ESOs: Accounting For Employee Stock Options.
Relevance above Reliability.
We will not revisit the heated debate over whether companies should "expense" employee stock options. However, we should establish two things. First, the experts at the Financial Accounting Standards Board (FASB) have wanted to require options expensing since around the early 1990s. Despite political pressure, expensing became more or less inevitable when the International Accounting Board (IASB) required it because of the deliberate push for convergence between U. S. and international accounting standards. (For related reading, see The Controversy Over Option Expensing .)
As of March 2004, the current rule (FAS 123) requires "disclosure but not recognition". This means that options cost estimates must be disclosed as a footnote, but they do not have to be recognized as an expense on the income statement, where they would reduce reported profit (earnings or net income). This means that most companies actually report four earnings per share (EPS) numbers - unless they voluntarily elect to recognize options as hundreds have already done:
2. Pro Forma Diluted EPS.
A key challenge in computing EPS is potential dilution. Specifically, what do we do with outstanding but un-exercised options, "old" options granted in previous years that can easily be converted into common shares at any time? (This applies to not only stock options, but also convertible debt and some derivatives.) Diluted EPS tries to capture this potential dilution by use of the treasury-stock method illustrated below. Our hypothetical company has 100,000 common shares outstanding, but also has 10,000 outstanding options that are all in the money. That is, they were granted with a $7 exercise price but the stock has since risen to $20:
Basic EPS (net income / common shares) is simple: $300,000 / 100,000 = $3 per share. Diluted EPS uses the treasury-stock method to answer the following question: hypothetically, how many common shares would be outstanding if all in-the-money options were exercised today? In the example discussed above, the exercise alone would add 10,000 common shares to the base. However, the simulated exercise would provide the company with extra cash: exercise proceeds of $7 per option, plus a tax benefit. The tax benefit is real cash because the company gets to reduce its taxable income by the options gain - in this case, $13 per option exercised. Why? Because the IRS is going to collect taxes from the options holders who will pay ordinary income tax on the same gain. (Please note the tax benefit refers to non-qualified stock options. So-called incentive stock options (ISOs) may not be tax deductible for the company, but fewer than 20% of options granted are ISOs.)
Pro Forma EPS Captures the "New" Options Granted During the Year.
First, we can see that we still have common shares and diluted shares, where diluted shares simulate the exercise of previously granted options. Second, we have further assumed that 5,000 options have been granted in the current year. Let's assume our model estimates that they are worth 40% of the $20 stock price, or $8 per option. The total expense is therefore $40,000. Third, since our options happen to cliff vest in four years, we will amortize the expense over the next four years. This is accounting's matching principle in action: the idea is that our employee will be providing services over the vesting period, so the expense can be spread over that period. (Although we have not illustrated it, companies are allowed to reduce the expense in anticipation of option forfeitures due to employee terminations. For example, a company could predict that 20% of options granted will be forfeited and reduce the expense accordingly.)
Our current annual expense for the options grant is $10,000, the first 25% of the $40,000 expense. Our adjusted net income is therefore $290,000. We divide this into both common shares and diluted shares to produce the second set of pro forma EPS numbers. These must be disclosed in a footnote, and will very likely require recognition (in the body of the income statement) for fiscal years that start after Dec 15, 2004.
There is a technicality that deserves some mention: we used the same diluted share base for both diluted EPS calculations (reported diluted EPS and pro forma diluted EPS). Technically, under pro forma diluted ESP (item iv on the above financial report), the share base is further increased by the number of shares that could be purchased with the "un-amortized compensation expense" (that is, in addition to exercise proceeds and the tax benefit). Therefore, in the first year, as only $10,000 of the $40,000 option expense has been charged, the other $30,000 hypothetically could repurchase an additional 1,500 shares ($30,000 / $20). This - in the first year - produces a total number of diluted shares of 105,400 and diluted EPS of $2.75. But in the forth year, all else being equal, the $2.79 above would be correct as we would have already finished expensing the $40,000. Remember, this only applies to the pro forma diluted EPS where we are expensing options in the numerator!
Expensing options is merely a best-efforts attempt to estimate options cost. Proponents are right to say that options are a cost, and counting something is better than counting nothing. But they cannot claim expense estimates are accurate. Consider our company above. What if the stock dove to $6 next year and stayed there? Then the options would be entirely worthless, and our expense estimates would turn out to be significantly overstated while our EPS would be understated. Conversely, if the stock did better than expected, our EPS numbers would've been overstated because our expense would've turned out to be understated.

