Key Terms |

Issued: October 1972

Effective Date: For awards granted after December 31, 1972

(Financial Accounting Standards Board)

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This Opinion deals with accounting for stock issued to employees through both non-compensatory and compensatory plans (a plan

is any arrangement to issue stock to officers and employees, as a group or individually).

(Financial Accounting Standards Board)

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options in 1979. The model divides the time to an option’s expiry into a large number of intervals, or steps. At each step it computes

that the stock price will move either up or down with a given probability. This model also takes into considerations of the underlying

stock’s volatility, the time to expiration, the risk free interest rate and dividend amount/yield.

As shown in the above diagram, the structure of the model is a branch network in which the underlying stock price can move either up

or down by a limited amount at each node. The weighted present values of the terminal node values are summed to determine the

value of the underlying option. At expiry the option values for each possible stock price are known as they are equal to their intrinsic

values. The model then works backwards through each time interval, calculating the value of the option at each step. At the point

where a dividend is paid the model takes this into account. The final step is at the current time, time 0, and stock price, where the fair

value of the option is calculated.

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price of any derivative dependent on a non-dividend-paying stock. They used the equation to compute values for European cal and put

option on the stock.

To compute the value by using Black-Scholes Option Pricing Model, five inputs are needed: stock price, exercise price, risk-free rate,

time to expiration date, and volatility. Black-Scholes Generalized Model has one more assumption: a company paying a continuous

dividend during the life of option. According to FASB123 (superseded by FASB ASC Topic 718 - Stock Compensation), six inputs are

needed to compute the fair value of options. Black-Scholes Generalized Model is used in the Model to compute the fair value of option

for public companies and the minimum value of options for non-public companies.

C: Value of stock option

S: Stock price

E: Exercise price

? Annual volatility of stock in %

q: Dividend yield rate

r: Risk-free rate

t: Expected life of option

e: Base of the natural logarithm

Ln: Natural logarithm

N(x): Cumulative normal distribution function

N'(x): Normal density function

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rights until they actually exercise the options and become shareholders. Thus, the options are less valuable than the related stock.

The higher the expected dividend yield, the lower the option value. FAS 123 (superseded by FASB ASC Topic 718 - Stock

Compensation) requires company to estimate the expected dividend yield rate over the expected life of the option. If a company has a

past history of increases in dividends which is reasonably expected to continue in the expected life of option, the current dividend yield

likely should be modified to reflect that expectation.

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more time the option holder has available to allow the stock price to increase without personal investment and risk, and thus the more

valuable the option. Companies most likely will estimate the expected option life based on actual experience with similar grants.

FAS123 (superseded by FASB ASC Topic 718 - Stock Compensation) provides some factors to consider in estimating the expected

life of an award of stock options: the vesting period of the grant, the average length of time similar grants have remained outstanding

in the past, and the expected volatility of the underlying stock.

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share option's exercise price. Option-pricing theory generally holds that the optimal (or profit-maximizing) time to exercise an option is

at the end of the option's term; therefore, if an option is exercised prior to the end of its term, that exercise is referred to as suboptimal.

Suboptimal exercise also is referred to as early exercise. Suboptimal or early exercise affects the expected term of an option.

(Footnote 79, page 70, FAS123 R (superseded by FASB ASC Topic 718 - Stock Compensation))

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Issued: October 1995 (superseded by FASB ASC Topic 718 - Stock Compensation)

Effective Date: For fiscal years beginning after December 15, 1995

This Statement provides financial accounting and reporting standards for stock-based employee compensation plans. It also applies

to transactions in which entities issue their equity instruments to acquire goods or services from non-employees. According to FAS

123, those transactions must be accounted for based on the fair value of the consideration received or the fair value of the equity

instruments issued, whichever is more reliably measurable.

(Financial Accounting Standards Board)

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This Statement is a revision of FASB Statement No. 123, Accounting for Stock-Based Compensation. This Statement supersedes APB

Opinion No. 25, Accounting for Stock Issued to Employees, and its related implementation guidance.

