Gap (GPS)

Note 7. Share-Based Compensation

Share-based compensation expense recognized in the Condensed Consolidated Statements of Earnings, primarily in operating expenses, is as follows:

Share-Based Compensation

Share-based compensation expense for all share-based compensation awards granted after January 29, 2006 is determined based on the grant-date fair value estimated in accordance with the provisions of SFAS 123(R), “Share-Based Payment.” We recognize share-based compensation cost net of estimated forfeitures over the vesting period of the share-based compensation awards. We estimate the forfeiture rate based on historical experience as well as expected future behavior. See Note 10 of Notes to Consolidated Financial Statements.

Share-Based Compensation

Note 10. Share-Based Compensation

Total share-based compensation expense recognized in the Consolidated Statements of Earnings, primarily in operating expenses, is as follows:

No share-based compensation expense was capitalized in fiscal 2008, 2007, and 2006.

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Other than the stock option modification noted below, there were no other material modifications made to our outstanding stock options and other stock awards in fiscal 2008, 2007, and 2006.

Share-Based Compensation

On January 29, 2006, we adopted
the provisions of SFAS 123(R), “Share-Based Payment,” using the modified prospective transition method. In accordance with the fair value recognition provisions of SFAS 123(R), the fair value of stock options is estimated at the date of
grant using the Black-Scholes-Merton option-pricing model which requires assumptions requiring a high degree of judgment. These assumptions include estimating the length of time employees will retain their vested stock options before exercising
them, the estimated volatility of our common stock price over the expected term and the number of options that will ultimately not complete their vesting requirements. For stock options and other stock awards, measured compensation cost, net of
estimated forfeitures, is recognized over the vesting period of the related share-based compensation award. As required by SFAS 123(R), the estimated fair value of our share-based awards granted prior to the adoption of SFAS 123(R), less expected
forfeitures, will continue to be amortized based on an accelerated recognition method. The estimated fair value of our share-based awards granted after the adoption of SFAS 123(R), less expected forfeitures, with time-based service conditions
are being amortized on a straight-line basis, while those that were granted or earned with performance conditions are being amortized on an accelerated basis.

In
the fourth quarter of fiscal 2006, we elected the Simplified Method to establish the beginning balance of the additional paid-in capital pool related to the tax effects of employee share-based awards, and to determine the subsequent impact on the
APIC pool of employee awards that were fully vested and outstanding upon adoption of SFAS 123(R).

Prior to the adoption of SFAS 123(R), share-based compensation
expense related to stock options was not recognized in the Consolidated Statements of Earnings if the exercise price was equal to or greater than the market value of the common stock on the grant date, in accordance with Accounting Principles Board
Opinion No. (“APB”) 25, “Accounting for Stock Issued to Employees.” The following table shows the effect on net earnings and

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earnings per share for fiscal 2005, had share-based compensation been recognized based upon the estimated fair value recognition provisions of SFAS 123,
“Accounting for Stock-Based Compensation,” on the grant date of stock options, and employee stock purchase rights prior to the adoption of SFAS 123(R).

NOTE 9. SHARE-BASED COMPENSATION

Share-based compensation cost recognized in fiscal 2007 and 2006 included: a) compensation cost for all share-based awards granted prior to, but not yet vested as of January 28, 2006, based on the grant-date fair value estimated in accordance with the original provisions of SFAS 123, and b) compensation cost for all share-based awards granted subsequent to January 28, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123(R). The impact of forfeitures that are estimated to occur prior to vesting is considered in the amount recognized.

Total share-based compensation expense recognized in the Consolidated Statements of Earnings is as follows:

There was no share-based compensation capitalized in fiscal 2007, 2006, and 2005.

Other than the stock option modifications noted below, there were no other material modifications made to our outstanding stock options and other stock awards in fiscal 2007, 2006, and 2005.

Share-Based Compensation

On January 29, 2006, we adopted the provisions of SFAS 123(R) using the modified prospective transition method. We account for share-based compensation in accordance with the fair value recognition provisions of SFAS 123(R). We use the Black-Scholes-Merton option-pricing model which requires assumptions requiring a high degree of judgment. These assumptions include estimating the length of time employees will retain their vested stock options before exercising them, the estimated volatility of our common stock price over the expected term and the number of options that will ultimately not complete their vesting requirements. Changes in the subjective assumptions can materially affect the estimate of fair value of share-based compensation and, consequently, the related amount recognized in the Consolidated Statements of Income.

Prior to fiscal 2006, we accounted for share-based awards to employees and directors using the intrinsic value method of accounting in accordance with Accounting Principles Board Opinion No. (“APB”) 25, “Accounting for Stock Issued to Employees.” Under the intrinsic value method, when the exercise price of the employee stock options equals the market price of the underlying stock on the date of grant, no compensation

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expense is recognized in the Consolidated Statements of Income. Service awards and discounted stock options, which are granted at less than fair market value, are amortized to operating expenses over the vesting period of the stock award. We amortized deferred compensation for each vesting layer of a stock award using the straight-line method.

The following table shows the effect on net earnings and earnings per share had share-based compensation been recognized prior to the adoption of SFAS 123(R) based upon the estimated fair value recognition provisions of SFAS 123 on the grant date of stock options, and employee stock purchase rights during fiscal 2005 and fiscal 2004.

See Note 8 of Notes to the Consolidated Financial Statements for the assumptions used to value option grants.