scholarly journals A Note On Accounting For Employee Stock Options When Reporting Diluted Earnings Per Share Under The Treasury Stock Method

2011 ◽  
Vol 6 (10) ◽  
Author(s):  
David T. Doran
Keyword(s):  
Stock Options ◽  
A Priori ◽  
Market Price ◽  
Accounting Standards ◽  
Fair Value ◽  
Financial Accounting ◽  
Employee Stock Options ◽  
Financial Accounting Standards Board ◽  
Earnings Per Share ◽  
Free Environment

<p class="MsoNormal" style="text-align: justify; margin: 0in 0.5in 0pt;"><span style="font-size: 10pt;"><span style="font-family: Times New Roman;">Firms must currently apply the fair value method in determining the amount of employee compensation incurred in the case of employee stock options.<span style="mso-spacerun: yes;">&nbsp; </span>Current GAAP also requires that for purposes of calculating diluted earnings per share (EPS), the treasury stock method be applied where the assumed proceeds from exercise of the optioned shares is used to purchase shares of the firm&rsquo;s stock at its average market price of the earnings period.<span style="mso-spacerun: yes;">&nbsp; </span>These incremental shares increase the denominator for purposes of calculating diluted EPS.<span style="mso-spacerun: yes;">&nbsp; </span>These requirements are consistent across the pronouncements of the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB).<span style="mso-spacerun: yes;">&nbsp; </span>This study extends the work of Doran (2005) and Doran (2008).<span style="mso-spacerun: yes;">&nbsp; </span>These previous studies found that applying the treasury stock method where shares are assumed purchased at the average for the period price (instead of end of year price) understates the number of incremental shares (the denominator), which overstates diluted EPS.<span style="mso-spacerun: yes;">&nbsp; </span>However, these previous works assumed that no shares were actually purchased for the treasury during the earnings period.<span style="mso-spacerun: yes;">&nbsp; </span>The FASB indicates one reason that the average for the period price is appropriate is because if treasury shares purchases were to occur, &ldquo;the shares would be purchased at various prices, not at the price at the end of the period.&rdquo;<span style="mso-spacerun: yes;">&nbsp; </span>This study tests the notion that the average for the period price is appropriate under circumstances where the firm actually purchases shares for the treasury at its average market price during the earnings period.<span style="mso-spacerun: yes;">&nbsp; </span>This paper employs a simple one period model that assumes a risk free environment with complete certainty.<span style="mso-spacerun: yes;">&nbsp; </span>The model allows comparison of computed EPS with an a priori known, correct amount.<span style="mso-spacerun: yes;">&nbsp; </span>Consistent with Doran (2005) and Doran (2008), the results here again indicate that assuming purchase of treasury shares at their average market price of the earnings period understates the EPS denominator which results in EPS overstatement. <span style="mso-spacerun: yes;">&nbsp;</span>Correct diluted EPS is derived when the shares assumed purchased under the treasury stock method are acquired at the higher period ending market price.<span style="mso-spacerun: yes;">&nbsp; </span></span></span></p>

scholarly journals Employee Stock Options And Diluted Earnings Per Share

2011 ◽  
Vol 3 (11) ◽  
Author(s):  
David T. Doran
Keyword(s):  
Stock Price ◽  
Stock Options ◽  
Intrinsic Value ◽  
Market Price ◽  
Fair Value ◽  
Employee Stock Options ◽  
Research Support ◽  
Earnings Per Share ◽  
Free Environment ◽  
Period Model

At the time of this writing, SFAS No.123 (1995) prescribes GAAP in accounting for employee stock options.  It allows firms to choose either the intrinsic or fair value method in determining the amount of compensation expense recognized for employee stock options.  The choice of method affects the numerator of the earnings per share (EPS) calculation.   The FASB recently issued a revised SFAS No. 123 (2004) which will require uniform application of the fair value method.  GAAP also requires that the denominator for the diluted EPS calculation be increased for incremental shares under the treasury stock method.  SFAS 128 requires the treasury stock method be applied where the proceeds from the assumed exercise of options are used to acquire shares of the firm’s outstanding stock at the average market price for the period.  Previous to SFAS No. 128, APB Opinion No. 15 required that the higher of average or period ending stock price be used in determining the number of shares reacquired with the proceeds from the assumed exercise of stock options.  This paper develops a simple one period model that assumes a risk free environment with complete certainty conditions in testing the accuracy of EPS calculated under GAAP using the fair value method vs. the intrinsic value method.   The results indicate that EPS reported under the intrinsic value method are overstated, and further indicate that a combination of both the fair value method and the treasury stock method is needed in calculating diluted EPS.  This fair value and treasury stock method combination is shown to not “double count” the stock option’s impact upon EPS.  The results also indicate a slight misstatement of diluted EPS under the fair value method when applying the treasury stock method requirements of SFAS No. 128.  Correct EPS results when shares are assumed reacquired for the treasury at the higher year ending price, consistent with superseded APB 15.  However, the diluted EPS misstatement is so slight that the FASB’s rationale for always requiring the use of average period price seems likely to be justified.  The findings of this research support the requirements of SFAS No. 123 (revised 2004) and SFAS No. 128.

