SFAS 123 Guide

Employee stock options are non-standardized call options that aren’t traded on options exchanges, but rather exist as a private contract between a company and its employees (or other parties such as lawyers, consultants, vendors, etc. as a form of compensation). Accounting for stock options is often in the news relative to executive or employee stock option compensation, so I am including a brief explanation of FAS 123 on this site so that if nothing else people can be directed to the authority website on this subject.

Briefly, the purpose of the SFAS 123R ruling, as issued by FASB (Financial Accounting Standards Board, the authority for financial accounting standards in the USA) is to define a fair value based method of accounting for stock options issued to employees and others by corporations as part stock compensation plans. Option “fair value” can be estimated by option pricing models like Black-Scholes, Black-Scholes-Merton model, lattice models or by other methodologies. Corporations then expense the option compensation an asset over the vesting period of the option.

Under SFAS 123 standards it is also acceptable for a company to measure or quantify compensation cost for their stock option plans using an intrinsic value based method of accounting, as covered by APB Opinion No. 25, Accounting for Stock Issued to Employees. See this FASB pdf file for detailed information, as well as a lucid SFAS 123 summary. Also, here is an excellent site that can help companies value employee stock option with an easy to use calculator using the lattice model with variable inputs. I hope this has been helpful; I felt that as you get stock options explained to you, confusion might be avoided if I explicitly cover the difference between exchange-traded options and options in other familiar contexts, such as employee stock options.