How To Account for Stock Based Compensation

Stock compensation is a way for companies to pay employees.The most common type of stock compensation is stock options, which allow an employee to purchase the company’s stock at a set price.Accounting for stock compensation is more complicated than traditional compensation.The company has to value the stock and make accounting entries to record stock compensation expense.

Step 1: There are important dates.

There are a number of important dates associated with stock compensation plans.Recording and reporting options plans can be difficult.The grant date is the first thing that comes to mind.This is when the employee is paid.The date when you can get your money.A stock option plan allows an employee to exercise their options on a certain date.The date for the exercise.The employee can exercise his or her options on that date.There will not be an exercise date recorded if they don’t exercise their options.The expired date.The date at which the options will no longer be valid.

Step 2: The stock-based compensation value can be determined using a method.

The stock compensation must be valued in order for it to be recorded.Intrinsic value and fair value methods are the two most common methods recognized by the FASB.Intrinsic value is the difference between the stock price when granted and the price at the earliest date that stock can be sold.The fair value is based on a model of factors that estimate the value of the stock or option at the time of grant.The fair value method is used by publicly traded companies.Both methods may be used by non-public companies.

Step 3: The value of restricted stock can be found.

Non-vested stock includes stock compensation that is not vested.Employees given this stock are unable to exercise their options or sell the stock that they have been compensated with.The market price of a share of the stock on the grant date is recorded as the fair value of this stock.The total value of restricted stock is the number of shares divided by the fair value.

Step 4: The stock option value can be calculated.

The fair values of stock shares are simpler to calculate than the stock option values.The model used to calculate option values takes into account the market price at the grant date, the price of the option exercised, volatility, expected dividends, and the risk-free interest rate.One of the more common methods for fair- value estimation of options is the Black- Scholes model.Accounting or financial modeling software handles this calculation.

Step 5: If you want to record compensation, make an entry.

When the stock or options become vested, the original stock compensation is recorded.Specific to individual employee stock compensation plans, the specifics of when this occurs are created at the discretion of the company.The fair value of the vested options is taken into account when calculating compensation expense and additional paid-in capital.An example would be if an employee is granted a stock option plan on the first day of the year that will allow them to purchase 1,000 shares of stock after 2 years.The plan’s options are valued at $35,000 using a fair value model.The entry that was made on the last day of the year is a credit to compensation expense and a debit to stock options.

Step 6: You can record the exercised options.

The stock compensation plans are likely to be the only entries made on the expiration date.Changes in common stock and options accounts will be reflected in the recorded exercised options.Imagine if the employee decided to exercise 400 of his options.He would buy 400 shares of the stock at the option price.The company would get $20,000 in cash from the option price of $50.40 percent of the stock options originally granted leaving the company would be included.The common stock shares created in the purchase must be recorded.The par value is where this will be done.The company has gained $2,000 in common stock if the par value is $5.The transaction would be recorded as a debit to Cash for $20,000, a credit to Common Stock for $2,000, and a balance to Additional Paid-In Capital, Common stock.

Step 7: You can write off expired options.

Unexercised options are also recorded.The employee decided not to exercise the remaining 60 percent of their options after 40 percent had been exercised.60 percent of the original $35,000 value will be written off as expired stock options.There will be a credit to Additional Paid-In Capital, Expired Stock Options, for the $21,000 fair value of the expired options.

Step 8: Employee stock-based compensation is included in your financial statements.

When distributing statements to your stockholders, you must include all stock-based compensation.Stock compensation should be recorded as an expense on the income statement.The company’s balance sheet and statement of cash flows must include stock compensation expenses.

Step 9: You can find the grant price.

Determine the price at which you could purchase a share under the terms of your employee stock-based compensation plan.The par value is the grant price for stock options.If you received stock-based compensation at different price points, repeat this process for each “batch” of stock.You can find this information by contacting your HR department.An employee might have a grant price of $10Regardless of the current market price, this represents how much a person would pay for a share.

Step 10: Determine the difference between the grant price and market price at the exercise date.

You need to record the full market value of the stock shares at the time when you exercised the options.If you don’t hold the stock for a long enough period of time, the difference between the market price and the grant date will be taxed as income.Depending on federal and state law, this period of time can be one or two years.If your grant price is $10 and the current market price at the date of exercise is $50, you would need to calculate the difference, which is $40 per share.You will have to pay income tax on the difference if you sell before the waiting period is over.The total amount of compensation would be used to calculate the marginal tax rate.If you exercised 100 options, you would have to pay income tax on the per share difference, which would be $4,000.

Step 11: Capital gains are determined when the stock is sold.

Capital gains must be paid when you sell the stock in your compensation plan.If you have already reached the end of the waiting period, you won’t owe any taxes on your stock compensation gains.Capital gains are determined by the difference between the market value at exercise and the selling date.If you sold 100 shares from the previous example when the price was $70, you would have a capital gain of $20 per share or $2,000.

Step 12: Make sure you file your taxes correctly.

Capital gains and losses should be reported on your income taxes.You should include any stock that was sold before the waiting period.If you don’t know when the waiting period ends, speak to a financial professional.Failure to report these gains can result in fines or criminal penalties.