EMPLOYEE STOCK OPTIONS Question No Explain in detail what are employee stock options and restricted stock? Employee Stock Options (ESOP) is a call option where the option writer is the company. Call option is an agreement that gives an investor the right but not the obligation to buy a stock, bond, commodity, or other instrument at a specified price within a specific time period. The option buyer would make profit if the price of the underlying asset increases. The premium in case of ESOP is sacrificed in lieu of the future services to be rendered by the employees during the vesting period and lock in period, if any. Thus ESOP is a right but not an obligation to purchase certain number of shares of the company at a pre-determined price.
Restricted stock is that part of equity of the company that is allotted or sold on a conditional basis in lieu of compensation to be paid or as a part of ESOP. The conditions associated with the restricted stock would be that the investor should hold the stock for certain period of time. Another condition would be that the Employee needs to stay with the company for certain period of time to be eligible to trade in the restricted stock.
Question No.2. How are employee stock options and restricted stock accounted for in financial statements?
Companies need to disclose the Stock based employee compensation in the Notes to the financial statements. 1ESOPs should be accounted based on Fair value based method of accounting or intrinsic value based accounting. Compensation cost under the fair value based method is measured at the option grant date based on the value of the option and is recognized over the service period, which is usually the vesting period. Compensation under the intrinsic value based method is the excess, if any, of the quoted market price of the stock at grant date over the amount an employee must pay to acquire the stock.
Restricted stock awarded to an employee is measured at the market price of the non-restricted stock on the grant date. However, if a restriction is imposed after the employee is vested with the stock, then restricted stock is accounted at the fair value of stock calculated after taking into account such restriction.
Question No.3. Why are many corporate managers opposed to the FASBs proposed accounting change?
The major advantage of ESOPs is that the compensation cost pertaining to ESOPs is not charged to profit and loss account but is just disclosed in the notes to the financial statements. This would enable the companies to show more profits. Now the proposed accounting change of FASB is to make the companies to charge ESOP to the Profit and loss account. This will reduce the profits of many companies and hence the price of the stock of the company, this would prevent these corporate managers from selling the ESOPs granted to them.
Question No.4.Briefly discuss back ground and dispositions of recent stock options cases (at least 2 cases) that drew media attention
Apple Company has issued backdated ESOPs to match the previous share price lows so that the Employees can make huge profits by exercising the options. The investigation revealed that 6428 stock options grants have been improperly backdated between 1997 and 2002. Finally Apply has agreed for a 14 million dollar settlement of this shareholder lawsuit.
2) K.V.Pharmacuetical Co.
The case was filed alleging that the company has not recorded compensation costs in accordance with the US GAAP during the period 1996 and 2006. The company has agreed to restate its financial statements for this period and record the compensation cost net of tax to the tune of $12 million.
1) FASB, FASB.org: Accounting for Stock based compensation, retrieved on 16 March 2009, from http://www.fasb.org/st/summary/stsum123.shtml