Lesson: Noncompensatory Stock Options

Instructor: Nick Palazzolo

In this lesson, Nick Palazzolo, CPA, delves into the specifics of noncompensatory stock option plans, detailing the conditions that allow these plans to incentivize employees without the need for cash compensation. He explains the essence of such plans under U.S. GAAP, including the criteria they must meet: a reasonable exercise period, offering stock at a discount that is not excessively below market price, equal availability to all qualifying employees, and limitations on the total amount of shares available for purchase. Nick also underscores the distinction between noncompensatory and compensatory plans, clarifying that those which meet the set criteria do not necessitate the recognition of compensation expense from the company's perspective.

Updated: Oct. 20, 2021 Create an account

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Transcript

Instructor: Nick Palazzolo

Nick Palazzolo is head instructor of ExamPrep.ai CPA Review. Nick's teaching style is engaging & upbeat, combining practical Big 4 tax & assurance expertise with years of 1-on-1 coaching. His lessons are concise and emphasize what you need to know to pass. Whether you're a recent grad or working full-time, we’re confident you can conquer your CPA exams with Nick’s review.

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Well, noncompensatory stock options. What's the intention here? The intention is to compensate employees and officers without having to pay them cash. So again, it's just to incentivize employees, incentivize people to join your company, to join your organization. Right.

So in order for a plan to be noncompensatory, it needs to follow certain criteria per US GAAP. The exercise period must be limited to a reasonable period. Okay, so that makes sense. You can't have, once it's vested and once you've got those options available, you can't just have like forever to exercise them. It's probably like a year. You have a year to use the stock option.

If the plan offers stock at a discount from the market price, it cannot be greater than a reasonable offer of shares to its shareholders. So this is going to be basically like, you can't be doing anything too sketchy, right? You can't do anything too sketchy. It's got to be reasonable. So definitely reasonable there. We will follow that rule.

Stock is offered equally to all qualifying employees. So you can't favor one employee over another. You can't say, okay, I like you better. You're going to get this option better than all the other employees. All right. However, there can be a limit in the plan to the total amount of shares able to be purchased.

Generally speaking, all full-time employees must be allowed to participate. There's a few exceptions here. We're not really going to get into that. Not too important. But yeah, all employees need to be able to participate. We need equality here. Everyone needs a fair share.

Stock option plans that meet the requirements do not require the recognition of compensation expense by the sponsoring company. Remember, we are from the perspective of the company.

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