Debate the thoeries of Accounting for stock options Research Paper

Debate the thoeries of Accounting for stock options - Research Paper Example Fair value model, lattice model and finally minimum value method which is based upon the someone’s willingness to purchase a call option on a share of stock at the current fair value of the stock with the right to postpone payment of the exercise until the end of the options period, ignoring the volatility of the underlying stock in valuation calculation. This has necessitated the emergence of alternative incentive methods to premium cash thus employee stock options. Any stock option with exercise price higher than the price of the underlying stocks at the exercise date are exchanged for new ones with lower exercise price because companies have to account for the stock issued to their employees. But the companies have to account for them although they do not incur any costs to grant the options. Guides and standards on how such transactions are accounted for in the books of the company have to be provided. Stock option compensation that needs to be looked at is the backdating of employee stock option and how it affects the company. Agency theory argues that compensation policy should provide management with incentives to select and implement actions that add shareholder wealth. Discussion Pertaining the use of the intrinsic value method of accounting for stock options, a company is to value stock options based on their intrinsic value at that juncture they were granted. Intrinsic value refers to the difference between the stock’s market price on the grant date and also including the exercise price at which the employees can use the option to purchase stock. Incase the stock’s market price is slightly higher than the option exercise price, therefore, the stock option’s value is the difference between the two. Realizing the shortcomings of the method there is need to look for a more comprehensive and efficient method of stock options .By using this method it will result in no compensation expense since we grant employees options with e xercise prices same as the fair market value of the underlying stock at the time of the grant. Fair value was encouraged to be used but it was not a mandatory requirement to be used by the companies as stipulated by the Financial Accounting Standards Board (FASB). The fair value accounting approach valued stock options basing on various factors that establish the underlying value. This is because the companies are to outlay for option grants based on the fair value of the options that were expected to vest on the date it granted them. In December 2004, FASB issued a Statement of Financial Accounting Standards (Statement) No. 123(R), Share-Based Payment. Statement 123(R) replaced Statement 123, Accounting for Stock-Based Compensation, and was consequently effective for public companies as of July 1, 2005. It was effective for non-public companies as of January 1, 2006. The company had an option of either using Black-Schole option pricing model or the binomial option so as to come up with the options fair value. However, if the company continues with the intrinsic value of the approach they required to avail additional closure in the footnotes to their financial on what the expenses would have been with fair value approach. Under Statement 123, the company is only allowed to disclose information on the effects