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First of all I am not a professional accountant so please I request your patience.
So I am surprised by how unclear the explanations online are on ESOP accounting. I reviewed 100s of website and none seem to paint a clear picture of GAAP accounting around option grant.
Anyhow here is the situation.
I understand that as options are granted the options price (derived out of black scholes model) is expensed as they vest over a period of time.
Lets assume option price to be 8$, strike price at grant is 15$.
Now AFTER vesting, lets assume that employees exercise the option when the share is trading for 25$. Now this is the best explanation I could find for accounting when option gets exercised:
"When an employee exercises stock options, you’ll credit Common Stock for the number of shares x par value, debit Cash for the number of shares x the exercise price, then debit Additional Paid-In Capital for the difference, representing the increase in value of the shares during the service period."
So going by the above, we Dr the Cash account for 15$ x Amt of Shares. We Cr the common stock for par viz 1$ x Amt of Shares.
And then comes Dr for difference in Additional Paid-In Capital.
So here are the questions:
1. What is this Dr for Additional Paid In Capital? Is it 15$ (strike price) -1$ (par) difference to balance the entry? OR Is it 25$(share price) - 15$(strike price) difference to represent the premium.
2. My next question would follow from the first question. When the above amount is Dr to Additional Paid In Capital will it appear as an expense item in income statement or OCI?
3. Why should the Additional Paid in capital be DR in the first place? It being on the Equity side I am not sure what is there to reduce by DR additional paid in capital. If anything I am thinking it should be CR (Increased) to account for 15$ cash from employees - 1$ par (already accounted for).
4. Will the premium above the strike price (25$-15$) be expensed on the income statement at all? This single question is by far the most important to me. I know RSUs are fully expensed at market price of stocks in vesting tranches. Not sure the same is done when options are exercised.
So I am surprised by how unclear the explanations online are on ESOP accounting. I reviewed 100s of website and none seem to paint a clear picture of GAAP accounting around option grant.
Anyhow here is the situation.
I understand that as options are granted the options price (derived out of black scholes model) is expensed as they vest over a period of time.
Lets assume option price to be 8$, strike price at grant is 15$.
Now AFTER vesting, lets assume that employees exercise the option when the share is trading for 25$. Now this is the best explanation I could find for accounting when option gets exercised:
"When an employee exercises stock options, you’ll credit Common Stock for the number of shares x par value, debit Cash for the number of shares x the exercise price, then debit Additional Paid-In Capital for the difference, representing the increase in value of the shares during the service period."
So going by the above, we Dr the Cash account for 15$ x Amt of Shares. We Cr the common stock for par viz 1$ x Amt of Shares.
And then comes Dr for difference in Additional Paid-In Capital.
So here are the questions:
1. What is this Dr for Additional Paid In Capital? Is it 15$ (strike price) -1$ (par) difference to balance the entry? OR Is it 25$(share price) - 15$(strike price) difference to represent the premium.
2. My next question would follow from the first question. When the above amount is Dr to Additional Paid In Capital will it appear as an expense item in income statement or OCI?
3. Why should the Additional Paid in capital be DR in the first place? It being on the Equity side I am not sure what is there to reduce by DR additional paid in capital. If anything I am thinking it should be CR (Increased) to account for 15$ cash from employees - 1$ par (already accounted for).
4. Will the premium above the strike price (25$-15$) be expensed on the income statement at all? This single question is by far the most important to me. I know RSUs are fully expensed at market price of stocks in vesting tranches. Not sure the same is done when options are exercised.
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