Stock Option Compensation SFAS 123
Stock Option Compensation – SFAS 123
The new FASB standard requires that companies recognize compensation cost using the fair-value method (SFAS 123). The FASB position is that companies should base the accounting for the cost of employee services on the fair value of the compensation paid. This amount is presumed to be a measure of the value of the services received.
Determining Expense:
Under the fair value method, companies compute total compensation expense based on the fair value of the options expected to vest on the date they grant the options to the employees (i.e., the grant date). Public companies estimate fair value by using an option-pricing model (e.g., Black-Scholes). No adjustments occur after the grant date in response to subsequent changes in the stock price – either up or down.
Allocating Compensation Expense:
In general, a company recognizes compensation expense in the periods in which its employees perform the service – the “service period.” Unless otherwise specified, the service period is the VESTING period – the time between the grant date and the vesting date. Thus, the company determines total compensation cost at the grant date and allocates it to the periods benefited by its employees’ services.
Example:
Assume that the Board of Directors of Goizueta Company approves a plan that grants the company’s 5 executives options to purchase 2000 shares each of the company’s $1 par value common stock. The company grants the options on 1/1/06. The executives may exercise the options at any time over the next 10 years. The option price per share is $60 and the market price of the stock is $70 per share on the grant date.
Under the fair-value method, the company computes the total compensation expense by applying an acceptable fair value option-pricing model. To keep the example simple, assume that the option-pricing model determines Goizueta’s total compensation expense to be $220,000.
Basic entries
At date of grant (1/1/2006)
NO ENTRY
12/31/2006
To record compensation expense for 2006, assuming that the company recognizes the value of the options as an expense in the periods in which the employee performs services, which in this case is 2 years.
Dr. Compensation Expense (Income statement) 110,000
Cr. Paid-in-capital – Stock Options (Balance sheet – SHE) 110,000
To allocate compensation expense for 2006.
12/31/2007
Dr. Compensation Expense (Income statement) 110,000
Cr. Paid-in-capital – Stock Options (Balance sheet – SHE) 110,000
To allocate compensation expense for 2007.
As indicated, Goizueta allocates compensation expense evenly over the 2-year service period.
Exercise:
The executives exercise the options on June 1, 2009.
Cash (10,000 options X $60) 600,000
Paid in Capital – Stk Options 220,000
Common Stock (10,000 x $1 par value) 10,000
Paid-in capital in excess of par 810,000