Stock compensation to employees and other suppliers of goods or services can take many forms, including the stock option grants, awards of restricted and non-restricted stock, cash payments based upon the company’s share price, and employee stock ownership plans, amongst many others. The one common attribute of the many varying forms of stock compensation is the fact that the entity involved in these types of transactions should recognize a compensation expense associated with the stock compensation provided to the employee. This blog is going to concentrate on stock option awards; however there may be similarities with other forms of stock based compensation.
Granting stock options are a great way to attract and retain top talent, reward employees for services in the early life of a business with growth potential, and provide a form of compensation to employees without any initial cash outflow to the Company. However, I have seen several cases where companies have granted stock options to employees and others but were totally unaware of the accounting requirements for the options and thus have not recognized any compensation cost related to the granting of stock options.
Without getting bogged down in the detail, companies should recognize compensation cost for stock options over the related service period based upon the grant date fair value of the options. Furthermore, Accounting Standards state that the fair value of a stock option should be estimated using a valuation technique or option-pricing model that considers several variables, one of which is the underlying stock’s current price. Since there are many companies that are not publicly traded issuing stock options, there is a lack of readily available stock price to use in calculating the fair value of the stock options. Accordingly, those companies must determine the current value (i.e. the fair value, not book value) of the company’s stock via a formal valuation report or other acceptable valuation approach.
Beyond the accounting requirements, the granting of stock options could also have an income tax effect for the recipient and/or could create taxes or other penalties to the company if it fails to report certain information regarding the stock option grant to the recipient. In addition, the company will want to make sure that these stock options are structured in such a way to comply with any other regulations.
In summary, there is much more to the granting of stock options than many companies are aware of. If you have recently granted stock options or are planning to grant stock options in the near future, please bring this to the attention of your accountant, tax advisor, and legal counsel to ensure that the options are designed and documented appropriately, the appropriate steps are taken to determine the current fair value of the company’s stock, and they are accounted for properly.
Jonathan Poppel, CPA