Employee Stock Options FAS 123 R fair value

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Employee Stock Options FAS 123 (R) (fair value model) Note that use of APB

Employee Stock Options FAS 123 (R) (fair value model) Note that use of APB 25 is no longer permitted 1

A. NON-COMPENSATORY PLANS Conditions: • All Employees • Equal opportunity for all eligible employees

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 2

B. Compensatory Plans 1. Incentive Plans • No tax to employee when exercised, only

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 3

2. Non-qualified Plans • Employees taxed when option exercised • Taxed on the difference

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 4

Terms z. Option - opportunity to buy stock at fixed price (Exercise price) z.

Terms z. Option - opportunity to buy stock at fixed price (Exercise price) z. Grant date - date on which employee receives option z. Measurement date - date on which both ythe number of shares and ythe exercise price are known 5

Terms z. Compensation expense – fair market value of options – determined through use

Terms z. Compensation expense – fair market value of options – determined through use of option pricing model z. Service Period - time period over which compensation expense is amortized 6

Example - Data z# of Options issued z. Service Period z. Exercise Price of

Example - Data z# of Options issued z. Service Period z. Exercise Price of stock z. Market Price of option z. Expected forfeiture 10, 000 3 years $20 $6 10% 7

Dr. deferred compensation expense $54, 000 cr. Paid in capital - options $54, 000

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 (record issuance of options and first year compensation expense) Note that deferred compensation expense will offset PIC options) 8

Exercise of 80% of options Dr. cash $160, 000 dr. paid in capital -

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) 9

Stock Appreciation Plans z. Non qualified plans z. Employee receives cash based on the

Stock Appreciation Plans z. Non qualified plans z. Employee receives cash based on the increase in stock value z. Used to generate cash, i. e. , for tax when options are exercised z. Compensation expense must be estimated between grant and exercise date 10

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FAS 123 versus APB 25 z Compensation expense based on market value of option

FAS 123 versus APB 25 z Compensation expense based on market value of option z Black-Sholes Option pricing model used z Compensation expense is always recognized z Compensation expense only if market > exercise price on grant date z For most plans No compensation expense is recognized 14

Required Disclosures under FAS 123 z # of shares under option plan z# of

Required Disclosures under FAS 123 z # of shares under option plan z# of options issued, exercised, lapsed zweighted av. option price per category zweighted av. fair value of options granted zassumptions made to estimate fair value z. Average remaining contractual life of options outstanding 15