scholarly journals Employee Stock Options And Diluted Earnings Per Share: An Extension

2011 ◽  
Vol 7 (2) ◽  
Author(s):  
David T. Doran
Keyword(s):  
Stock Options ◽  
Market Price ◽  
Accounting Standards ◽  
Fair Value ◽  
Employee Stock Options ◽  
Employee Compensation ◽  
Earnings Per Share ◽  
Service Period ◽  
The Impact ◽  
Period Model

Firms must currently apply the fair value method in determining the amount of employee compensation incurred in the case of employee stock options. The amount of such compensation is required to be measured as fair value of the equity instrument at the grant date, with compensation expense recognized over the service period under the straight-line method. This compensation expense affects the numerator for purposes of calculating earnings per share (EPS) under generally accepted accounting principles (GAAP). Current GAAP also requires that for purposes of calculating diluted EPS, the treasury stock method be applied where the assumed proceeds from exercise of the optioned shares is used to purchase shares of the firms stock at its average market price of the earnings period. These incremental shares increase the denominator for purposes of calculating diluted EPS. These requirements are consistent across the pronouncements of the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB). This study extends the work of Doran (2005) where a single period model was assumed and found: 1. Application of the fair value method does not double count the impact of compensation recognized, and 2. Applying the treasury stock method where shares are assumed purchased at the average for the period price (instead of end of year price) understates the number of incremental shares (the denominator), which overstates diluted EPS. This paper employs a simple multi period model that assumes a risk free environment with complete certainty in testing the accuracy of GAAP compliant diluted EPS in the case of employee stock options. Consistent with Doran (2005) the results here again indicate that assuming purchase of treasury shares at their average market price of the earnings period understates the EPS denominator. The results of this study also indicate that the reported employee compensation expense is understated. The observed cause of this numerator error is treating the payment for the option (employee service) as if it was received in full at the grant date - as a lump sum (like inventory or some other asset), rather than being received ratably over the employee service period as an annuity. Each of these findings contributes to the observed overstatement of diluted EPS. Correct diluted EPS is observed when the employee service is treated as being received ratably over the service period, and the shares assumed purchased as treasury stock are acquired at the higher period ending market price. The amount of diluted EPS overstatement under both FASB and IASB standards is directly related to the length of the term of the option.

scholarly journals An Alternative Method Of Accounting For Stock Options

2014 ◽  
Vol 30 (2) ◽  
pp. 439
Author(s):  
Thomas Smith ◽  
Adrian Valencia ◽  
Ara Volkan
Keyword(s):  
Stock Options ◽  
Intrinsic Value ◽  
Market Price ◽  
Fair Value ◽  
Financial Accounting ◽  
Employee Stock Options ◽  
Financial Accounting Standards Board ◽  
Exercise Price ◽  
The Difference ◽  
The Impact

<p>Currently, the grant date fair value of employee stock options is expensed over the vesting period. Our study introduces a new valuation approach for stock options and examines the impact of this change on earning per share (EPS) for a sample of firms over the period 2002-2011. The new valuation approach provides data useful to the Financial Accounting Standards Board (FASB) as it determines whether to revise the current option accounting rules. Under the proposed approach, options are valued at their intrinsic value on the grant date (i.e., the opportunity cost or the economic promise associated with the difference between the exercise price of the option and the market price of the stock at each measurement date) and further revalued each reporting date until the options are exercised.</p>

Stock Option Expense: The Sword of Damocles Revealed

2001 ◽  
Vol 15 (4) ◽  
pp. 311-327 ◽  
Author(s):  
Christine A. Botosan ◽  
Marlene A. Plumlee
Keyword(s):  
Accounting Standards ◽  
Fair Value ◽  
Stock Option ◽  
Financial Accounting ◽  
Financial Accounting Standards Board ◽  
Return On Assets ◽  
Earnings Per Share ◽  
Disclosure Requirements ◽  
Differences Of Opinion ◽  
Fortune Magazine

