Employee Stock Options
description
Transcript of Employee Stock Options
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FAS 123 (R) (fair value model)
Note that use of APB 25 is no longer permitted
Employee Stock Options
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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 10,000Service Period 3 yearsExercise Price of stock $20Market Price of option $6Expected forfeiture 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 $18,000
cr. Deferred compensation expense $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 plansEmployee receives cash based on
the increase in stock valueUsed to generate cash, i.e., for tax
when options are exercisedCompensation expense must be
estimated between grant and exercise date
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Total est. Cumulative Expense Deferredcompensation compensation debit expense
expense expense (credit) balance# of options 10000Option price $15Market 1 $20 $50,000 $12,500 $12,500 37500Market 2 $22 $70,000 $35,000 $22,500 35000Market 3 $18 $30,000 $22,500 ($12,500) 7500Market 4 $24 $90,000 $90,000 $60,000 0
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Year 1dr. compensation expense $12,500dr. deferred compensation expense $37,500cr. Liability - stock appreciation plan $50,000
Year 2dr. compensation expense $22,500 cr. Deferred compensation expense $2,500 cr. Liability - stock appreciation plan $20,000
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Year 3dr. liability - stock appreciation plan $40,000 cr. Compensation expense $12,500 cr. Deferred compensation expense $27,500
Year 4dr. compensation expense $60,000 cr. Deferred compensation expense $7,500 cr. Liability - stock appreciation plan $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, lapsedweighted av. option price per categoryweighted av. fair value of options granted assumptions made to estimate fair valueAverage remaining contractual life of
options outstanding