Stock Compensation

Question 1

What is a stock option?

Answer 1

it is the right to purchase shares of a corporation’s capital stock under fixed conditions of time, place, and amount

Question 2

Noncompensatory stock option/purchase plans

Answer 2

certain stock options and employee stock purchase plans are used by entities to raise capital or diversify ownership among employees or officers

stock option plans that meet the requirements of a noncompensatory plan do not require the recognition of compensation expense by the sponsoring company; plans that do not contain these characteristics are usually classified as compensatory plans

Question 3

Compensatory stock option/purchase plans

Answer 3

compensatory stock options and stock purchase plans are valued at the fair value of the options issued

under the fair value method, total compensation expense is measured by applying an acceptable fair value pricing model such as the Black-Scholes Option Pricing Model; any CPA exam question will supply this number; this compensation expense, calculated on the grant date of the options, is allocated over the service period in accordance with the matching principle; the service period is the vesting period, which is the time between the grant date and the vesting date

expiration of options requires a reclassification of the remaining balance in the “APIC - stock options” account’ reclassification is accomplished by the following JE:

DR: APIC - stock options
CR: APIC - expired stock options

Note: compensation expense is not affected by the expiration of options

Question 4

Key terms for stock options

Answer 4

option/exercise price - the price at which the underlying stock can be purchased pursuant to the option contract

exercise date - the date by which the option holder must use the option to purchase the underlying option (and typically the date at which the stock options outstanding account is reduced)

fair value of the option - determined by an economic pricing model such as the Black-Scholes method

grant date - the date the option is issued

vesting period - the period over which the employee has to perform services in order to earn the right to exercise the options (the time from the grant date to the vesting date)

service period - the period over which compensation expense is recognized (the period the employee performs the service); the service period is generally the vesting period

Question 5

What are stock appreciation rights (SARs)?

Answer 5

it entitles an employee to receive an amount equal to the excess of the market price of stock at the exercise date over a predetermined amount (usually market price at grant date); this excess multiplied by the number of rights outstanding is recorded as compensation expense and a liability

compensation expense for stock appreciation rights outstanding must be adjusted annually to account for changes in the market price of the stock; unlike stock options, stock appreciation rights do not require the employee to make a cash payment