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The Financial Accounting Standards Board recently passed new standards on how to calculate compensation for stock options. While the actual recording of a compensation expense under the new rules is not required, footnote disclosure of this amount is required. This calculation mandates the use of an option pricing model (Black-Scholes is the dominant but not required model). This article outlines the rules in SFAS 123, Accounting for Stock-Based Compensation and goes through an example calculation using the Black-Scholes option pricing model.
FAS No. 123, Accounting for Stock-Based Compensation, which was issued in October 1995, is the culmination of a ten year debate on how companies should account for stock compensation awards. This statement continues the current trend toward more fair-value measurement and increased disclosure. Most of the objections to the new standard were based on the notion that it would reduce reported corporate earnings.l Start-up companies would be the hardest hit. They frequently grant stock options to their employees as an alternative to paying high salaries. The bureau of National Affairs reported that 14 different national business groups who wrote letters to Congress warning that the proposal's changes "would fall hardest on the employees of those companies which provide stock options and employee stock purchase opportunities to their entire workforces."2 The initial proposal required all companies to record stock options as compensation expense on their income statements. While the FASB firmly believes that stock options are compensation and should be recorded as such, they compromised this stance due to heavy negative feedback from both the business and accounting communities. The new statement allows companies the choice. Companies may choose to continue to apply APB Opinion 25, Accounting for Stock Issued to Employees in calculating compensation expense or they may adopt the new standard. Companies that choose to continue to apply APB Opinion 25 for compensation expense purposes are required to disclose in the notes to the financial statements the effect SFAS 123 would have had on net income and earnings per share. Therefore, because of this disclosure rule, SFAS 123 calculations must be performed by all firms offering employee stock options. All accountants need to be comfortable with required calculations to meet the disclosure requirements of SFAS 123. Who Does 123...