Basics of accounting for stock options

August 17, 2014

This article touches upon accounting for stock options which was (and still is) a hot topic in the accounting realm.

1. Conceptual issues

A stock option is the right to purchase shares in a company for a specific price at a specific time - this could be a date or a range of dates. Options are common fixtures of executive compensation packages because they can motivate corporate managers to focus more on long-term shareholder value and less on immediate profit.

The accounting problem is one of timing. Stock options are usually exercisable only after a certain period of service – should an expense be recorded now or later? Should the expense be ignored completely since the option holder has to actually pay for the stock?

2. Options not considered compensation

Certain kinds of employee share purchase plans, and even some types of stock options, are not recorded as expense. These plans must meet the following four requirements to avoid expense recognition.

  1. All eligible employees can partake in the plan (this rule does not apply to employees who already own a lot of shares). In other words, the plan does not discriminate between low level employees and managers.
  2. In the same vein, the plan must be offered the same way to all eligible employees. The company is, however, allowed to limit the number of shares that can be issued under the plan.
  3. Exercise time for options needs to be a reasonable period.
  4. If the stock offered is discounted from market price, the discount must be reasonably similar to a discount that might be offered to other stakeholders.
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