Rather than offering shares or warrants to employees, many companies grant stock appreciation rights (SAR). Under these arrangements, employees do not have to buy shares but are rewarded just as if they owned them.
For example, an executive might be entitled to receive a cash payment after four years amounting to the increase in the value of 10,000 shares of stock. As an alternative, part or all of the compensation might be paid with shares.
In accounting, the process that the company uses to record SAR agreements is to accrue a liability and recognize expense over the term of service. At the end of the service period, the liability is settled in cash or stock (or both).
Let’s consider an example of calculating the annual expense under a plan offered by the Sample Company.
An agreement is established on 31 December 2018 stating that employees will receive cash payments on 2 January 2023 amounting to the difference between the present market value of 10,000 shares and their value on 31 December 2022.
For employees to receive the SAR, they must work for the Sample Company for the whole period of four years.
The first calculation depends on an estimate of the total compensation for the plan based on the year-end stock value. This amount is adjusted for previous charges, and the balance is spread over the remaining life. This is shown in the example below.
The journal entries at the end of each of the four years are presented below:
It is worth noting that this approach to estimating the expense can result in a negative expense. This occurs when the market value rises and then falls such that the prior years’ charges exceed the net appreciation to date.
In this example, there would be a debit to the liability and a credit to compensation expense if the ending market value per share in 2022 falls below $33.