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Options to Buy Stock document sample
Document Sample
Acct 414 3/7/2011 Prof. Teresa Gordon
Example 1 - Award Classified as Equity Public Company
On January 1, Year 1, an Alice receives 1,000 options for to buy the company’s $3 par value
common stock for $8 per share. On the date of the grant, the market price was also $8. The
employee must work for the company for 4 years before she can exercise the options. The options
expire at the end of 5 years. An option pricing model determines that the fair value of the options is
$6 each. APIC-Stock Options Balance
$ 3.00 = par value 1,000 = number of options 0
$ 8.00 = Option (strike) price 0
$ 8.00 = Market price on Jan 1, Year 1 0
$ 6.00 = Fair value on Jan 1, Year 1 0
Grant date Exercise Period
0
0
0
0
0
Service Period
0
#REF!
JOURNAL ENTRIES Debit Credit
Jan 1, Yr 1
Grant date
Dec 31 Yr 1
Dec 31 Yr 2
Dec 31 Yr 3
Dec 31 Yr 4
VERSION A:
Mar 31, Yr 5 Employee exercises all options when market price = $ 15 per share
Version B:
WHAT IF EMPLOYEE QUIT AFTER 2 YEARS?
Jan 15 Yr 3
Version C:
WHAT IF EMPLOYEE FAILS TO EXERCISE OPTIONS AFTER THEY ARE VESTED?
Dec 31 Yr 5
ad6db501-147a-4a66-b3b0-4667defa293e.xls -1- Example 1
Acc4 414 3/7/2011 Prof. Teresa Gordon
Example 2 - Award Classified as Liability NOT TESTED!
Mary works for a nonpublic company. On January 1, Year 1, Mary receives 1,000 units of stock
appreciation rights (SARS). She is told that she will receive the difference between the current
stock prices ($10) and the stock price that exists when she exercises her 1,000 SARs. She
cannot exercise the options for 2 years. The options expire 3 years from the grant date. SARS Liability Balance
This is the "last vestige" of the intrinsic value method. 0
$ 3.00 = par value 1,000 = number of options 0
$10 = Option (strike) price 0
$10 = Market price on Jan 1, Year 1 0
Grant date Expiration Date 0
0
0
0
0
Service Period Exercise Period 0
JOURNAL ENTRIES Debit Credit
Jan 1, Yr 1 Market price = $10
Dec 31, Yr 1 Market price = $11
Dec 31, Yr 2 Market price = $13
Dec 31, Yr 3 Market price = $8
Mar 31, Yr 4 Market price rises to $12 and she exercises all 1,000 SARS
ad6db501-147a-4a66-b3b0-4667defa293e.xls - 22 - Example 2
Acc4 414 3/7/2011 Prof. Teresa Gordon
Example 3 - Award Classified as Liability
Sally works for a public company. On January 1, Year 1, Sally receives 1,000 units of stock
appreciation rights (SARS). She is told that she will receive the difference between the current
stock prices ($10) and the stock price that exists when she exercises her 1,000 SARs. She
cannot exercise the options for 2 years. The options expire 3 years from the grant date. SARS Liability Balance
For this award, the company must re-compute fair value at each balance sheet date 0
$ 3.00 = par value 1,000 = number of options 0
$10 = Option (strike) price 0
$10 = Market price on Jan 1, Year 1 0
Grant date Expiration Date 0
0
0
0
0
0
Service Period Exercise Period
JOURNAL ENTRIES Debit Credit
Jan 1, Yr 1 Market price = $10, fair value = $3
Dec 31, Yr 1 Market price = $11, FAIR VALUE = $1.50
Dec 31, Yr 2 Market price = $13 Fair value = $4
Dec 31, Yr 3 Market price = $8, fair value = $1
Mar 31, Yr 4 Market price rises to $12 and she exercises all 1,000 SARS
ad6db501-147a-4a66-b3b0-4667defa293e.xls - 33 - Example 3
Acct 414 3/7/2011 Prof. Teresa Gordon
Example 1 - Award Classified as Equity
On January 1, Year 1, an executive receives 1,000 options for to buy the company’s $3 par value APIC-Stock Options Bal
1500 -1500
$ 3.00 = par value 1,000 = number of options 1500 -3000
$ 8.00 = Option (strike) price 1500 -4500
$ 8.00 = Market price on Jan 1, Year 1 1500 -6000
$ 6.00 = Fair value on Jan 1, Year 1 6000 0
Grant date Exercise Period
0
0
0
0
0
Service Period 0
0
JOURNAL ENTRIES Debit Credit
Jan 1, Yr 1 Total value = $6 FV * 1,000 options =
Grant date $6,000 * 0% earned
Memo entry only
Dec 31 Yr 1 Compensation expense $ 1,500.00
APIC-stock options outstanding $ 1,500.00
Recognize comp expense 25% * 1,000 options *
$6 FV
Dec 31 Yr 2 Compensation expense $ 1,500.00
APIC-stock options outstanding $ 1,500.00
Recognize comp expense 25% * 1,000 options *
$6 FV
Dec 31 Yr 3 Compensation expense $ 1,500.00
APIC-stock options outstanding $ 1,500.00
Recognize comp expense 25% * 1,000 options *
$6 FV
Dec 31 Yr 4 Compensation expense $ 1,500.00
APIC-stock options outstanding $ 1,500.00
Recognize comp expense 25% * 1,000 options *
$6 FV
VERSION A:
Mar 31, Yr 5 Employee exercises all options when market price = $ 15.00 per share
Cash (1000 shares * $8) $ 8,000.00
APIC - stock options outstanding $ 6,000.00 $6 FV * 1,000 shares
Common stock ($3 par * 1,000) $ 3,000.00
APIC - common stock $ 11,000.00
$ 14,000.00 $ 14,000.00
Version B:
WHAT IF EMPLOYEE QUIT AFTER 2 YEARS?
