ACCOUNTING FOR STOCK OPTIONS

Accounting for Stock Options

Accounting for Stock Options

Part A

The proposed obligation that companies total cost stock options, combined with the trials offered by a depressed stock market and greater inspection of equity compensation practices by institutional shareholders, has created a move in aim away from traditional stock options to alternative types of equity reimbursement awards. The latest broadcast by Microsoft that it will discontinue stock option grants in favor of constrained stock accolades is one famous example.

The economic Accounting measures Board (FASB) tentatively concluded in April that stock-based reimbursement should be identified as an expense in a company's earnings declarations based on the Fair value of the awards. In the last two months, FASB has come to further tentative decisions engaging the procedure for reversing cost affiliated with forfeited options, and a reliable procedure of accounting for employee and non-employee stock compensation. Draft rules may be released by year end, and final accounting measures may be in location by early 2004.

Expensing

Under present measures, treating the fair worth of stock options as a ascribe against earnings is the favored, but not needed, reporting procedure for employees and controllers recounted in FASB declaration No. 123, Accounting for Stock-Based Compensation ("FAS 123").

Under FAS 123, the Fair value of an option is assessed utilizing an option-pricing model that takes into account the stock price at the allocate designated day, the workout price, the anticipated life of the option, the instability of the underlying stock and the expected dividends on the stock, and the risk-free interest rate over the expected life of the option. The "Black-Scholes" option pricing model takes into account these factors in valuing an option and has been utilized by most businesses to worth their stock options for SEC revelation purposes. Critics argue that this is an unsuitable method of measuring the genuine value of an employee stock option because the "Black-Scholes" option pricing model was not designed to worth compensatory stock options, does not adequately account for the risk of forfeiture of the stock options if service vesting is required, and outcomes in a high stock option worth (as a percentage of the market worth of the underlying business stock) if the market price of the company stock is volatile (which is usually the case with expertise company stock).

In lieu of expensing, employers are actually permitted to account for stock option grants to employees and controllers under Accounting Principles Board Opinion 25, Accounting for stock handed out to Employees ("APB 25"). APB 25 assesses compensation cost as the excess, if any, of the Fair market value of the stock at the allocate designated day or other measurement designated day over the workout price. Stock options with a repaired workout cost equal to fair market worth at the date of grant result in no reimbursement expense.

However, the addition of certain characteristics in the option agreements (e.g., permodelance-contingent vesting or snare exercise fee method where the boss withholds portions to cover the workout price), and modifications to spectacular options ...