends.
Date of grant – The date on which the board of directors awards the stock to the employees in stock option plans.
Date of payment – The date on which the shareholders are paid the declared dividends.
Date of record – The date on which ownership of the shares is determined. Those owning stock on this date will be paid the declared dividends.
Deficit – A debit balance in the retained earnings account. Dividends may not generally be paid when this condition exists. Formally known as accumulated deficit.
What is Derived Service Period?
A service period for an award with a market condition that is inferred from the application of certain valuation techniques used to estimate fair value. For example, the derived service period for an award of share options that the employee can exercise only if the share price increases by 10% at any time during a 4-year period can be inferred from certain valuation techniques. If the derived service period is three years, the estimated requisite service period is three years and all compensation cost would be recognized over that period, unless the market condition was satisfied at an earlier date. Also, an award of fully vested, deep out-of-the money share options has a derived service period that must be determined from the valuation techniques used to estimate fair value. (See also explicit service period, implicit service period and requisite service period).
Discount on capital stock – Occurs when the stock of a corporation is originally issued at a price below par value. The original purchasers become contingently liable to creditors for this difference.
Economic interest in an entity – Any type or form of pecuniary interest or arrangement that an entity could issue or be a party to, including equity securities; financial instruments with characteristics of equity, liabilities, or both; long-term debt and other debt-financing arrangements; leases; and contractual arrangements such as management contracts, service contracts, or intellectual property licenses.
What is Employee in Term with Share-based Compensation?
An individual over whom the grantor of a share-based compensation award exercises or has the right to exercise sufficient control to establish an employer-employee relationship based on common law as illustrated in case law and currently under US Internal Revenue Service Revenue Ruling 87-41.171. A grantee meets the definition of an employee if the grantor consistently represents that individual to be an employee under common law.
The definition of an employee for payroll tax purposes under the US Internal Revenue Code includes common law employees. Accordingly, a grantor that classifies a grantee potentially subject to US payroll taxes as an employee for purposes of applying ASC 718 also must represent that individual as an employee for payroll tax purposes (unless the grantee is a leased employee). A leased individual is deemed to be an employee of the lessee for purposes of ASC 718 if all of a series of requirements are met, as defined in the ASC Master Glossary. For purposes of ASC 718, and only for awards granted for service as directors, nonemployee directors acting in their role as members of a board of directors are treated as employees if those directors were (a) elected by the employer’s shareholders or (b) appointed to a board position that will be filled by shareholder election when the existing term expires.
Employee stock ownership plan (ESOP) – A form of defined contribution employee benefit plan, whereby the employer facilitates the purchase of shares of stock in the company for the benefit of the employees, generally by a trust established by the company. The plan may be leveraged by borrowings either from the employer-sponsor or from third-party lenders.
Equity restructuring – A nonreciprocal transaction between an entity and its shareholders— such as a stock dividend, stock split, spin-off, rights offering, or recapitalization through a large, nonrecurring cash dividend—that causes the per-share fair value of the shares underlying an option or similar award to change.
Excess tax benefit – The realized tax benefit related to the amount (caused by changes in
the fair value of the entity’s shares after the measurement date for financial reporting) of deductible compensation cost reported on an employer’s tax return for equity instruments in excess of the compensation cost for those instruments recognized for financial reporting purposes.
Explicit service period – A service period that is explicitly stated in the terms of a sharebased payment award. An award that vest after three years of continuous employee service from the grant date has an explicit service period of three years. (See also derived service period, implicit service period, and requisite service period.)
Fair value – The amount at which an asset (or liability) could be bought (or incurred) or sold (or settled) in a current transaction between willing parties, that is, other than in a forced or liquidation sale.
Fixed options – Options that grant the holder the rights to a specified numbers of shares at fixed prices. They are not dependent upon achievement of performance targets.
Freestanding financial instrument – A financial instrument that is entered into separately and apart from any of the entity’s other financial instruments or equity transactions or that is entered into in conjunction with some other transaction and is legally detachable and separately exercisable.
Graded vesting – A vesting process whereby the employee becomes entitled to a stockbased award fractionally over a period of years.
