Discuss With Your Team The Client X Case Study ✓ Solved

Discuss with your team the following case study: Client X of

Client X offers a generous employee compensation package that includes employee stock options. The exercise price has always been equal to the market price of the stock at the date of grant. The corporate controller, John Jones, believes that employee stock options, like all obligations to issue the corporation's own stock, are equity. The new staff accountant, Marcy Means, disagrees. Marcy argues that when a company issues stock for less than current value, the value of preexisting stockholders' shares is diluted.

Pretend you are hired to debate the issue of the proper treatment of options written on a company's own stock. Write a response of 175 words in which you address the following requirement: Describe how Client X should account for its employee stock option plan under existing GAAP.

Paper For Above Instructions

Client X should account for its employee stock option plan in accordance with the Accounting Standards Codification (ASC) 718, which is part of Generally Accepted Accounting Principles (GAAP). Under ASC 718, employee stock options are classified as equity awards when the exercise price is not less than the fair market value of the stock on the grant date. Consequently, if Client X sets the exercise price at the market price, as indicated, the options would be classified as equity instruments.

When accounting for these options, Client X must measure the fair value of the stock options at the grant date using an acceptable valuation model, such as the Black-Scholes model or a binomial model. This fair value is then recognized as compensation expense over the requisite service period, which corresponds to the employees’ vesting schedule.

In addition, while stock options might result in the dilution of existing shareholders' equity when exercised, accounting for them as equity instruments under GAAP recognizes that the options do not represent an immediate cash outflow or a liability on the balance sheet until they are exercised (FASB, 2016). Furthermore, this treatment allows companies to manage their equity compensation plans effectively without distorting their financial positions unnecessarily.

In conclusion, by adhering to ASC 718, Client X ensures compliance with GAAP while providing clarity to existing shareholders regarding the impact of the employee stock option plan on their equity interests.

References

• Financial Accounting Standards Board (FASB). (2016). Accounting Standards Codification 718—Compensation—Stock Compensation.
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