Journal entry for granting stock options

Questions / Comments / discussions are welcome. The views expressed herein are meant mainly to be discussions for a learning experience in applying IFRS rather than a set of definitive interpretations. Hence, they should not be construed to be any sort of a recommendation or opinion on any matter being discussed here. The application of IFRS to a specific company is a matter of judgement given its particular facts and circumstances and might be influenced by the views of regulators.
Saturday, June 12, 2010.
Journal Entries for Exercise of Share Options ( IFRS-2)
We have a Share optiion reserve at the end of 3rd year of $300,000 for 30,000 shares and the excecise price of $20/share.
Yes, More details are required to provide JEs! However, Let me try to give it a shot based the following ASSUMPTIONS:

Journal entries for three grants.
The following information relates to three grants that the town of College Hills received from the state during its fiscal year ending December 31, 2003:
a. A cash grant of $200,000 must be used to repair roads.
b. $150,000 in cash is received out of a total grant of $200,000 intended to reimburse the town for actual expenditures incurred in repairing roads. During the year, the town incurred $150,000 in allowable repair costs.
c. A cash entitlement grant of $200,000 is intended to supplement the town's 2004 budget and must be expended in that year.
1. Prepare journal entries to record the three grants in a governmental fund.
2. What amount of revenue would be reported for each grant in the town's government-wide statement of activities for 2003? Where on that statement would these revenues be most likely to be reported?
Attachments.
Solution Preview.
The Solution is as following:
Q1.a) CASH A/C Dr $ 200,000.
To Cash Grant A/c 200,000.
b) Road Repairs A/C Dr. $150,000.
Solution Summary.
The solution prepares journal entries for three grants that were given to the town of College Hills.
Purchase Solution.
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Q&A Forum.
What are the accounting entries used for Restricted Stock Units?
What are the accounting entries (the debits, credits and accounts) used for grant accounting of Restricted Stock Units? An example would be great.
Company: Frank, Rimerman + Co. LLP.
Accounting for restricted stock units (RSU’s) is very similar to accounting for stock options. The major difference is that valuation is generally much simpler for RSU’s, since for non-dividend paying stocks, the RSU is worth the fair value of the underlying stock—no complex option pricing model necessary.
RSU’s granted to employees are valued at the date of grant and recognized in compensation expense over the service period, which is generally the vesting period.
So let’s take a simple example: 1,000 RSU’s granted on the first day of the accounting period, vesting in four equal, annual installments. Let’s assume the stock does not pay a dividend and has a fair value of $1.00 per share. By the end of the first accounting period, you should have debited compensation expense for $250, credited common stock for the par value of 250 shares and credited APIC for the difference. This same entry would be made each year. The amount of the entry should also be reduced for expected forfeitures (RSU’s not expected to vest) and periodically trued-up for actual forfeitures.
I hope this is helpful—if you have some follow-up questions, fire away.
Hi Brian or anyone who may help. I am trying to see what accounting treatments are needed when the restricted stock units are vested. say 100 shares granted at $35.00.. so my original accounting is Dr Expense $3,500 Cr APIC $3,500. the dividends are 25 shares and the total vested shares is 1,250 shares at $40.00.. and the net shares to be issued is 94 shares. the diff is the tax withholding.
should I do the following?? or can someone help me?
Cr C/S $0.1 par value $9.4.
if treasury shares used.
Cr Treasury shares $39.0 $3,900.
You may also want to take a look at this free.
"Sample Restricted Stock Purchase Agreement:
Also, take a look at this free webinar with CPE here at Proformative titled,
"Equity Compensation Plans: Benchmarking Operational and Reporting Performance"
I hope it helps!
Company: Stock & Option Solutions.
Exactly right, Brian. And to complicate matters just a bit. you should also be reducing the expense you accrue by an estimated forfeiture rate and truing up to actual forfeitures at the time of, or even before, the vesting occurs.
If 10% of the 125 shares get deferred, i. e. 112.5 shares issued and 12.5 shares deferred, what should I do on the deferral of 12.5 shares? say the market value is $35 (debits, credits and accounts)
I haven't found any authoritative answer on this, but one approach that occurs to me would be to create a Dr. balance XEQ account called "restrictions" and debit that for the value of the restricted shares. When they vest, the credit to this account is offset by recognition of the compensation expense. This way the issuance of the shares is recognized, but there is no overall impact on contributed capital until the employment condition is satisfied.
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