Grant date – The date at which employer and employee reach a mutual understanding of the key terms and conditions of a share-based payment award. The employer becomes contingently obligated on the grant date to issue equity instruments or transfer assets to an employee who renders the requisite service. Awards made under an arrangement that is subject to shareholder approval are not deemed to be granted until that approval is obtained, unless approval is essentially perfunctory. Individual awards that are subject to approval by the board of directors, management, or both are not deemed to be granted until all such approvals are obtained. The grant date for an award of equity instruments is the date that an employee begins to benefit from, or be adversely affected by, subsequent changes in the price of the employer’s equity shares. (See also service inception date).
Implicit service period – A service period that is not explicitly stated in the terms of a share-based payment award but that may be inferred from an analysis of those terms and\ other facts and circumstances. For instance, if an award of share options vests upon the completion of a new product design, which is deemed probable in 18 months, then the implicit service period is 18 months. (See also derived service period, explicit service period, and requisite service period.)
Intrinsic value – The amount by which the fair value of the underlying stock exceeds the option exercise price. A nonvested share may be described as an option on that share with an exercise price of zero. Thus, the fair value of a share is the same as the intrinsic value of such an option on that share.
Issuance costs – The costs incurred in underwriting an equity offering, to be reported as reductions of paid-in capital.
Issuance of equity instrument – An equity instrument is issued when the issuing entity receives the agreed-upon consideration, which may be cash, an enforceable right to receive cash or another financial instrument, goods or services. An entity may conditionally transfer an equity instrument to another party under an arrangement that permits that party to choose at a later date or for a specified time whether to deliver the consideration or to forfeit the right to the conditionally transferred instrument with no further obligation. In that situation, the equity instrument is not issued until the issuing entity has received the consideration. ASC 718 does not use the term issued for the grant of stock options or other equity instruments subject to vesting conditions.
Issued stock – The number of shares issued by the firm and owned by the shareholders and the corporation. It is the sum of outstanding shares plus treasury shares.
Junior stock – Shares with certain limitations, often as to voting rights, which are granted to employees pursuant to a performance compensation program. Such shares are generally convertible to ordinary shares upon achievement of defined goals.
Lattice model – A multiperiod model that produces an estimated fair value based on the assumed changes in prices of a financial instrument over successive periods. The binomial model is a lattice model. In each time period, the model assumes that at least two price movements are possible. The lattice represents the evolution of the value of either a financial instrument or a market variable for the purpose of valuing a financial instrument. In this context, a lattice model is based on risk-neutral valuation and a contingent claims framework. (Refer to closed form model for an explanation of the terms risk-neutral valuation and contingent claims framework.)
Legal capital – The aggregate par or stated value of stock. It represents the amount of owners’ equity that cannot be distributed to shareholders. It serves to protect the claims of the creditors.
Liquidating dividend – A dividend distribution that is not based on earnings. It represents a return of contributed capital.
Market condition – A condition affecting the exercise price, exercisability, or other factors used in determining the fair value of an award under a share-based payment arrangement that relates to the achievement of either (a) a specified price of the issuer’s shares or a specified amount of intrinsic value indexed solely to the issuer’s shares, or (b) a specified price of the issuer’s shares in terms of a similar (or index of similar) equity security (securities).
Measurement date – The date at which the equity share price and other factors (e.g., expected volatility) that enter into measurement of the total recognized amount of compensation cost for an award of share-based payment become fixed.
Modification – A change in any of the terms or conditions of a share-based payment award.
Non-compensatory stock options – Options which do not include an element of compensation. Under ASC 718 most stock plans include an element of compensation to be measured and allocated over the service periods of the employees or to be disclosed as such in the notes to the financial statements.
Non-public entity – Any entity other than one (1) whose equity securities trade in a public market either on a stock exchange or in the over-the-counter market, including securities quoted only locally or regionally, (2) that makes a filing with a regulatory agency in preparation for the sale of any class of equity securities in a public market, or (3) that is controlled by an entity covered by (1) or (2). An entity that has only debt securities trading in a public market (or that has made a filing with a regulatory agency in preparation to trade only debt securities) is a nonpublic entity for purposes of ASC 718.
Non-vested shares – Shares that an entity has not yet issued because the agreed-upon consideration, such as employee services, has not yet been received.
No-par stock – Stock that has no par value. Sometimes a stated value is determined by the board of directors. In this case, the stated value is accorded the same treatment as par value stock.
Outstanding stock – Stock issued by a corporation and held by shareholders (i.e., issued shares that are not held in the treasury).
