 Hello and welcome to this session in which we'll discuss stock appreciation rights. Stock appreciation rights are form of compensation, equity compensation, just like stock options and stock rights. They're more preferable than stock options. So to appreciate, no pun intended, stock appreciation right is to compare them to why they are more preferable than stock options. What are stock options? Stock options is when the company gives you the right to buy the stock, for example, at $10, then let's assume the stock goes up to 15 and let's assume you have 10,000 shares of 10,000 options. What do you have to do? Well, you have to buy the shares. You have to buy the shares. So you have to come up with, if you have to buy the shares at $10 and you have to exercise all your options, not you have to, if you decided to, you have to pay $100,000 upfront to be able to buy the shares. Then you can sell them at 15. And that's really not a major issue because although you may not have the money, you may not have the $100,000, you can borrow it from your broker and immediately buy the shares then sell them. But the real problem with stock options are the tax consequences. What does that mean? Let's assume the stock options are non-qualified options and we're not going to go into this topic a little bit more. If you want to learn about the tax consequences, go to farhatlectures.com. Simply put, if you happen to buy the stocks at 10 and the current price is 15, you still have to pay taxes. Although you don't want to sell them, you just want to keep them because you think the stock is going to rise to 20, 25, you still have to pay taxes. So simply put, paying taxes might create a hardship because you have no, you don't have the ability to pay, nevertheless, the options are taxable. So the difference between 10 and 15, you made basically $50,000 and you have to pay taxes on it. So how is stock appreciation different? Well stock appreciation is you don't have to pay taxes unless you exercise. So the compensation received equal to what we call the share appreciation. Now how do we measure the share appreciation? So if you don't get the shares, you don't have to pay taxes. But what is the share appreciation? Well the share appreciation is the excess market price of the stock at the date of the exercise over a predetermined established price. So the way stock appreciation work is something like this. Let's assume the company granted you $100,000 stock appreciation rights rather than stock options and the pre-established price is $10. So this is the spot that we said we have to have a pre-established price. And when you exercise, let's assume the price is at 15 now and you exercise, well the difference between $5, $15 and $10 is $5, $5 times $100,000, you have a compensation of a half a million. However, you receive those stocks. So you receive the stocks or the cash. So simply put, you don't have to pay any money upfront. And when you receive the cash, you have the ability to pay. Now the stock appreciation right, they can pay you in cash or they can pay you in equity. So we have what's called share-based liability or just shares liability, which shares, which is an equity compensation. So stock appreciation can be classified as equity where you would receive the shares. So rather than giving you half a million in cash, they can give you half a million worth of stocks or they can give you half a million in cash, which is called the share liability. Now let's kind of illustrate the difference a little bit more between share-based compensation, which is the equity part and share-based liability, which is the cash. Well under share-based compensation, the employee, the executive receives shares of stocks rather than cash. That's how they compensate you. How does the company record the expense? Well, the expense is considered as the fair value of the source. So we would assign a fair value like options and we allocate the fair value over the service period of that executive's service period. So you need to be familiar with options. For share-based liability, the employee would receive actually cash. Here the expense is will be accrued, basically an accrued expense over the service period. But what's going to happen over the service period, we're going to have to re-measure the fair value each period until the award is settled. Why? Here's what's going to happen. The option, I'm sorry, the pre-established stock price is $10. Now in year one, at the end of year one, the stock goes up to $15. You have $5 profit per source. Then the stock might go up in year two to $18. Now you have an additional $3. Then the stock might drop to $11. Now we have to go from $18 to $11, so you lost $7. So we keep on adjusting the source. So adjust the cost of the changes and the prorated for the portion of the service period completed. So we have to keep adjusting those compensation. Don't worry, we're going to work an example. Once the service period completed, determine the compensation expense, each subsequent period by reporting the full change in the market price as an adjustment to compensation expense. So once you have earned those source, you may not exercise them. In other words, you may not ask the company to give you the money. You may keep them for several years because that could be an option for you. So if you keep them for several years and the source went from $11 to $13, the company will have to make the adjustment or if they go from $13 to $12, they'll have to make another adjustment again. So the expense will change as the fair market value changes. Don't worry, we're going to work an example to illustrate this concept. The good thing is about source is the changes are done prospectively. Prospectively means you don't have to go back and change the expense from prior period. You just have to change the expense going forward. The best way to illustrate this concept is actually to work an example, which we will. But before we work an example, I would like to remind you whether you are an accounting student or a CPA candidate to take a look at my website, farhatlectures.com. I