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Employee Stock Options

Employee Stock Options. FAS 123 (R) (fair value model) Note that use of APB 25 is no longer permitted. A. NON-COMPENSATORY PLANS. Conditions: All Employees Equal opportunity for all eligible employees Limited time offer

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Employee Stock Options

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

  2. 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

  3. 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

  4. 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

  5. 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

  6. 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

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

  8. 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)

  9. 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)

  10. 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

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

  12. 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

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