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B. Accounting Principles Board Opinion No. 25, “Accounting
for Stock Issued to Employees” (APB 25)
In 1972, FASB authorized APB 25, which required ESOs to be
valued using the “intrinsic value method” (IVM). From 1972 to
December 15, 1995, the IVM was the only authorized financial
accounting method for valuing ESOs. Under the IVM, the value of
ESOs is the excess of the stock’s market price on the grant date
over the exercise price. This value is reported directly on the
employer’s income statement relating to the year in which the
ESOs are granted. ESOs granted at-the-money have no intrinsic
value because the stock’s market price on the grant date is equal
to the exercise price.
C. Statement of Financial Accounting Standard No. 123,
“Accounting for Stock-Based Compensation” (SFAS 123)
In October of 1995, FASB issued SFAS 123, which is effective
for fiscal years ending after December 15, 1995. SFAS 123 added
the “fair value method” (FVM) as the preferred method for valuing
ESOs. Pursuant to SFAS 123, companies continuing to use the IVM
were required to “make pro forma disclosures of net income and,
if presented, earnings per share, as if the * * * [FVM] had been
applied.”
The value of an ESO is composed of two components: the
intrinsic value and the call premium. While the intrinsic value
is equal to the stock’s market price on the grant date over the
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