Jan 15 Yr 3 APIC - stock options outstanding $ 3,000.00
Compensation expense $ 3,000.00
Reverse compensation related to options forfeit by
employee
Version C:
WHAT IF EMPLOYEE FAILS TO EXERCISE OPTIONS AFTER THEY ARE VESTED?
Dec 31 Yr 5 APIC -stock options outstanding $ 6,000.00
APIC - expired stock options $ 6,000.00
Move expired options out of APIC-stock options
outstanding
Note: This is most likely to occur when the options
are "underwater" during the exercise period (also
called "out of the money"). For example, the
market price might range from $6.50 to $7.25
during the exercise period.
ad6db501-147a-4a66-b3b0-4667defa293e.xls -4- Example 1 (sol)
Acc4 414 3/7/2011 Prof. Teresa Gordon
Example 2 - Award Classified as Liability NONPUBLIC COMPANY
Mary works for a nonpublic company. On January 1, Year 1, Mary receives 1,000 units of stock
appreciation rights (SARS). She is told that she will receive the difference between the current
stock prices ($10) and the stock price that exists when she exercises her 1,000 SARs. She
cannot exercise the options for 2 years. The options expire 5 years from the grant date.
SARS Liability bal
This is the "last vestige" of the intrinsic value method. 500 -500
$ 3.00 = par value 1,000 = number of options 2500 -3000
$10 = Option (strike) price 3000 0
$10 = Market price on Jan 1, Year 1 2000 -2000
Grant date Expiration Date 2000 0
0
0
0
0
0
Service Period Exercise Period
NOTE - I WILL NOT HAVE A NONPUBLIC COMPANY ON ANY EXAM!
JOURNAL ENTRIES Debit Credit
Jan 1, Yr 1 Market price = $10
Nothing has benn earned yet
0% *($10-10) = 0
NO ENTRY NEEDED
Dec 31, Yr 1 Market price = $11
Compensation expense $ 500.00
SARS Liability $ 500.00
50% * ($11-10) * 1,000 = 500
Record liability at estimated amount
Dec 31, Yr 2 Market price = $13
Compensation expense $ 2,500.00
SARS Liability $ 2,500.00
100% earned * 1,000 * ($13-10) = $3,000
(desired ending balance in liability account)
Therefore, we make journal entry to go from
$500 to $3,000:
Dec 31, Yr 3 Market price = $8
SARS liability $ 3,000.00
Compensation expense $ 3,000.00
100% * 1,000 * (worthless) so liability balance
should be ZERO - the intrinsic value can never
be negative.
Mar 31, Yr 4 Market price rises to $12 and she exercises all 1,000 SARS
100% * 1,000 * ($12-10) = 2,000 owed
Compensation expense $ 2,000.00
SARS liability $ 2,000.00
Up-date balance in SARS liability account from
the previous estimate to the actual amount
owed to employee
SARS liability $ 2,000.00
Cash $ 2,000.00
Pay employee amount owed
ad6db501-147a-4a66-b3b0-4667defa293e.xls - 55 - Example 2 (sol)
Acc4 414 3/7/2011 Prof. Teresa Gordon
Example 3 - Award Classified as Liability PUBLIC COMPANY
Sally works for a public company. On January 1, Year 1, Sally receives 1,000 units of stock
appreciation rights (SARS). She is told that she will receive the difference between the current
stock prices ($10) and the stock price that exists when she exercises her 1,000 SARs. She
cannot exercise the options for 2 years. The options expire 5 years from the grant date.
SARS Liability bal
For this award, the company must re-compute fair value at each balance sheet date 750 -750
$ 3.00 = par value 1,000 = number of options 3250 -4000
$10 = Option (strike) price 3000 -1000
$10 = Market price on Jan 1, Year 1 1000 -2000
Grant date Expiration Date -2000
-2000
-2000
-2000
-2000
-2000
Service Period Exercise Period
JOURNAL ENTRIES Debit Credit
Jan 1, Yr 1 Market price = $10, fair value = $3
Nothing has been earned yet
0% * 1,000 * $3 FV
NO ENTRY NEEDED
Dec 31, Yr 1 Market price = $11, FAIR VALUE = $1.50
50% * $1.50 FV * 1,000 options=$750
Compensation expense $ 750.00
SARS Liability $ 750.00
Record liability at estimated amount
Dec 31, Yr 2 Market price = $13 Fair value = $4
Compensation expense $ 3,250.00
SARS Liability $ 3,250.00
100% earned * 1,000 * $4 FV = $4,000
(desired balance in liability account.) Adjust
from previously estimated balance of $750.
Dec 31, Yr 3 Market price = $8, fair value = $1
SARS liability $ 3,000.00
Compensation expense $ 3,000.00
100% * 1,000 * $1 FV = $1,000 correct liability
balance. Adjust balance in liability account to
new estimate
Mar 31, Yr 4 Market price rises to $12 and she exercises all 1,000 SARS
This is the MEASUREMENT DATE.
Computation: 100% * 1,000 * ($12-10) =
$2,000 amount owed
Compensation expense $ 1,000.00
SARS liability $ 1,000.00
Up-date balance in SARS liability account
from $1,000 estimated balance to $2,000
actual.
SARS liability $ 2,000.00
Cash $ 2,000.00
Pay employee amount owed
Note that the fair value at exercise = intrinsic value. Compare total
compensation expense to Example 2.
However different amounts could be recognized in particular time periods.
ad6db501-147a-4a66-b3b0-4667defa293e.xls - 66 - Example 3 (sol)
