USA Employee Stock Options Accounting

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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.
 
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Ok I got more clarity on this from this post here:

Apparently the Dr to Additional Paid in capital is wrong. In fact it should be a CR and then it all makes sense.

The only question remaining then is (from the example in the linked above) if the stock exercise option entries is when they are exercised:

debit)cash(35 * 5m) 175
(debit)Paid in capital-stock options 40
(credit)Common stock 5
(credit)Paid in capital-excess of par 210


I want to know how the entry (credit)Paid in capital-excess of par 210 will manifest in income statement. Will it be left out completely?

If so how does that square well with RSUs which are expensed using avg market price as they vest?
 

kirby

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Yellojacket wrote:
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?
No - it's going to be a credit to APIC

Is it 15$ (strike price) -1$ (par) difference to balance the entry? Yes

OR Is it 25$(share price) - 15$(strike price) difference to represent the premium. No

DR Cash for $15 x amt of Shares
CR Common Stock for Par $1 x Amt of Shares
CR APIC for $15 - $1 x Amt of Shares

And don't forget the $8 option price. You recorded a total of $8 x Amt of shares granted in previous years as DR Options Expense CR to APIC - Stock Options. So when options are exercised, record Dr to APIC stock Options $8 times options exercised and Credit Equity -APIC.


2. When the above amount is Dr to Additional Paid In Capital will it appear as an expense item in income statement or OCI?
Again, not a debit in your example. And neither Income item nor OCI. Just an element of Equity.

3. Why should the Additional Paid in capital be DR in the first place?
In your example it is not a debit.

4. Will the premium above the strike price (25$-15$) be expensed on the income statement at all?
No these are Equity transactions and not Income transactions.

Apparently the Dr to Additional Paid in capital is wrong. In fact it should be a CR and then it all makes sense.
BINGO!

I want to know how the entry (credit)Paid in capital-excess of par 210 will manifest in income statement. Will it be left out completely?
Yes. these are Equity transactions and not Income transactions
 
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Yellojacket wrote:
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?
No - it's going to be a credit to APIC

Is it 15$ (strike price) -1$ (par) difference to balance the entry? Yes

OR Is it 25$(share price) - 15$(strike price) difference to represent the premium. No

DR Cash for $15 x amt of Shares
CR Common Stock for Par $1 x Amt of Shares
CR APIC for $15 - $1 x Amt of Shares

And don't forget the $8 option price. You recorded a total of $8 x Amt of shares granted in previous years as DR Options Expense CR to APIC - Stock Options. So when options are exercised, record Dr to APIC stock Options $8 times options exercised and Credit Equity -APIC.


2. When the above amount is Dr to Additional Paid In Capital will it appear as an expense item in income statement or OCI?
Again, not a debit in your example. And neither Income item nor OCI. Just an element of Equity.

3. Why should the Additional Paid in capital be DR in the first place?
In your example it is not a debit.

4. Will the premium above the strike price (25$-15$) be expensed on the income statement at all?
No these are Equity transactions and not Income transactions.

Apparently the Dr to Additional Paid in capital is wrong. In fact it should be a CR and then it all makes sense.
BINGO!

I want to know how the entry (credit)Paid in capital-excess of par 210 will manifest in income statement. Will it be left out completely?
Yes. these are Equity transactions and not Income transactions
Thanks a lot Kirby. Really appreciate your response. So much makes sense now. I want to harp on two points.

"And don't forget the $8 option price. You recorded a total of $8 x Amt of shares granted in previous years as DR Options Expense CR to APIC - Stock Options. So when options are exercised, record Dr to APIC stock Options $8 times options exercised and Credit Equity -APIC."

I thought it is interesting that you mention DR to options expense to create the APIC-Stock Option liability. Yes it was an expense throughout options vesting and yes CR to APIC-Stock Option account did increase that liability. However what I read mentioned that the offsetting balance was a DR to cash account asset, not a DR to expense. But I guess if you think about it increase in expense and reduction in cash is the same thing. So perhaps its all the same.


MORE IMPORTANTLY on this point:
Will the premium above the strike price (25$-15$) be expensed on the income statement at all?
No these are Equity transactions and not Income transactions.

So why aren't we doing this with RSU vesting? I know that at the start of an RSU vest an equity account is created as per the MARKET value of the stock which is offset by a Contra-Equity Account. And as the stocks vest this contra equity account is amortized to zero, bringing the entire market value of those stocks as APIC.

SO THEN, in case of RSUs the Par + APIC reflects the market price after full vesting. But in case of options it is just par + strike. NEVERTHELESS, the shares created are the same with same tradability and same dilutionary effect. WHY? Perhaps this is a drawback of GAAP?
 

kirby

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Accounting for options differs from accounting for RSUs because they are very different instruments. It is an 'apples and oranges" situation.
 
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Accounting for options differs from accounting for RSUs because they are very different instruments. It is an 'apples and oranges" situation.
Yah +1. It is what it is, but I don't understand how a third party independent options writer will undergo a huge loss (10$) on call options he underwrites if the stock price is at 25$ when the exercise price is at 15$. But the same loss is not recorded by the company if IT issues/grants the same options at the same strike price of 15$.

Seems like a disconnect to me in GAAP.
 

kirby

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Recording an expense for an options grant has been a topic of discussion for some time. Here is a 2003 article by Harvard Business Review.
.
 
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Recording an expense for an options grant has been a topic of discussion for some time. Here is a 2003 article by Harvard Business Review.
.
Good article thank you! Yah I am more convinced now than before that options accounting is grossly understating the true cost of its issuance.
 

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