Employee Stock Options
Gives employees the right to purchase shares of the company’s stock at a fixed price over a specific period of time. - Most prevalent form of compensation plan. Restricted form of call option. Seek to motivate employees to work to increase company market value.
Call Option
gives an investor the right to purchase a security at a fixed price over a specified period of time.
Exercise/Strike Price
fixed amount paid to acquire a share of stock.
Vesting/Service Period
time the employee must remain with the company before exercising the options.
Expiration Date
date at which the employee can no longer exercise the options.
What is the relationship between stock option compensation and net income?
Stock option compensation is recorded as an expense. Expensed at fair value.
How do you estimate the Fair Value for stock-based compensation?
The market price of the options or similar option, if available. If not availabile - use option-pricing model.
Why is a Forfeiture Estimate necesarry?
Employees may be terminated before the vesting period is over - options are forfeited. The value of the forfeited options reduces total compensation expense.
What benefits do employees receive in equity-classified stock options?
Employees have the right to receive equity shares.
What is the journal entry for equity-classified awards?
Debit: Compensation Expense
Credit: APIC-Stock Options
Recognized at period end over vesting period; NOT at grant date.
Compensation Expense Formula
If Adjusted for estimated forfeiture rate: Expenses the adjusted fair value on SL basis over vesting period. Multiply this by % of vesting period that has passed. Subtract the total compensation expense recognized in past years.
Equity Classified Award. Estimating Forfeitures. Granted stock options - 1/2/22. Acquired 60,000 shares of $1.20 par value common stock. $5.10 exercise price. Market price: $5.10. 2 year vesting period. 5 year expiration date. Option-Pricing model: $9.60 per option. 10% forfeiture rate. 2,500 options forfeited in 2022. 28,000 otpions forfeited in 2023. What is the estimated fair value? 2022 journal entry? 2023 journal entry?
Estimated Fair Value: 576,000
2022 JE
Compensation Expense 259,200 (60,000 * 9.60) * (.90) * (1/2)
APIC Stock Options 259,200
2023 JE
Compensation Expense 259,200 (60,000 * 9.60) * (.90) * (2/2) - (259,200)
APIC Stock Options 259,200
Equity Classified Award. Accounting for Forfeitures When They Occur. Granted stock options on 1/2/22. Acquire 60,000 shares of $1.20 par value common stock. Market price: $5.10. Exercise price: $5.10. 2 year vesting period. 5 year expiration date. Option-Pricing Model is $9.60. 2,500 options forfeited in 2022. 28,000 options forfeited in 2023. What is estimated fair value? Journal entries for 2022? 2023?
Estimated Fair Value: $576,000
JE 2022
Compensation Expense: $276,000 (600,000 - 2,500) * (9.60) * (1/2)
APIC: $276,000
JE 2023
Compensation Expense: $7,200 (600,000 - 2,500 - 28,000) * (9.60) * (2/2) - (276,000)
APIC: $7,200
What happens if there is a change in the fair value of equity-classified awards?
The fair value at the grant date is the compensation agreed on by both the company and the employee.
What happens when there is a change in the estimated forfeiture rate?
Companies revalue equity-classified awards when there is a change in the estimated percentage of options that will be forfeited.
Equity-Classified Award. Forfeiture Change.
