What are non-qualified stock options and incentive stock options, and how does expense recognition differ for these two types of stock options?
What will be an ideal response?
ANSWER:
With a non-qualified stock option, a bargain purchase price is established in the plan (market price exceeds the option exercise price). In an incentive stock option, the exercise price of the stock equals or exceeds the market price at the date the option is granted.
APB Opinion No. 25 requires the bargain amount of non-qualified stock options to be allocated as a periodic expense from the grant date through the period of service required to receive the benefits. The bargain amount is measured by the difference between market price and the stock option exercise price on the measurement date, when both the number of options and the exercise price are known. Usually the grant date and measurement date are the same, in which case a deferred compensation expense account is debited and contributed capital is credited for the total bargain purchase. The deferred compensation expense is amortized (to an owners’ equity contra account) over the number of periods required to exercise the options.
If either the number of shares or exercise price is unknown at the grant date, a yearly estimate is made of both, as well as of the market price of the stock at the future measurement date. The estimated additional compensation expense arising from the options is then accrued annually. At the measurement date, the actual compensation cost is measured by subtracting the option price from the market price on that date. The actual bargain value, less previous yearly expense recognition, is debit to deferred compensation expense and amortized over the remaining service period required to exercise the options. A corresponding amount is credited to contributed capital.
In incentive stock options, expense recognition is not required. However, SFAS No. 123 requires footnote disclosure of what the effect of stock options would have been on income and earnings per share, and encourages recognition in the income statement.
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