Stock Options

A stock option is to give the holder the right to buy a given number of a company's stock at a preestablished price. This price is referred to as the option price by FASB but is usually called the strike price by the business community.

Compensatory Stock Option

The purpose of stock option is to compensate employees beyond the amount of their cash salary.

Noncompensatory Stock Option

The purpose is to raise capital or obtain more widespread ownership of the company's stock by its employees.

Accounting Rule -- Accounting Principles Board's APBO No. 25, Accounting for Stock Issued to Employees (APBO 25)

This accounting rule was established in October 1972 and certain criteria must be met for a plan to be considered noncompensatory. Options under a noncompensatory plan are not accounted for when granted and no compensation expense is ever considered. When such options are exercised, the transaction is accounted for as a normal sale of stock.

Under compensation plans, stock options can be fixed or variable. The most common are fixed plans, which vest after an employee has worked for a set period of time. With fixed plans, both the number of options and the strike price are established on the date the options are granted. With variable, these are not set but are usually depend upon future events, such as meeting target amounts of return on equity.

The amount of total compensation associated with a compensatory stock option must be determined, then amortized to compensation expense over the service period, which is normally the period of time that the option takes to vest.

The total compensation per option is measured as the difference between the market price of the stock and the strike price on the measurement date. The measurement date is the first date on which both the number of options and the strike price are known. Since the most companies set the strike price equal to the market price on the grant date, no compensation expense is ever recorded.

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