How to Account for Forfeited Stock Options

Employers grant stock options as part of a compensation package to employees. Although the practice originated in the executive ranks, some companies, including many start-up firms, now make stock options a part of every employee's compensation. The option grants must be recorded on the company's financial statements, and if an employee leaves the company, the financial statements need to reflect the decrease in compensation expense since the employee forfeited his options.

Verify that the employee terminated employment before completing the vesting period for his stock options. Stock option awards usually vest based on meeting certain performance or service conditions. Vesting means the employee can now exercise his options and convert them to company stock.

Confirm vesting conditions for the stock options. If the option vesting period was contingent upon a certain market condition, and the market condition does not occur before the employee terminates, the stock option expense is not reversed on the financial statements.

Make a journal entry to reverse the expense related to the forfeited stock options out of the compensation expense account.

Verify the reduced compensation expense on the company's income statement.