Employee Stock Options
FAS 123 (R) (fair value model)
Note that use of APB 25 is no longer permitted
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A. NON-COMPENSATORY
PLANS
Conditions:
•
All Employees
•
Equal opportunity for all eligible employees
•
Limited time offer
•
Limited discount (same as offered to existing
stockholders
Accounting Issues: None, no compensation expense
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B. Compensatory Plans
1. Incentive Plans
• No tax to employee when exercised, only when
stock is sold
• Tax law requires that option price on grant date is
equal to the market price
• Compensation expense = fair value of options
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2. Non-qualified Plans
• Employees taxed when option exercised
• Taxed on the difference between market price and
exercise price
• Company receives tax deduction
• Option price may be lower than market price on the
measurement date
• Compensation expense must be recognized
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Terms
Option - opportunity to buy stock at fixed
price (Exercise price)
Grant date - date on which employee
receives option
Measurement date - date on which both
the number of shares and
the exercise price are known
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Terms
Compensation expense – fair market
value of options – determined through use
of option pricing model
Service Period - time period over which
compensation expense is amortized
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Example - Data
# of Options issued
Service Period
Exercise Price of stock
Market Price of option
Expected forfeiture
10,000
3 years
$20
$6
10%
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Dr. deferred compensation expense $54,000
cr. Paid in capital - options
$54,000
(10,000 * 6 *.9) – adjusted for expected forfeitures
dr. compensation expense
cr. Deferred compensation expense
$18,000
$18,000
(record issuance of options and first year compensation
expense) Note that deferred compensation expense will offset
PIC options)
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Exercise of 80% of options
Dr. cash
$160,000
dr. paid in capital - options
$ 48,000
cr. Common stock ($1 par)
$ 8, 000
cr. Additional paid in capital
$200,000
dr. compensation expense
$ 12,000
Dr. Paid in capital – options $ 6,000
cr. Deferred compensation expense
$18,000
(adjusted for additional forfeited options)
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Stock Appreciation Plans
Non qualified plans
Employee receives cash based on the
increase in stock value
Used to generate cash, i.e., for tax when
options are exercised
Compensation expense must be estimated
between grant and exercise date
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Total est.
Cumulative Expense
compensation compensation debit
expense
expense (credit)
# of options
Option price
Market 1
Market 2
Market 3
Market 4
10000
$15
$20
$22
$18
$24
$50,000
$70,000
$30,000
$90,000
$12,500
$35,000
$22,500
$90,000
$12,500
$22,500
($12,500)
$60,000
Deferred
expense
balance
37500
35000
7500
0
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Year 1
dr. compensation expense
dr. deferred compensation expense
cr. Liability - stock appreciation plan
Year 2
dr. compensation expense
cr. Deferred compensation expense
cr. Liability - stock appreciation plan
$12,500
$37,500
$50,000
$22,500
$2,500
$20,000
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Year 3
dr. liability - stock appreciation plan
cr. Compensation expense
cr. Deferred compensation expense
Year 4
dr. compensation expense
cr. Deferred compensation expense
cr. Liability - stock appreciation plan
$40,000
$12,500
$27,500
$60,000
$7,500
$60,000
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FAS 123 versus APB 25
Compensation
expense based on
market value of
option
Black-Sholes Option
pricing model used
Compensation
expense is always
recognized
Compensation
expense only if
market > exercise
price on grant date
For most plans No
compensation
expense is recognized
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Required Disclosures
under FAS 123
 # of shares under option plan
# of options issued, exercised, lapsed
weighted av. option price per category
weighted av. fair value of options granted
assumptions made to estimate fair value
Average remaining contractual life of
options outstanding
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