Par value method – A method of accounting for treasury shares which charges the treasury stock account for the aggregate par or stated value of the shares acquired and charges the excess of the purchase cost over the par value to paid-in capital and/or retained earnings.
A deficiency of purchase cost is credited to paid-in capital.
Participating – An optional characteristic of preferred stock whereby preferred shareholders may share ratably with the common shareholders in any profit distributions in excess of a predetermined rate. Participation may be limited to a maximum rate or may be unlimited (full).
Performance-based options – Options that are granted to employees conditional on the achievement of defined goals, such as market price of the underlying stock or earnings of the entity.
Performance condition – A condition affecting the vesting, exercisability, exercise price, or other pertinent factors used in determining the fair value of an award that relates to both (1) an employee’s rendering service for a specified (either explicitly or implicitly) period of time, and (2) achieving a specified performance target that is defined solely by reference to the employer’s own operations (or activities). Attaining a specified growth rate in return on assets, obtaining regulatory approval to market a specified product, selling shares in an initial public offering or other financing event, and a change in control are examples of performance conditions for purposes of ASC 718. A performance target also may be defined by reference to the same performance measure of another entity or group of entities.
Phantom stock plan – A type of stock compensation arrangement that gives employees the right to participate in the increase in value of the company’s shares (book value or market value, as stipulated in the plan), without being required to actually purchase the shares initially.
Public entity – An entity (1) with equity securities that trade in a public market, which may be either a stock exchange or an over-the-counter market, including securities quoted only locally or regionally, (2) that makes a filing with a regulatory agency in preparation for the sale of any class of equity securities in a public market, or (3) that is controlled by an entity covered by (1) or (2).
Quasi reorganization – A procedure that reclassifies amounts from contributed capital to retained earnings to eliminate a deficit in that account. All the assets and liabilities are first revalued to their current values. It represents an alternative to a legal reorganization in bankruptcy proceedings.
Reload feature and reload option – A reload feature provides for automatic grants of additional options whenever an employee exercises previously granted options using the entity’s shares, rather than cash, to satisfy the exercise price. At the time of exercise using shares, the employee is automatically granted a new option, called a reload option, for the shares used to exercise the previous option.
Replacement award – An award of share-based compensation that is granted (or offered to grant) concurrently with the cancellation of another award.
Requisite service period – The period or periods during which an employee is required to provide service in exchange for an award under a share-based payment arrangement. The requisite service period for an award that has only a service condition is presumed to be the vesting period, unless there is clear evidence to the contrary. If an award requires future service for vesting, the entity cannot define a prior period as the requisite service period. Requisite service periods may be explicit, implicit, or derived, depending on the terms of the share-based payment award.
What is Restricted share?
A share for which sale is contractually or governmentally prohibited for a specified period of time. Most grants of shares to employees are better termed non-vested shares because the limitation on sale stems solely from the forfeitability of the shares before employees have satisfied the necessary service or performance condition(s) to earn the rights to the shares. Restricted shares issued for consideration other than employee services, on the other hand, are fully paid immediately.
For those shares, there is no period analogous to a requisite service period during which the issuer is unilaterally obligated to issue shares when the purchaser pays for those shares, but the purchaser is not obligated to buy the shares.
ASC 718 uses the term restricted shares to refer only to fully vested and outstanding shares whose sale is contractually or governmentally prohibited for a specified period of time. (See also non-vested shares).
Restriction – A contractual or governmental provision that prohibits sale (or substantive sale by using derivatives or other means to effectively terminate the risk of future changes in the share price) of an equity instrument for a specified period of time.
Retained earnings – The undistributed earnings of a firm.
Service condition – A condition affecting the vesting, exercisability, exercise price, or other pertinent factors used in determining the fair value of an award that depends solely on an employee rendering service to the employer for the requisite service period. A condition that results in the acceleration of vesting in the event of an employee’s death, disability, or termination without cause is a service condition.
Service inception date – The date at which the requisite service period begins. The service inception date usually is the grant date, but the service inception date may differ from the grant date.
Service period – The period over which a stock-based compensation award is earned by the recipient. If not otherwise defined in the plan, it is the vesting period. Under ASC 718, if performance conditions affect either exercise price or date, then the service period must be consistent with the related assumption used in estimating fair value.
