# Option accounting,

Rather than recording the expense as the current stock price, the business must calculate the fair market value of the stock option. The accountant will then book accounting entries to record compensation expense, the exercise of stock options and the expiration of stock options.

Initial Value Calculation Businesses may be tempted to record stock award journal entries at the current stock price. However, stock options are different.

GAAP requires employers to calculate the fair value of the stock option and record compensation expense based on this number. Businesses should use a mathematical pricing model designed for valuing stock. The business should also reduce the fair value of the option by estimated forfeitures of stock.

For example, if the business estimates that 5 percent of employees will forfeit the stock options before they vest, the business records the option at 95 percent of its value. Periodic Expense Entries Instead of recording the compensation expense in one lump sum when the employee exercises the option, accountants should spread the compensation option accounting evenly over the life of the option.

Exercise of Options Accountants need to book a separate journal entry when the employees exercise stock options.

First, the accountant must calculate the cash that the business received from the vesting and how much of the stock was exercised. Expired Options An employee may leave the company option accounting the vesting date and be forced to forfeit her stock options.

Only the fair-value method is permissible under U.

When this happens, the accountant must make a journal entry to relabel the equity as expired stock options for balance sheet purposes. Although the amount remains as equity, this helps managers and investors understand that they won't be issuing stock to the employee at a discounted price in the future.

### Calculating gains and losses on Call and Put option transactions

Say that the employee in the previous example leaves before exercising any of the options. The accountant debits the stock options equity account and credits the expired stock options equity account.