Hello, everyone. In today's lesson, we will continue with the stock-based compensation plans and this one we will designate for the stock options. What do we mean by stock options? Stock option plans where they employees are given the option to purchase. 1, a specified number of shares of the firm stock. 2, those shares at a specified price. 3, during a specified period. One of the most heated controversies in standard setting history has been actually that they built over the amount of the compensation to be recognized as an expense for those stock option plans. An issue is how the value of the stock options is measured, which for most options determines whether any expense at all is recognized. Historically, options have been measured at what we call intrinsic values, which is simply the difference between the market price of the shares and the option price at which they can be acquired. For instance, an option that permits an employee to buy $25-per-share stock for $10-per-share has an intrinsic value of $15. However, plans in which the exercise price equals the market value of the underlying stock at the grant date have no intrinsic value. And therefore, result in zero compensation when measured this way even though the fair value of the options can be quite significant. Currently, we measure compensation of those stock options as the fair value of the stock options at the grant date. And then record that amount as a compensation expense over the service period for which employees received the options. Estimating obviously, the fair value requires the use of one of the several option pricing model that are out in the market. These mathematical models assimilate a big variety of information about the company's stock and the terms of the stock option to estimate the option's fair value. The model or whatever model used should take into account various elements. 1, the exercise price of the option. 2, the expected term of the option. 3, the current market price of the stock. 4, expected dividends. 5, expected risk-free rate of return during the term of the option. Finally, expected volatility of the stock. Obviously, combination of all those factors in a model will drive, it's a very complicated mathematical process, but at least we infer a fair value of the option. Once the fair value of the granted option is determined, such value will be allocated over the vesting period equally using the following entry that shows up in front of you. A debit to a stock-based compensation expense and a credit to paid in capital stock options. The designation is determining that that PIC for those stock options. Please notice that this entry should be the same for each period throughout the vesting period since the total compensation will be equally allocated over the vesting period. So the amount should be the same unless something happens. That we will talk about later. When the options are exercised, we recognize the issuance of the stock using the following simple journal entry. Obviously in debit to cash, that's for the exercise price. The PIC-stock options will be debited, will be reversed, I will get rid of it. And then the issuance of the common stock and the PIC-common stock in the credit side, as you can see in the journal in front of you. Please notice that the net increase in equity is simply equal to the cash received from the exercise of the options. And no reference whatsoever was made at all to the market price of the stock on the exercise date. If options that have vested expire without being exercised, the following entry, as you can see, will be recorded. A debit to the paid-in capital stock options and a credit, another credit of paid-in capital expiration of stock options. Here, the company debits paid-in capital stock options and credits paid-in capital expiration of stock options for the same amount. And in fact, we just renamed the paid-in capital that is attributable to the stock option plan. Compensation expense as of the measurement date is not affect. As in summary, in conclusion for this lesson, stock options compensation plans give employees the option to purchase a specified number of shares at a specified exercise price during a specified period. The total compensation for the fair value is determined at the grant date and will be allocated equally over the vesting period. The yearly compensation expense will be the same unless some of these options are forfeited during any time throughout the vesting period. Thank you.
