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Proper Accounting for
Stock Options is Required.

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SFAS No. 123

Companies are now required to properly expense stock based compensation in accordance with FASB ruling SFAS 123R.

The Financial Accounting Standards Board (FASB), is the designated organization in the private sector for establishing and improving standards of financial accounting and reporting in the United States, which govern the preparation of financial reports.

SFAS 123 provides guidance for estimating the Fair value of option grants to its employees and/or contractors in exchange for their services and/or goods.

The fair value of an option granted by a company is estimated using an option pricing model such as the Black-Scholes or Black-Scholes-Merton model or various lattice models such as the Binomial model.

The fair value of option compensation, initially recorded as an asset, is generally expensed ratably over the service period or vesting period.

Expected future volatility is an important parameter in the fair value calculation, so it should be reasonably determined and based on supportable evidence. For non-public companies where it is more difficult to calculate volatility, the historical volatility of an appropriate industry sector index can be used.

If a company has data on factors that would trigger early exercise of their options, such as vesting period, employees' past exercise and termination behavior, or the volatility of share price, that data can be utilized in the valuation.

A reasonable and supportable option valuation requires careful consideration of the inputs to the valuation model, based on economically sound analysis and professional expertise.

Here is the a pdf file of the full SFAS 123 ruling.

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