You are Assistant Controller of Stamos & Company, a medium-size manufacturer of machine parts. On October 22, 2010, the board of directors approved a stock option plan for key executives. On January 1, 2011, a specific number of stock options were granted. The options were exercisable between January 1, 2013, and December 31, 2017, at 100% of the quoted market price at the grant date. The service period is for 2011 through 2013.

Your boss, the controller, is one of the executives to receive options. Neither he nor you have had occasion to deal with GAAP on accounting for stock options. He and you are aware of the traditional approach your company used years ago but do not know the newer method. Your boss understands how options might benefit him personally but wants to be aware also of how the options will be reported in the financial statements. He has asked you for a one-page synopsis of accounting for stock options under the fair value approach. He instructed you, “I don't care about the effect on taxes or earnings per share—just the basics, please.”

Required:

Prepare such a report that includes the following:

1. At what point should the compensation cost be measured? How should it be measured?

2. How should compensation expense be measured for the stock option plan in 2011 and later?

3. If options are forfeited because an executive resigns before vesting, what is the effect of that forfeiture of the stock options on the financial statements?

4. If options are allowed to lapse after vesting, what is the effect on the financial statements?