Incentive Programs for Restaurateurs: Part 2

In addition to short term incentives discussed in the first installment in this series, there are many long-term incentives (LTIs) available for businesses to apply when attracting and retaining key talent. If you’re a restaurateur that envisions using equity to share your operation’s long-term growth with key employees, you’re likely considering using restricted stock or stock options.

Restricted stock
Restricted stock is similar to common stock in a company, with one main difference: the employee you issue the restricted stock to can’t sell until it vests. That means there is a requirement that must be met, whether it’s a time-based or a performance-based requirement, before the key employee can sell or monetize the stock. If the key employee leaves before the restricted stock vests, the shares are typically forfeited and that employee does not realize any of the potential gains in value since they were granted. In addition, any expense previously recognized is reversed.  Restricted stock also has very specific tax and accounting implications that not only affect your operation, but may also have consequences for those employees, if not fully understood.

Before we consider the accounting for stock granted to an employee as compensation, let’s first consider how to account for a sale of stock.  Imagine that ABC Corporation, a fictitious entity, decides to issue 1,000 shares of $100 cumulative nonparticipating preferred stock with a 6 percent dividend rate. Like common stock, preferred stock can be issued for more than par value. If that is the case, the additional funds are placed into an additional paid-in capital account that is separate from the common additional paid-in capital account. For this example, we’ll say that ABC issues the shares for $105.
Account Names Debits Credits
Cash 105,000*  
     Preferred Stock, $100 par value   100,000
     Additional Paid-in Capital – Preferred Stock   5,000
(*) $105,000 = $105 x 1,000

A cash dividend at the end of the first year is handled in a similar manner to common stock dividends. Again, you must separate preferred dividends from common dividends.
Account Names Debits Credits
Preferred Dividends 6,000*  
     Cash   6,000
(*) $6,000 = 1,000 shares x $6
Note, if the dividends are not paid on cumulative preferred stock, a liability for dividends in arrears is not reported on the balance sheet. Instead, the company discloses the amount in financial statement notes.
Stock options
Stock options are another popular form of equity that restaurateurs apply. Stock options differ from restricted stock in that when they are initially granted, they are not considered stock but still have a dilutive effect on the company.

Like restricted stock, stock options have a number of tax and accounting issues that may impact both your operation and your key employees’ personal tax and financial positions. 
Accounting for Stock Compensation
All stock plans are assumed to be a form of compensation, which requires recognition of an expense under U.S. Generally Accepted Accounting Principles (GAAP). In the case of grants of restricted stock, the fair value of stock on the date of grant represents the amount of expense to be recognized.  For stock options, the amount of the expense is the fair value of the options, but that value is not apparent from the exercise price and the market price alone. Determination of the value requires the utilization of an appropriate option pricing model (e.g. Black-Scholes model).

Assuming equity classification[1] of the restricted stock and stock options, the expense is recorded equally throughout the entire vesting period, which is the time between the date the company grants the stock or options and when the individual is allowed to exercise the option or sell the stock. In other words, U.S. GAAP considers the stock or options earned by the employee during the vesting period. The entry credit applies to a special additional paid-in capital account.

Consider a scenario where ABC Corporation grants its CEO 5,000 stock options on January 1, 20X4. Each option allows the CEO to purchase 1 share of $1-par-value stock for $80 on December 31, 20X7. The current market value of the stock is $75. The value of one stock option calculated using an option pricing model is $10. Each year, the company will record the following compensation entry:
Account Names Debits Credits
Compensation expense 12,500  
       Additional paid-in capital – stock options   12,500
The total value of the options is $50,000 (5,000 x $10), and the vesting period is four years, so each year the company will record $12,500 of compensation expense related to the options. If the options are exercised, the additional paid-in capital built up during the vesting period is reclassified. The stock’s market value is irrelevant to the entry, the credit to additional paid-in capital (common stock) is to balance the entry and is not related to market value.
Account Names Debits Credits
Cash 400,000  
Additional paid-in capital – stock options 50,000  
       Common stock   5,000
       Additional paid-in capital – common stock   445,000
If the options are not used before the expiration date, the balance in additional paid-in capital is shifted to a separate APIC account to differentiate it from stock options that are still outstanding.  If the CEO leaves the company prior to the end of the vesting period, the options will be forfeited.  In that case, any expense previously recognized is reversed through a credit to earnings, and the APIC account is reversed as well.

In case you missed it, check out part one of this series exploring short-term incentives and stay tuned for part three of this series where we discuss pseudo-equity long-term incentives.

For more information on incentive programs for restaurants, contact Randy Ramirez at [email protected] or Vince Stasiulewicz at [email protected]. And be sure to keep up with the Restaurant Practice’s latest thoughts by subscribing to our blog on the Selections homepage here and following us on Twitter at @BDORestaurant.

This article is intended for educational purposes only and does not substitute guidance from your legal, tax or accounting professional.
[1] Stock-based compensation that can or is required to be settled in cash may result in liability classification, in which case the accounting treatment is different than that discussed above.  Accounting for liability-classified employee compensation is beyond the scope of this blog.