# Accounting for exercised stock options. Companies pay its employees using restricted stocks and stock options and the accounting treatment for both of them is very different. In this post, I will try to . Options become stocks at some point in future when the market price of the stock is higher than the exercise or strike price. Let us understand this.

## Accounting for exercised stock options. By David Harper Relevance above ReliabilityWe will not revisit the heated debate over whether companies should "expense" employee stock options. However, we should The tax benefit is real cash because the company gets to reduce its taxable income by the options gain - in this case, \$13 per option exercised. Why?

Because stock option plans are a form of compensation, generally accepted accounting principles, or GAAP, requires businesses to record stock options as compensation expense for accounting purposes. Rather than recording the expense as the current stock price, the business must calculate the fair market value of the stock option. The accountant will then book accounting entries to record compensation expense, the exercise of stock options and the expiration of stock options.

Businesses may be tempted to record stock award journal entries at the current stock price. However, stock options are different. GAAP requires employers to calculate the fair value of the stock option and record compensation expense based on this number. Businesses should use a mathematical pricing model designed for valuing stock. The business should also reduce the fair value of the option by estimated forfeitures of stock.

For example, if the business estimates that 5 percent of employees will forfeit the stock options before they vest, the business records the option at 95 percent of its value. Instead of recording the compensation expense in one lump sum when the employee exercises the option, accountants should spread the compensation expense evenly over the life of the option. Accountants need to book a separate journal entry when the employees exercise stock options.

First, the accountant must calculate the cash that the business received from the vesting and how much of the stock was exercised. An employee may leave the company before the vesting date and be forced to forfeit her stock options.

When this happens, the accountant must make a journal entry to relabel the equity as expired stock options for balance sheet purposes. Although the amount remains as equity, this helps managers and investors understand that they won't be issuing stock to the employee at a discounted price in the future.

Say that the employee in the previous example leaves before exercising any of the options. The accountant debits the stock options equity account and credits the expired stock options equity account. Based in San Diego, Calif. Initial Value Calculation Businesses may be tempted to record stock award journal entries at the current stock price. Periodic Expense Entries Instead of recording the compensation expense in one lump sum when the employee exercises the option, accountants should spread the compensation expense evenly over the life of the option.

Exercise of Options Accountants need to book a separate journal entry when the employees exercise stock options. Expired Options An employee may leave the company before the vesting date and be forced to forfeit her stock options. References McGraw Hill Connect:

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