provide your resources to help you with your CPA exam and your accounting courses. I don't replace your CPA review course nor your accounting courses. My motto is saving CPA candidate and accounting students one at a time. How? By providing resources to help you in your accounting courses and your CPA preparation. This is a partial list of my accounting courses. My CPA supplemental material is aligned with your Becker, Roger, Wiley and Gleam. So it's very easy to go back and forth between my material and your CPA review course. I give you access to 1500 MCQs previously released. Those are released by the AI CPA. So they actually appeared on the CPA exam. That's an addition to thousands of CPA questions and practice questions. If you have not connected with me on LinkedIn, please do so and take a look at my LinkedIn recommendation. Like this recording. It helps me a lot. Connect with me on Instagram. I'm trying to grow my Instagram following Facebook, Twitter and Reddit. So the best way to illustrate stock appreciation right is to actually look at an example. Farhatlectures started a stock appreciation right plan on January 1st, 2021. The plan and title executives receive cash, so it's a liability-based at the date of the exercise for the difference between the market price and the price of the difference between the market price and the pre-established price of $20. And we are granting the executives $100,000. So the value of the source at December 31st, X1, is $4. Simply put, it means the stock price rose to $24. Now the difference between $20 and $24 is $4. And the service period for those executives are two years. So they have to work X1 and X2 with us. So how do we start to compute the expense and how do we record the expense? We're going to prepare this table. For year one, the fair value is $24, so there's additional $4. The cumulative compensation expense is $400,000. Why? The stock price went up $4. We have $100,000 so our cumulative compensating expense is $400,000. Now this $400,000 will have to be spread over two years because the executives will have to work for us two years. So we're going to be using something called the percentage method. So we're going to split this over 50%. And for year one, the cumulative expense accrued to date is only $200,000. Therefore, the expense that we will record for year one is $200,000, which is half of $400,000. We'd have a compensation expense $200,000, credit liability under stock appreciation plan of $200,000. Year two, so this is X1. In year two, the fair value is $7. Simply put, the stock price went to $27,000. Now the cumulative compensating expense recognize is $700,000. Why? Because the difference between $20,000 and $27,000 is $7,000, and we have $100,000 so ours. Now remember, in the prior year, $707,000 times $100,000 to $700,000. In the prior year, we recognized $200,000 of the $700,000. Therefore, in year two, we only have to recognize half a million. Therefore, in year two, we recognize expenses of only half a million. So notice the total is $700,000. $200,000 was already recorded in year one. Therefore, the total expense recognized in year two is $500,000. Therefore, this is the entry that we will make in year two. Now the executives, they were greedy. They did not exercise. They did not want to cash out. In year three, the fair value of the stock went down to $25,000. So it was $27,000. Now the fair value of the stock appreciation right is $5 above the predetermined established price of $20,000. Now the cumulative compensating expense, notice what we do is we keep on adjusting that, is half a million. And by the way, by year two, it's 100% because the executive completed the period of two years. In year three, the period has been, the service period has been met. Therefore, everything is 100%. In year three, the compensating, cumulative compensating expense should be half a million, not $700,000. Therefore, we have to reduce our expense by $200,000. The executive should have exercised by the end of year two, but they did not. They waited, they thought, they've been greedy, the stock price went down. So in year two, we have to reverse $200,000, we have negative expense, we have to credit expense. And that's not normal, but it could happen. If you follow my financial accounting courses, I always say, we never credit expense to make it easy for introductory accounting student, but we do credit expense sometime. And this is an example of it. Therefore, we reduce expenses and we reduce our liability by $200,000 because the stock price went down and we still have that liability to settled. Now we have to keep in mind that we have a liability under SARS, a liability under SARS of $700,000. Now we reduced it, $200,000, what's left is half a million. And let's assume now the executive gave up and wants to cash out, wants to cash out. Therefore, they want to settle the liability, that means they want to cash out. We're gonna debit the liability, $500,000, because that's it. They don't want to wait anymore, they want their money. And we're gonna credit cash half a million and this is what happened in year three. So notice this happened in year three and this happened in year three because the executive decided to just settled. Now usually there's a limit in time, maybe they have five years to settle, but they decided to settle. So in case we have X4, we have to determine what happened after $5, did it go down to $3, did it go up to $9, we have to make certain adjustments. The point is it's accumulative and you have to keep track of it. Now the best way to learn about SARs and other topics is to go to my website farhatlectures.com and work additional MCQs, additional practice questions, look at additional resources. Farhat Lectures is your resources for your accounting courses as well as your CPA exam. Don't shortchange yourself. Your accounting career is important. Your accounting courses are important. You have a strong background so you will succeed on the exam. This way you can focus on your career, move on and have a good life. It's worth it, invest. Good luck, study hard and of course, stay safe.