Accounting for Employees Stock Options Coursework

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FASB has prescribed new rules under Financial Accounting Standard 123(R) Share-Based Payment (FAS 123(R)), repealing the intrinsic value method of accounting prescribed by the original standard FAS 123, for accounting and reporting of employee stock options. The rules have been made applicable to both public and non-public companies.

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Application of the Rules

As per the requirements of the accounting standard, the employer who issues equity instruments such as share, share options or similar other instruments, has to recognize the cost of such compensation in the books of accounts. The cost of compensation shall be taken as equal to the fair value of the stock as on the grant-date as the stocks vest on the employees. The stocks shall be deemed to vest on the employees as they perform the services to the company necessary to earn the instruments.

The fair value is computed based on the observable price of such instruments if an observable price is available. In case there is no observable price available, (which is normally the case in respect of stock options awarded to the employees) the fair value can be determined on the basis of a recognized option pricing model such as a lattice model (Hardesty, 2006). A closed form model such as Black-Sholes-Merton can be used for valuing the stock options.

Although there is no prescription of the option pricing model to be used in this case, majority of the companies use Black-Sholes-Merton model or valuing their stock options. “An employer recognizes compensation cost only for equity instruments that vest, and only over the vesting period.” (Hardesty, 2006) Compensation cost is determined based on the fair value of the award at grant as reduced by any amount paid by the recipient and the corresponding amount is credited to the capital. The date of grant shall be reckoned as the date of the mutual understanding of the terms and conditions underlying the award on obtaining the necessary approvals.

Compensation cost for full value stock options shall be determined based on the market value of the underlying stock as on the date of the grant. Dividends if any paid during the vesting or performance period do not qualify as additional cost of compensation. In case the underlying awards are subsequently forfeited and the dividends are not repaid by the recipient then such dividends shall be added to the cost of compensation.

Recognizing Compensation Cost

Where the cost of compensation is accounted based on the fair value of the stock option, the amount shall be amortized on a straight-line basis over the vesting period. Statement 123 (R) has introduced a concept of “requisite service period” for determination of the period during which the compensation cost should be recognized. The standard prescribes

  1. explicit – as explicitly stated in the award agreement by which the options are granted,
  2. implicit – to be inferred from the service or performance conditions, or
  3. derived – which is derived from the valuation of the market condition at the time when the fair value of the stock options is estimated.

In the given instance the stock option shall be the fair value of the stocks as on January 1, 2009 which is calculated based on the quoted market price as on that date. The requisite period of service is explicit as the award conditions specify the service period of three years from 2009 to 2011. The cost of compensation shall be amortized over the period between 2009 and 2011, the vesting period, which is the period during which the employees serve the company.

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Lapse of Unvested Option

An unvested option gets lapsed in the event of an employee not conforming to the vesting conditions. For example, if an executive resigns from the services of the company during the vesting period, the sock option gets lapsed. In the situation of an unvested option getting lapsed after the fair value of the option has been accounted as the cost of compensation, the Rules prescribe that the accounting treatment shall be reversed by a credit to the employee’s compensation cost with an amount equal to the amortized portion of the accounting value of the lapsed options. Credit is to be given to the deferred compensation expenses with an amount equal to the unamortized portion.

Lapse of Vested Option

The rule prescribes a different accounting treatment when the vested option lapses on expiry of the exercise period, after the fair value of the option has been recorded in the books, as cost of employee compensation. In this case a reversal of the earlier accounting by crediting the cost of employee compensation becomes necessary. However previously recognized compensation cost does not get reversed if a vested stock option expires unexercised under situations where the award is “underwater”.

Reference

Hardesty, D. E. (2006). FASB Statement 123 (R) Consulting Services. Web.

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IvyPanda. (2022, March 3). Accounting for Employees Stock Options. https://ivypanda.com/essays/accounting-for-employees-stock-options/

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"Accounting for Employees Stock Options." IvyPanda, 3 Mar. 2022, ivypanda.com/essays/accounting-for-employees-stock-options/.

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IvyPanda. (2022) 'Accounting for Employees Stock Options'. 3 March.

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IvyPanda. 2022. "Accounting for Employees Stock Options." March 3, 2022. https://ivypanda.com/essays/accounting-for-employees-stock-options/.

1. IvyPanda. "Accounting for Employees Stock Options." March 3, 2022. https://ivypanda.com/essays/accounting-for-employees-stock-options/.


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IvyPanda. "Accounting for Employees Stock Options." March 3, 2022. https://ivypanda.com/essays/accounting-for-employees-stock-options/.

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