Individual Assignment 6 - Tesla Stock Compensation

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Interpreting Financial Statements (ACCTG 5610) Individual Assignment 6 – Tesla: Stock Options (10 Points) Learning Objectives The purpose of this assignment is to ensure the student is able to: • Locate and interpret a stock compensation note. • Understand the assumptions used in the Black-Scholes-Merton option pricing model. • Consider the impact of stock compensation on motives/opportunities for financial statement manipulation. • Understand the strengths and weakness of accounting for stock-based compensation. • Critically think through current issues regarding stock-based compensation plans offered by public companies. Tesla, Inc. (“Tesla”), ticker: TSLA , has robust stock-based compensation plans which have recently made headlines. The following questions pertain to Tesla’s financial statements for the year ended December 31, 2023 (although you will also need to reference the 2018 10-K filing for question 5). 1. What types of stock-based compensation does the company offer? Briefly describe the different types of awards that are offered to company employees. (1 point) Tesla offers service and/or performance-based, stock compensation, of which, restricted stock, employee stock purchase plans, employee incentive stock options, and nonstatutory stock option are available as equity awards. The restricted stocks are recognized over the required service time the employee who possesses them works, whereas the employee stock purchase plans and stock options, are based off of services provided to Tesla and service time. 2. How does Tesla estimate the risk-free rate, expected option life, and volatility for use in the Black- Scholes option pricing model? On a scale of 1 (little), 2 (some) or 3 (a lot), how much managerial judgement is employed in making estimates such as these? Why might this be a concern? (2 points) Tesla estimates the risk-free rate, “based on the U.S. Treasury yield for zero-coupon U.S. Treasury notes with maturities approximating each grant’s expected life.” Said expected life is estimated from historical data, with “generally four years for stock options and RSUs and six months for the ESPP.” Finally, “volatility is based on the average of the implied volatility of publicly traded options for [Tesla’s] common stock” and said common stocks’ historical volatility. I would rate managerial judgement as a 1 because the risk-free rate has a direct location, however, expected life and volatility are based on historical data and assumptions. Companies would rather take less expenses from stock options, encouraging taking liberties with such “expected changes” to minimize costs. 3. Using the option pricing worksheet posted on Canvas and Tesla’s assumptions, estimate the Black- Scholes weighted average fair value per share for the options granted in fiscal 2023. What is Tesla’s estimate? How does your estimate compare? (Please include a screenshot of your spreadsheet) (1 point) Tesla’s weighted average fair value per share for the options granted in fiscal 2023 was $121.62. My result was $194.38. I believe, unlike we saw with Zillow, that Tesla only providing one number under votality and expected life option is a reflections as to why amounts could be so different, based on the historical amounts for “expected changes.” A almost 1.6 increase from the 10-K amount to my demonstrates the limitations of estimatuons due to chaging volatilites, rates, etc.

4. Assume that the options that Tesla granted in fiscal 2023 are exercised at some future date when Tesla’s stock is worth $450 per share. Under grant-date accounting , what is the cumulative amount of expense that Tesla would charge against income for these options ( hint: use the estimated weighted-average fair value per share for 2023 from the 10-K --- note: this is the number that you compared your calculation against in the previous question )? Under exercise- date accounting, what is the cumulative amount of expense that Tesla would charge against income for these options? Which of these (grant date or exercise date accounting) is required by US GAAP? Which provides a more representationally faithful estimate of the amount of wealth transferred from existing shareholders to employees? Ignore related tax benefits. (2 points) Cumulative Expense = Grant Date Fair Value * Number of Options Granted 121.60 * 9,521,000 = $1,157,753,600 Cumulative Expense = (Market Price of the Stock at Exercise Date - the Exercise Price of the Option AKA Intrinsic Value) * the Number of Options Granted (100 – 226.50) * 9,521,000 = $1,204,406,500 Grant date is required by US GAAP, but settlement date provides a more representationally faithful estimate of the amount of wealth transferred from existing shareholders to employees because grant dates are easier to manipulate, require disclosures, and are not “trued up.” 5. In accordance with US GAAP, stock-based compensation expense is recognized over the longer of the expected achievement period for performance/operational milestones, beginning at the point in time when the relevant milestone is considered probable of being met. Now, refer to the 2018 Tesla 10-K (filed on 2/19/19). This filing provides a detailed discussion of the 2018 CEO Performance Award that was granted to Elon Musk. According to Note 15, what performance and market conditions are required in order for the compensation package to vest? Which of these conditions did management believe were probable of achievement as of December 31, 2018? As a

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