Statement of Financial Accounting Standards (SFAS) No. 123 is one of the most controversial accounting standards ever issued by the Financial Accounting Standards Board (FASB 1995) (SFAS No. 123, para. 376). More than five years have passed since SFAS No. 123 first required firms to either recognize or disclose stock option expense based on the fair value of options granted. In light of the fractious debate surrounding its passage and ongoing differences of opinion regarding the usefulness of stock option expense data, this paper reports how the standard impacts firm performance. This study examines the effect of stock option expense on the diluted earnings per share and return on assets of 100 firms identified by Fortune magazine as “America's Fastest-Growing Companies.” We find that stock option expense has a material impact on the performance measures for a majority of our sample firms. Moreover, our analysis predicts stock option expense will grow over the next several years, potentially doubling in magnitude during that time. We also document some noncompliance with the disclosure requirements of SFAS No. 123, finding that 12 percent of the sample firms provided incomplete information during the most recent year examined.

scholarly journals Accounting standards for employee stock option disclosure: The current debate

2007 ◽  
Vol 4 (3) ◽  
pp. 87-95
Author(s):  
Geoffrey Poitras
Keyword(s):  
Accounting Standards ◽  
Financial Statements ◽  
Fair Value ◽  
Stock Option ◽  
Financial Accounting ◽  
Current Debate ◽  
Employee Stock Options ◽  
Net Income ◽  
Financial Accounting Standards Board ◽  
Employee Stock Option

The paper examines the implications of recent changes to accounting standards for employee stock based compensation with contingent features. The Dec. 2005 implementation of FAS 123R by the Financial Accounting Standards Board requires the fair value of such expenses to be recorded in net income. The change is now impacting the reported financial statements of firms that have been substantial users of employee stock options. This provides an opportunity to directly assess the actual impact of FAS 123R on such firms. Arguments for and against mandatory expensing are reviewed and an assessment of the contrasting positions provided. Significant limitations of current reporting requirements are identified

scholarly journals Accounting For Employee Stock Options With Service, Performance, And Market Conditions

2012 ◽  
Vol 9 (1) ◽  
pp. 47
Author(s):  
John F. Boschen ◽  
Denise A. Jones ◽  
Kimberly J. Smith
Keyword(s):  
Stock Options ◽  
Accounting Standards ◽  
Service Performance ◽  
Financial Accounting ◽  
Creative Design ◽  
Employee Stock Options ◽  
Financial Accounting Standards Board ◽  
Market Conditions ◽  
Accounting Standard

The accounting for employee stock options has long been a subject of debate among executives, regulators, and standard-setters. The accounting standard passed by the Financial Accounting Standards Board (FASB) in 2004 allows for more creative design of these types of options. In this case, students learn about employee stock options with service, performance, and market conditions. They also learn how to value options with these conditions, and how to report them on company income statements under the new accounting guidance.

scholarly journals Diluted Earnings Per Share Overstatement Bias: Including Unrecognized Employee Compensation In Proceeds From Assumed Exercise Of Employee Stock Options Under The Treasury Stock Method

2013 ◽  
Vol 29 (6) ◽  
pp. 1657
Author(s):  
David T. Doran
Keyword(s):  
Financial Reporting ◽  
Stock Price ◽  
Stock Options ◽  
Fair Value ◽  
Stock Option ◽  
Employee Stock Options ◽  
Employee Compensation ◽  
Earnings Per Share ◽  
Service Period ◽  
Free Environment

Generally accepted accounting principles (GAAP) require firms to recognize compensation expense under the fair value method in the case of employee stock options. Straight line amortization of the options grant date fair value must be recognized as expense over the service period which decreases the earnings per share numerator. For diluted earnings per share (EPS), GAAP requires using the treasury stock method, where proceeds from assumed stock option exercise is used to purchase treasury shares at the average for the period price. Exercise proceeds include the exercise price plus unrecognized future employee compensation. For profitable firms, exercise is assumed if dilutive - more shares are assumed issued than are reacquired for the treasury which increases the diluted EPS denominator. These requirements are consistent across US GAAP and International Financial Reporting Standards. This paper tests whether including unrecognized employee compensation in proceeds from the assumed exercise of employee stock options under the treasury stock method is appropriate. A simple multi period model that assumes a risk free environment with complete certainty is applied. This study contributes to the literature by demonstrating that future unrecognized employee compensation should not be included in proceeds from the assumed exercise of stock options under the treasury stock method. Doing so consistently causes diluted EPS overstatement, and in certain instances causes assumed exercise of in the money options to be antidilutive, which results in complete exclusion from the diluted EPS calculation. This research extends the employee stock option work of Doran (2005 and 2008) that found: 1) Compensation expense recognized over the employee service period should equal the periodic annuity amount that provides the options grant date fair value, and 2) Treasury shares should be assumed purchased at the higher end of period stock price.

