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Selecting A Software Solution For Equity Compensation Accounting

I. Overview

Equity compensation is an item of keen interest in the executive suite and in the boardroom. It is closely scrutinized by many outside of the company, including shareholder groups and regulators. As such, equity compensation is a high profile item that needs to be calculated accurately.

The best plans align incentives with company performance, carefully weighed against the market for managerial talent. Meeting these competing objectives creates complexity. And complexity increases the risk of error.

The accounting risk associated with equity compensation can be addressed by software. This paper examines the criterion for selecting the best software for handling the accounting issues that are associated with equity compensation.


II. Understanding the problem

Complexities in equity compensation accounting arise from features and conditions such as performance shares, liability awards, forfeiture adjustments, immediate vesting conditions, or accelerated amortization schedules. Until recently, out-of-the-box software could not support complex features and conditions. Companies facing such complexity therefore had three imperfect choices. First, the company could create its own manual spreadsheets. Second, it could purchase costly, non-integrated and customized service–based solutions. Or third, it could purchase off-the-shelf software that did not provide customizations, in which the most complex areas of equity compensation accounting still needed to be supported through spreadsheets.


III. Optimal solution embraces changes in projections

Service-oriented firms and software-based vendors have attempted to retool their platforms for changes in demand for support of new, complex incentive plans. While most solutions will still require companies to support complex scenarios in spreadsheets, many now claim to support complexities out-of-the-box. In choosing a solution, accounting personnel must exercise due diligence to determine if software supports accounting for performance shares or other complexities without spreadsheets. Fundamentally, automating the accounting for complex incentive plans requires software to accommodate modifications as plan conditions change.


Let’s take a typical complex plan: Company PerformCo has performance shares with three terms. First, shares vest based on how PerformCo’s EPS performs relative to a competitor’s EPS. Second, PerformCo requires at least six months of service before acceleration of vesting is allowed for retirement eligibility. Third, amortization and vesting occur immediately in the case of termination due to a business combination. Determining the compensation expense under this plan requires the accounting system to integrate information about competitor’s performance, employee service time, and, rarely but importantly, equity restructuring.


PerformCo’s plan has a performance target in which the shares that vest change depending on Company’s relation to the target. Further, the grantees under the plan are subject to different vesting schedules depending on retirement eligibility or termination, which means vesting schedules change during vesting. PerformCo’s plan has one aspect in common, modifications. Therefore, the system of choice must support and allow users to control modifications, whether it is modifications of shares, schedules or participants.


IV. Illustrating modification solutions further

To better understand how a software platform incorporates modifications, break down the accounting implications of PerformCo’s plan. First, the software solution must permit modifications arising from changing projections. PerformCo’s accounting personnel must determine how many shares will vest during the vesting period and adjust the cumulative compensation expense accordingly. Outlook, or the expected amount of shares determined to vest however, can change periodically. In a software solution, the only way to account for changes in outlook is to multiply the inputted number of shares awarded by the performance outlook to date.


Therefore, the system needs to maintain the expense history up to the period of change, true up for the new outlook, and then amortize expense going forward based on the new outlook. This requires the system to store and maintain time-stamped outlooks for all components of expense calculations in order to provide multiple period reports.


Second, the accounting software must support different companies’ policies. In PerformCo’s case, the amortization period for compensation expense during the vesting period also depends on the retirement eligibility of grantees. Specifically, PerformCo requires a minimum six months of service for retirement eligible employees to vest. Other companies may require up to a year of service or may vest retirement eligible employees immediately on the grant date. The software, therefore, needs to integrate vesting schedule requirements with grantee data in a way that also incorporates modifications of employee status and plan requirements.


Third, the ideal system should also be able to account for one-off scenarios, such as how PerformCo provides for accelerated vesting if employees are terminated as a result of an acquisition. The ideal integrated system must permit PerformCo’s accounting personnel to change a particular grantee’s vesting schedule and maintain an audit trail of that grantee-specific change. Making such changes off-system in spreadsheets is complicated, time-consuming and error-prone, because manual manipulation requires all grant schedules to be manipulated one at a time. Instead, the optimal software solution uses a database structure in which personnel can modify multiple grants for a grantee simultaneously in time-stamped tables specifically designed to link grants to grantees. When evaluating the capabilities of a software solution, check whether that software provides the ability to search for a particular grantee, select specific grants assigned to that grantee, and modify them as of a point in time.


V. Summarizing the solution

The best solution is one that provides for all accounting within the software, or out-of-the-box. If modifications have to be supported outside of the software in spreadsheets, then the solution has created manual manipulations and extra reconciling issues. Ultimately, many solutions will claim to support complex scenarios, but more important than supporting a particular type of plan condition, is that the software time-stamps events and retains historical schedules, configures for plan differences, and is structured so that multiple levels of a vesting schedules can be altered quickly through strong search and modification functionality.


About the Author

John Sabochick – Director, Best Practices
Prior to joining ARMtech, John was one of the first employees at the start-up TaxStream, a tax provision company, which ultimately sold to Thomson Reuters in 2008 when it had over 60% of the Fortune 500 and the top ten accounting firms subscribing to its services. John was a key member in designing the equity compensation solution, now ARMtech, while at TaxStream. After the acquisition, ARMtech became independent and John has continued to help design ARMtech's banking (Process+) and equity compensation (EquiLink) solutions. John specializes in process improvement consulting, defining best practices for clients' equity compensation needs.

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