Stock Options Flashcards
Types of questions:
- Terminology
- Amount of compensation expense!
- Amount of APIC
- Impact on the financial statements
What is a stock purchase plan versus a stock option plan
Stock Purchase plan?
- Option to purchase plan
- Can be Noncompensatory (expense paid by employer)
- Compensatory- Amount paid by employer plus discount
Stock option plan-
Compensation Expense: FV of the stock option at the grant date
What are the criteria for a stock purchase plan to be noncompensatory?
All employees can participate
Employee must decide within one month of the firm setting the price for the stock on whether they are going to enroll.
Discount does not exceed the cost savings in issuing directly to employees (cannot give a huge discount to employees, usually less than 5%)
Purchase price has to be based on market price
Employee can cancel their enrollment before the purchase date and get a full refund.
What is the journal entry for a stock purchase plan- Noncompesntory
DB Compensation Expense (paid by the employee)
DB: Cash
CR: Common Stock (at par)
CR: APIC (share price - par value)
What is the journal entry for a stock plan- compensatory
DB: Compensation Expense (paid by employer + Discount)
DB: Cash (Paid by Employee)
CR: Common Stock (at par value)
CR: APIC (Remainder)
Define stock option:
Stock options give the holder the right (not the obligation) to purchase a share of stock at a set price (strike price) by a certain date.
What are stock option key dates:
Grant Date (date the options are awarded)
Service Period (compensation expense is recognized)
Vesting Date (employee can begin exercising the options)
Exercise date (Date the employee actually exercises the option)
How do you measure compensation expense?
Total compensation expense is the fair value of the options expected to be exercised.
Fair value is measured at the grant date using an option pricing model.
Total compensation expense is amortized over the service period.
What are forfeitures
Options that are not exercised
Compensation expense is reduced for forfeitures
The entity:
1) Recognize forfeitures as they occur
2) Estimate the amount of forfeitures
Example Fact Pattern for Forfeitures #1: On January 1, 20X4 several managers were granted options to purchase 100,000, $2 par common stock for $10 during the two-year period 1/1/X7-12/31/X8.
- The market price of the stock on grant date= $10
- The service period = 3 years 1/1/x4-12/31/X6
- The manager must work the entire service period for the option to vest
- The option expire 12/31/X8
- The fair value of one option is $3 based on the option pricing model
Compensation expense: (100,000 X 3)/3 years)
Compensation Expense $100,000 DB
APIC- Stock Options $100,000 CR
*Changes in the market price DO NOT affect compensation expense during the service period
Example Fact Pattern for Forfeitures #1: On January 1, 20X4 several managers were granted options to purchase 100,000, $2 par common stock for $10 during the two-year period 1/1/X7-12/31/X8.
- The market price of the stock on grant date= $10
- The service period = 3 years 1/1/x4-12/31/X6
- The manager must work the entire service period for the option to vest
- The option expire 12/31/X8
- The fair value of one option is $3 based on the option pricing model
- Assume in 20X5 that 3,000 options are forfeited
(3,000 X 3) = $9,000
Revised compensation expense ($300,000-9,000)= $291,000
Expense to be recognized in 2015 (2/3)*$291,000- $100,000 (for 20X4)= $94,000
20x6 Compensation expense (1/3)$291,000=97,000
Example Fact Pattern for Forfeitures #1: On January 1, 20X4 several managers were granted options to purchase 100,000, $2 par common stock for $10 during the two-year period 1/1/X7-12/31/X8.
- The market price of the stock on grant date= $10
- The service period = 3 years 1/1/x4-12/31/X6
- The manager must work the entire service period for the option to vest
- The option expire 12/31/X8
- The fair value of one option is $3 based on the option pricing model
- Assume the forfeiture rate is estimated to be 3% per year
Total compensation expense
(3x100,000 options)(1-.03)^3)) = 273,802 or $91,267 per year
*Note price on the stock does not have any effect compensation expense!!
Example Fact Pattern for Forfeitures #1: On January 1, 20X4 several managers were granted options to purchase 100,000, $2 par common stock for $10 during the two-year period 1/1/X7-12/31/X8.
- The market price of the stock on grant date= $10
- The service period = 3 years 1/1/x4-12/31/X6
- The manager must work the entire service period for the option to vest
- The option expire 12/31/X8
- The fair value of one option is $3 based on the option pricing model
- Assume the forfeiture rate is estimated to be 3% per year
ASSUME THE PREDICTED FORFEITURES WERE ACCURATE AND THE NUMBER OF OPTIONS EXERCISED ARE 91,267, WHAT IS THE ENTRY AT EXERCISE DATE?
Cash (91,267 X $10) 912,670
APIC- Stock Options 273,802
Common Stock (182,534)
APIC- Common Stock (1,003,938)
What if there is a change in estimate of forfeitures?
Total compensation expense: Update when the forfeiture rate changes.
The change is applied to the CURRENT PERIOD such that total compensation expense through the current year reflects the revised date
Total compensation expense: Update when the forfeiture rate changes.
The change is applied to the CURRENT PERIOD such that total compensation expense through the current year reflects the revised date
When do stock options expire?
Options expire if the stock price fails to raise above the option exercise price. NO retroactive application. Compensation expense remains.
The compensation expense remains but APIC-Stock Options is transferred to APIC- Expired Stock Options
APIC- Stock Options
APIC- Expired Stock Options
