Stock options are a common component of executive compensation packages. Additionally, many non-executive employees working in start-up companies receive stock options in lieu of market-rate salaries or as an incentive to deal with the demands of working in a start-up environment. Accounting for stock options on a company’s financial statements is a complex process that must follow specific reporting requirements and regulations.
Many companies offer stock options to help retain and attract new employees. A stock option plan consists of a contract between the company and its employees, giving them the right to buy a certain number of shares in the company at a specific, fixed price and within a set time period. The program serves as an employee incentive because employees stand a chance of profiting when they exercise their stock options at a higher price than when the options were granted.
Financial statement footnotes add explanations and supplemental information for a company’s set of financial statements. The footnotes are a critical part of the overall financial statement package and must be issued along with it. Certain footnotes are required, especially for publicly held companies. The content of the footnotes may vary, depending upon the accounting method used, such as U.S. generally accepted accounting principles (GAAP) or international financial reporting standards.
The Financial Accounting Standards Board (FASB) issued a revision to its FAS123 statement regarding footnote disclosures for stock options. FAS123R requires disclosure of a portion of the total fair value of a stock option award be expensed on the company's financial statements in a given year. The vesting schedule timing defines the amounts of stock options that must be expensed each year. The fair value of the full grant of stock options at the grant date needs to be disclosed in the table of the grants of plant-based awards in the financial fitness. The footnotes are required to contain the stock option valuation method and detailed calculations.
The minimum required footnote disclosures encompass three categories. First, a valuation summary needs to be reported with the fair value, interest rates, dividend rate, volatility and expected term of the options. Second, activity on the options must be reported based on outstanding options at the beginning of the period, activity during the period and several numbers related to option balances at the end of the period. The third category requires disclosure of the expenses recognized historically for options, the current amount of expense recognition and projected future option-related expenses.
If companies did not need to treat stock options as an expense, they would be understating the total amount of compensation expense on their profit and loss statement. Some, according to information provided by The Heritgage Fountain, argue this led to artificially high stock prices during the dot-com bubble and contributed to its bursting. Others, such as technology start-up companies, argue that expensing options will result in depressed profits, making it more difficult for companies to secure funding and retain current employees.