Employee Stock Options

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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 10,000
• Service Period 3 years
• Exercise Price of stock 20
• Market Price of option 6
• Expected 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 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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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 gt 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