how to create barcode in vb.net 2010 MEASURING THE VALUE OF OPTIONS in Software

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MEASURING THE VALUE OF OPTIONS
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In determining the accounting expense for options, there are two main questions: what is the measurement date and what is the valuation method Addressing the first question there are three possible measurement dates: the date options are granted, the date they vest or become exercisable, and the date they are actually exercised. There are two principal methods of determining value. One method is the intrinsic value, which is the spread between the exercise price of the option and the market price of the stock. The second is the fair value method, which is the market value of the stock option instrument itself. It is the combination of these two key variables that determines how much the expense will be and when it will be incurred. Let s take them one at a time.
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PART ONE The Stock Option Problem
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First consider the measurement date. Current accounting rules under APB 25 require that the measurement date be the date when you first know the exercise price and the number of shares under the option. In a traditional option both of these factors are known at the grant date. Therefore the grant date is used as the measurement date. However if either the number of shares or the exercise price can change or is variable, then the measurement date is postponed until these are known. The implications of this will be discussed later in this chapter. To adopt fully the expensing of options under FAS 123, it is required that the measurement date be the grant date. The grant date is also the measurement date under the proposed new accounting rules. The other factor to consider is the valuation method. Under APB 25 the valuation method is the intrinsic value, the spread between market price and exercise price. (Under FAS 123 and the proposed new rules, the valuation method is the fair value.) Under APB 25 if you know the exercise price and the number of shares under the option at the time it is granted and you usually do then the measurement date is the grant date. Since the valuation method under APB 25 is intrinsic value, the expense will reflect the intrinsic value as of the grant date. If the option exercise price is equal to the market price of the stock as of the grant date which is the case in virtually all option grants then the intrinsic value as of the grant date is zero. To show how expensing works under APB 25, let s take the hypothetical example of a company that grants an executive on January 1, 2003, an option to purchase 1000 shares of stock for $25 per share. (We ll also assume that the options vest become exercisable after three years, and do not expire for 10 years.) The market price of the stock at the time is also $25. Under APB 25 since the number of shares and the exercise price are known, the measurement date is the grant date. The intrinsic value is the difference between the $25 exercise price and the $25 share price. Thus the intrinsic value is zero, and the expense for these options is zero. However, under APB 25, if either the exercise price or the number of shares is unknown or variable, then the measurement date is postponed until both these facts are known. For example, if the
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CHAPTER THREE The Accounting Story
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options were to vest based on performance (and there is a possibility that some of the options might not vest), then the number of shares could not be determined until the vesting performance requirements are met. The measurement date is then postponed until that time. Let s assume that the option for 1000 shares vested at the end of three years, based upon the company s financial performance over that time period. The executive could earn the right to exercise the full 1000 shares or the right to exercise some portion of those shares, depending upon how the company performed. Thus the number of shares could not be determined until the end of the three-year performance period. In this case the end of the threeyear period becomes the measurement date. The intrinsic value could not be fixed until the measurement date. Until that time it is variable. If at the end of the three-year period the stock price is $40, then the intrinsic value would be $15 ($40 minus the $25 exercise price) and the expense would be $15 per share for every share that has vested. In the meantime, however, the potential expense would have to be estimated and amortized over the three-year performance vesting period. This is another complicating factor. As Figure 3-2 shows, each quarter the company would have to determine the spread between the exercise price and the market price and adjust its quarterly expense up or down accordingly. The variable accounting expense is unpredictable and potentially large. These are two things that company accountants and CFOs hate; they want to avoid these kinds of expenses at all cost. This explains why 99 percent of stock options have a fixed price and a fixed grant date and an exercise price equal to the market price of the stock as of the grant date. Under APB 25 this yields zero expense. This strange juxtaposition of arcane accounting requirements which must be met to achieve the zero expense has led to the proliferation of these plain vanilla stock option grants with no performance strings attached. The reason is virtually any performance requirement would result in variable accounting. For at least the last 30 years, the accounting tail has wagged the big dog of executive compensation.
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