1 FAS 123 (R) (fair value model) Note that use of APB 25 is no longer permitted Employee Stock Options

2 A. NON-COMPENSATORY PLANS Conditions: All Employees Equal opportunity for all eligible employees Limited time offer Limited discount (same as offered to existing stockholders Accounting Issues: None, no compensation expense

3 B. Compensatory Plans 1. Incentive Plans No tax to employee when exercised, only when stock is sold Tax law requires that option price on grant date is equal to the market price Compensation expense = fair value of options

4 2. Non-qualified Plans Employees taxed when option exercised Taxed on the difference between market price and exercise price Company receives tax deduction Option price may be lower than market price on the measurement date Compensation expense must be recognized

5 Terms zOption - opportunity to buy stock at fixed price (Exercise price) zGrant date - date on which employee receives option zMeasurement date - date on which both ythe number of shares and ythe exercise price are known

6 Terms zCompensation expense – fair market value of options – determined through use of option pricing model zService Period - time period over which compensation expense is amortized

7 Example - Data z# of Options issued 10,000 zService Period 3 years zExercise Price of stock$20 zMarket Priceof option$6 zExpected forfeiture10%

8 Dr. deferred compensation expense$54,000 cr. Paid in capital - options$54,000 (10,000 * 6 *.9) – adjusted for expected forfeitures dr. compensation expense$18,000 cr. Deferred compensation expense $18,000 (record issuance of options and first year compensation expense) Note that deferred compensation expense will offset PIC options)

9 Exercise of 80% of options Dr. cash$160,000 dr. paid in capital - options$ 48,000 cr. Common stock ($1 par)$ 8, 000 cr. Additional paid in capital$200,000 dr. compensation expense $ 12,000 Dr. Paid in capital – options$ 6,000 cr. Deferred compensation expense$18,000 (adjusted for additional forfeited options)

10 Stock Appreciation Plans zNon qualified plans zEmployee receives cash based on the increase in stock value zUsed to generate cash, i.e., for tax when options are exercised zCompensation expense must be estimated between grant and exercise date

11

12

13

14 FAS 123 versus APB 25 zCompensation expense based on market value of option zBlack-Sholes Option pricing model used zCompensation expense is always recognized z Compensation expense only if market > exercise price on grant date z For most plans No compensation expense is recognized

15 Required Disclosures under FAS 123 z # of shares under option plan z# of options issued, exercised, lapsed zweighted av. option price per category zweighted av. fair value of options granted zassumptions made to estimate fair value zAverage remaining contractual life of options outstanding