scholarly journals An Evaluation Of The Implementation Of Fair Value Accounting: Impact On Financial Reporting

2011 ◽  
Vol 9 (1) ◽  
Author(s):  
Karen T. Cascini ◽  
Alan DelFavero
Keyword(s):  
Financial Reporting ◽  
Accounting Standards ◽  
Fair Value ◽  
The United States ◽  
Financial Accounting ◽  
Financial Assets ◽  
Financial Accounting Standards Board ◽  
Continuous Change ◽  
Fair Value Accounting ◽  
The Cost

<p class="MsoNormal" style="text-justify: inter-ideograph; text-align: justify; margin: 0in 0.5in 0pt; mso-pagination: none;"><span style="color: #0d0d0d; font-size: 10pt; mso-themecolor: text1; mso-themetint: 242;"><span style="font-family: Times New Roman;">The accounting industry is in a state of continuous change.<span style="mso-spacerun: yes;">&nbsp; </span>In the United States, the historical cost principle has traditionally been the foundation of accounting.<span style="mso-spacerun: yes;">&nbsp; </span>Until recently, assets and liabilities have been required to be recorded at their acquisition prices, with the exception of designated financial assets and financial liabilities.<span style="mso-spacerun: yes;">&nbsp; </span>However, the Financial Accounting Standards Board (FASB) has now created accounting standards that are distant from the cost principle.<span style="mso-spacerun: yes;">&nbsp; </span>Statement of Financial Accounting Standards No. 157: Fair Value Measurements, issued in September 2006 (FAS157, now codified as ASC 820) and Statement of Financial Accounting Standards No. 159: The Fair Value Option for Financial Assets and Financial Liabilities, created in February 2007 (FAS159, now ASC 825-10-25), significantly increases the viability of fair value accounting. The purpose of this paper is to illustrate the benefits and pitfalls of fair value and the corresponding affects on various stakeholders. <span style="mso-spacerun: yes;">&nbsp;&nbsp;</span></span></span></p>

scholarly journals The FASBs Concepts Statement On Cash Flows And Present Value

2011 ◽  
Vol 19 (4) ◽  
Author(s):  
Stanley Martens ◽  
Thomas Berry
Keyword(s):  
Cash Flow ◽  
Accounting Standards ◽  
Fair Value ◽  
Cash Flows ◽  
Financial Accounting ◽  
Financial Accounting Standards Board ◽  
Present Value ◽  
Numerical Examples ◽  
Flow Information

In February 2000, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Concepts No. 7, Using Cash Flow Information and Present Value in Accounting Measurements.  In this document the FASB asserts without proof that a present value computation along its lines will provide a good estimate of the fair value of an asset or liability.  Using numerical examples provided by the FASB, we attempt to construct arguments in support of the FASB’s claim.  We find that such arguments require strong and not at all obvious assumptions about players in hypothetical markets.

scholarly journals Valuing the Reload Features of Executive Stock Options

1999 ◽  
Vol 13 (3) ◽  
pp. 219-240 ◽  
Author(s):  
P. Jane Saly ◽  
Ravi Jagannathan ◽  
Steven J. Huddart
Keyword(s):  
Option Pricing ◽  
Stock Options ◽  
Accounting Standards ◽  
Financial Accounting ◽  
Executive Stock Options ◽  
Pricing Model ◽  
Financial Accounting Standards Board ◽  
Option Pricing Model

For options with a reload feature, the holder is automatically entitled to new options when the initial option is exercised. Under Statement of Financial Accounting Standards No. 123, the grant date value of executive stock options excludes the value of a reload feature because the Financial Accounting Standards Board believes it is not feasible to value a reload feature at the grant date. We show how the Binomial Option Pricing Model can be used to value options and the reload feature at the grant date. Ignoring the reload can substantially understate the value of the option. Accordingly, the Financial Accounting Standards Board may wish to reconsider the accounting for reload features.

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