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Accounting For Stock Options. Essay

1500 words - 6 pages

Stock options are a form of compensation granted to an employee, by an employer, in lieu of salary and wages. Stock options grant employees the right to purchase a certain number of shares at a given price . Traditionally, firms have compensated their employees through some combination of salaries, commissions, or bonuses. Less prevalent was compensation tied to firm's performance, such as stock and/or stock options. Historically, performance-based compensation was designed for corporate executives and officers of the firm. This form of compensation helped align the interests of management and shareholders. Stock options encourage managers to maximize shareholder value. Although stock options were once reserved for upper management, there has been a trend to include more employees.Generally, the future purchase price, or strike price, is equal to the market price of the stock at the time of grant. When an employee exercises options, he or she pays the firm the strike price for the shares, regardless of the then- current market price. Employees usually remain with the firm for a specified period before options vest. Upon vesting, the employees may exercise their options. If an employee leaves the firm, outstanding vested and unvested options are forfeited or cancelled. Options not exercised by a date specified in the option contract will expire. When an employee decides to exercise their stock options, they may either purchase the underlying stock at a discounted price or receive an equivalent cash premium. This transfer from the firm to the employee becomes part of the employee's taxable income for the year.Firms now grant stock options to a much broader range of employees for many reasons. A firm's motivation in implementing a stock option plan includes increased employee productivity, the attraction and retention of valuable human capital, reduction of short-run compensation costs, increased cash flows, and higher levels of book income.Individuals, employers, and the government are all affected by the widespread use of stock option compensation. However another aspect that is affected by stock options is economic forecasters. Income from stock options is more volatile than traditional forms of compensation, such as wages and salaries. Stock options' ultimate value to the employee depends on the future stock performance. Consequently, the stock option value is uncertain at the time of grant.There are two major types of stock options: incentive stock options (ISO's) and nonqualified stock options (NSO's). ISO's have certain tax advantages for employees. If required holding periods are met, the spread income (difference between the market and strike price at the time of exercise * shares exercised) is treated as a long-term capital gain and taxed at lower tax rate of 20%. If an immediate sale is not made upon exercise of ISO, the event is non-taxable, unless taxpayer is subject to Alternative Minimum Tax. A Nonqualified Stock Option is an option...

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