Accounting Practice for Stock Options
In the United States, the accepted framework for financial accounting consists of the Generally Accepted Accounting Principles, called the GAAP. GAAP as they apply to for-profit businesses are determined by the standards periodically issued and amended by the Financial Accounting Standards Board, or FASB.
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History
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The proper accounting treatment of the use of stock options as an element in employee compensation was a much-disputed point in the United States in the 1990s and the early 21st century. This issue was addressed by the FASB's Statement of Financial Accounting Standards 123, issued in 2004.
SFAS 123 requires a public entity with limited exceptions, "to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award." This is known in shorthand as the "expensing" of stock options.
Fair Value
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If there are observable market prices for the options at issue or similar instruments, those market prices may be used for the fair value. If there are no such market prices, the grant-date fair value of employee stock options is to be estimated using various quantitative models.
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Considerations
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Even though there are exchange-traded stock options, it is generally necessary for firms that use stock options as employee compensation to resort to a model to determine fair value, because employee stock options differ from the traded options in three important respects. Sandra Alves outlined the key differences in an article for the International Research Journal of Finance and Economics. They are: the employee (unlike an exchange trader) does not have to pay the premium to obtain the options, the employee stock options have a much longer life until maturity/expiration than does an exchange traded option, and employee options cannot be sold to a third party.
Date of Measurement
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The FASB's decision to use the grant-date as the date of measurement was a controversial one. As Alves noted, some analysts believe that the vesting date -- the date on which the employer becomes obligated to issue stocks at the option price because the employee has fulfilled all preconditions -- would be more appropriate, because "the option contract is merely an executory contract between the employer and employee" when first granted.
Identification
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The issue of the valuation of stock options as a form of compensation is somewhat different from the issue of the valuation of the interest in an employer's stock that an employee can acquire through an Employee Stock Ownership Plan, known as an ESOP. There will be times when the valuation of the ESOP interest becomes a matter of accounting controversy too.
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