Settlement of an award – An action or event that irrevocably extinguishes the issuing entity’s obligation under a share-based payment award. Transactions and events that constitute settlements include (1) exercise of a share option or lapse of an option at the end of its contractual term, (2) vesting of shares, (3) forfeiture of shares or share options due to failure to satisfy a vesting condition, and (4) an entity’s repurchase of instruments in exchange for assets or for fully vested and transferable equity instruments. The vesting of a share option is not a settlement as that term is used in ASC 718 because the entity remains obligated to issue shares upon exercise of the option.
Share option – A contract that gives the holder the right, but not the obligation, either to purchase (or call) or to sell (to put) a certain number of shares at a predetermined price for a specified period of time. Most share options granted to employees under share-based compensation arrangements are call options, but some may be put options.
Share unit – A contract under which the holder has the right to convert each unit into a specified number of shares of the issuing entity.
Share-based payment (or compensation) arrangement – An arrangement under which (a) one or more suppliers of goods or services (including employees) receive awards of equity shares, equity share options, or other equity instruments, or (b) the entity incurs liabilities to suppliers (1) in amounts based, at least in part, on the price of the entity’s shares or other equity instruments, or (2) that require or may require settlement by issuance of the entity’s shares. For purposes of ASC 718, the term shares includes various forms of ownership interest that may not take the legal form of securities (for example, partnership interests), as well as other interests, including those that are liabilities in substance but not in form. Equity shares refers only to shares that are accounted for as equity.
Share-based payment (or compensation) transaction – A transaction under a sharebased payment arrangement, including a transaction in which an entity acquires goods or services because related parties or other holders of economic interest in that entity awards a share-based payment to an employee or other supplier of goods or services for the entity’s benefit.
Short-term inducement – An offer by the entity that would result in modification or settlement of an award to which an award holder may subscribe for a limited period of time.
Small business issuer – A public entity that is an SEC registrant that files as a small business issuer under the Securities Act of 1933 or the Securities Exchange Act of 1934.
Stock-based compensation – Compensation arrangements under which employees receive shares of stock, stock options, or other equity instruments, or under which the employer incurs obligations to the employees based on the price of the company’s shares.
Stock options – Enable officers and employees of a corporation to purchase shares in the corporation at a predetermined price for a defined period of time.
Stock rights – Enables present shareholders to purchase additional shares of stock of the corporation. They are commonly used if a preemptive right is granted to common shareholders by some state corporation laws.
Suspense shares – ESOP shares that usually collateralize ESOP debt. They have not been allocated or committed to be released.
Tandem plans – Compensation plans under which employees receive two or more components, such as options and stock appreciation rights, whereby the exercise of one component cancels the other(s).
What is “Terms of a share-based payment award”?
The contractual provisions that determine the nature and scope of a share-based payment award. For example, the exercise price of share options is one of the terms of an award of share options.
The written terms of a share-based payment award and its related arrangement, if any, usually provide the best evidence of its terms, but an entity’s past practice or other factors may indicate that some aspects of the substantive terms differ from the written terms.
The substantive terms of a share-based payment award as those terms are mutually understood by the entity and a party (either an employee or a nonemployee) who receives the award provide the basis for determining the rights conveyed to a party and the obligations imposed on the issuer, regardless of how the award and related arrangement, if any, are structured.
Time value of an option – The portion of the fair value of an option that exceeds its intrinsic value.
Treasury stock – Shares of a corporation that have been repurchased by the corporation. This stock has no voting rights and receives no cash dividends. Some states do not recognize treasury stock. In such cases, reacquired shares are treated as having been retired.
Vesting. Literally, to earn the rights to certain benefits. A share-based payment award becomes vested at the date that the employee’s right to receive or retain shares, other instruments, or cash under the award is no longer contingent on satisfaction of either a service condition or a performance condition. Market conditions are not vesting conditions for purposes of ASC 718. The stated vesting provisions of an award often establish the requisite service period, and an award that has reached the end of the requisite service period is vested. However, the stated vesting period may differ from the requisite service period in certain circumstances.
What is Volatility?
A measure of the amount by which a financial variable such as a share price has historically fluctuated or is expected to fluctuate during a period. Volatility also may be defined as a probability-weighted measure of the dispersion of returns about the mean. The volatility of a share price is the standard deviation of the continuously compounded rates of return on the share over a specified period. That is the same as the standard deviation of the differences in the natural logarithms of the stock prices plus dividends, if any, over the period. The higher the volatility, the more the returns on the shares can be expected to vary— up or down. Volatility is typically expressed in annualized terms.