ABC Expenses Stock Options As Required By GAAP On January 1

Abc Expenses Stock Options As Required By Gaap On January 1 2015 Ab

ABC expenses stock options as required by GAAP. On January 1, 2015, ABC granted 50 key executives 100 options each. Each option entitled the option holder to purchase 1 share of ABC common stock at $60 per share. The options will vest on January 1st 2018. On the grant date, January 1st, 2015, the stock was quoted on the stock exchange at $63 per share. The fair value of the options on the grant date was estimated at $15 per option. The amounts of compensation expense ABC should recognize with respect to the options during 2015, 2016, and 2017 are:

Paper For Above instruction

Under Generally Accepted Accounting Principles (GAAP), the accounting for stock options involves recognizing compensation expense over the vesting period. The Financial Accounting Standards Board (FASB) emphasizes measuring the fair value of stock options at the grant date, which is then allocated systematically over the vesting period, typically using the straight-line method unless another systematic method is more representative of the pattern of benefit accrual.

In this scenario, ABC granted stock options on January 1, 2015, to 50 key executives. Each receives 100 options, totaling 5,000 options (50 executives x 100 options each). The fair value of each option at the grant date was $15. The options vest on January 1, 2018, which means the vesting period spans three years: 2015, 2016, and 2017. This typical three-year vesting schedule mandates that ABC recognize a portion of the total compensation expense in each year based on the vesting period.

Calculation of Total Compensation Cost

The total compensation expense recognized is the fair value of all options granted, multiplied by the number of options granted, i.e.,

Total Fair Value of Options = Number of options x Fair value per option

= 5,000 options x $15 = $75,000

This $75,000 is the total amount ABC should recognize gradually over the vesting period, i.e., three years from 2015 to 2017.

Annual Compensation Expense

The expense is allocated equally over the vesting period unless there is evidence of a different pattern. Thus, the annual expense for each year of vesting is:

Annual Expense = Total Compensation Cost / Number of vesting years

= $75,000 / 3 years = $25,000 per year

Recognition of Expense

Therefore, ABC should recognize $25,000 as stock-based compensation expense in each of the years 2015, 2016, and 2017. This consistent allocation reflects the gradual vesting of the options, aligning the expense recognition with the period when the employees earn the right to exercise the options.

Impact on Financial Statements

The recognition of $25,000 each year affects ABC’s income statement by increasing expenses, thereby reducing net income for each year. On the balance sheet, a corresponding increase in stockholders’ equity occurs through additional paid-in capital, reflecting the equity component of the stock options.

Additional Considerations

Although the grant-date fair value is $15 per option, the actual stock price at grant ($63) and exercise price ($60) influence the intrinsic value but do not alter the fair value used for accounting purposes, which is derived from option valuation models like Black-Scholes. These models incorporate factors such as stock price volatility, risk-free interest rate, dividend yield, and remaining time to expiration.

In conclusion, the key aspect of accounting for stock options under GAAP is recognizing a systematic expense that reflects the fair value of the options over the vesting period. For ABC, this involves recognizing $25,000 annually from 2015 through 2017, accumulating to a total of $75,000.

References

• Financial Accounting Standards Board (FASB). (2014). Accounting Standards Codification (ASC) Topic 718 — Compensation—Stock Compensation.
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