This Statement is effective:

For public entities that do not file as small business issuers—as of the beginning of the first interim or annual reporting period that

begins after June 15, 2005

For public entities that file as small business issuers—as of the beginning of the first interim or annual reporting period that begins

after December 15, 2005

For nonpublic entities—as of the beginning of the first annual reporting period that begins after December 15, 2005.

(Financial Accounting Standards Board)

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No. 123 (Issued 12/02)

This Statement amends FASB Statement No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of

transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition,

this Statement amends the disclosure requirements of Statement 123 to require prominent disclosures in both annual and interim

financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on

reported results.

(Financial Accounting Standards Board)

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Issued: February 1997

Effective Date: For financial statements for both interim and annual periods ending after December 15, 1997

(Financial Accounting Standards Board)

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common stock or potential common stock. It simplifies the standards for computing earnings per share previously found in APB

Opinion No. 15, Earnings per Share, and makes them comparable to international EPS standards.

(Financial Accounting Standards Board)

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option on the grant date. FAS 123 (superseded by FASB ASC Topic 718 - Stock Compensation) defines a fair value based method of

accounting for an employee stock option or similar equity instrument and encourages all entities to adopt that method of accounting

for all of their employee stock compensation plans. However, employee stock options generally are not traded or sold, and therefore

no market quotes are available. As a result, companies are required to estimate the fair value of an option using valuation techniques.

FAS 123 (superseded by FASB ASC Topic 718 - Stock Compensation) requires that all six of the following inputs be used in the option

pricing model:

- Current price of the underlying stock on the date of grant
- Exercise price of the option
- Expected dividend yield of the stock over the option's life
- Expected volatility of the stock over the option's life
- Expected life of the option
- Risk-free interest rate during the life of the option

The input assumptions made on the grant date normally are held constant regardless of subsequent actual experience, and the fair

value per option would not be remeasured. For example, the fair value would not be adjusted subsequent to the grant date for

increases or decreases in the stock price or changes in the stock's volatility or actual dividend yield, or if the actual life of the option (i.

e., the period from date of grant to date of exercise) varied from the original expectation.

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with a remaining term equal to the expected life of the options being valued. Such data is not publicly available for free.

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underlying stock to fluctuate either up or down. Volatility is essentially a mathematical measure of the amount by which a stock price

has fluctuated or is expected to fluctuate during a period. Usually it is quoted as the annual standard deviation of a instrument's price.

The higher the volatility, the higher the potential for gain under the option and, the higher the fair value of option. FAS 123 requires

companies to estimate the expected volatility of stock over the expected life of the option. If historical stock price volatility is not

considered indicative of future trends, a company would have to adjust historical volatility for use in the valuation model. Please refer

to "Appendix F: Calculating Historical Volatility, FAS123."

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price for a given time period.

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APB25: Accounting for Stock Issued to Employees

APB25, Scope of Opinion

Binomial Option Pricing Model

Black-Scholes Option Pricing Model

Dividend Yield Rate

Expected Option Life

Suboptimal Factor

FAS123: Accounting for Stock-Based Compensation (superseded by FASB ASC Topic 718 - Stock Compensation)

FAS123 R: Share-Based Payment (superseded by FASB ASC Topic 718 - Stock Compensation)

FAS148 Summary

FAS128: Earnings per Share

FAS128 Summary

Fair Value of Stock Option

Risk-Free Interest Rate

Volatility

Warranty

APB25, Scope of Opinion

Binomial Option Pricing Model

Black-Scholes Option Pricing Model

Dividend Yield Rate

Expected Option Life

Suboptimal Factor

FAS123: Accounting for Stock-Based Compensation (superseded by FASB ASC Topic 718 - Stock Compensation)

FAS123 R: Share-Based Payment (superseded by FASB ASC Topic 718 - Stock Compensation)

FAS148 Summary

FAS128: Earnings per Share

FAS128 Summary

Fair Value of Stock Option

Risk-Free Interest Rate

Volatility

Warranty

complicated option valuations and beyond...

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