Compare the two (2) main accounting issues associated with stock option plans. M

Question

Compare the two (2) main accounting issues associated with stock option plans. Make one (1) recommendation to FASB for overcoming obstacles in accounting for stock option plans. Provide one (1) specific example of the way in which your recommendation could improve the accounting for stock option plans.

Suppose management is in need of large sums of cash to finance the construction of a new manufacturing plant and is considering issuing debt to obtain the cash. However, management is unsure of whether to issue convertible debt or debt issued with stock warrants. You are the senior accountant at your company, and management has asked for your help. Explain the similarities and differences between convertible debt and debt issued with stock warrants. Also, recommend to management the type of debt which it should issue. Provide a rationale for your recommendation.

Explanation / Answer

Similarities and differences

warrants and convertibles share many similarities, they are also different in many ways.

Differences between debt with stock warrants and convertible debt:

1-difference is that the warrant in the bond with warrant is a fixed price on company stock. E.g. for a $1000 bond, you can buy 500 shares at $2 each. And that convertible bonds does not have a fixed price term

2- a bond with warrant, the warrant can be sold separately from the bond, while a convertible bond has not that possibility.

company should issue debt issued with stock warrants becauset,he major difference is that the equity option embedded in a convertible bond is not detachable from the convert, so that you have to value the bond and the embedded option together. If you want to make a direct comparison with a detachable warrant, you can think of the the embedded option in a convertible bond as having a strike price equal to the value of the remaining cash flows of the convertible bond, so that the strike prices changes over time as coupon payments are made, and changes with the level of both interest rates and the credit quality of the bond issuer.

Accounting treatment of stock option plan:

Financial Accounting Standards Board (FASB), issued APB 25. The rule specified that the cost of options at the grant date should be measured by their intrinsic value—the difference between the current fair market value of the stock and the exercise price of the option. Under this method, no cost was assigned to options when their exercise price was set at the current market price.

The rationale for the rule was fairly simple: Because no cash changes hands when the grant is made, issuing a stock option is not an economically significant transaction. That’s what many thought at the time. What’s more, little theory or practice was available in 1972 to guide companies in determining the value of such untraded financial instruments.

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