Stock option expensing

Stock option expensing is a method of accounting for the value of share options, distributed as incentives to employees, within the profit and loss reporting of a listed business.

It is an accounting standard thought by several Socially Responsible Investors to improve transparency and accountability, and as such has been adopted by the US Financial Accounting Standards Board (FASB), in its "statement 123".

The fair value of an option may be established by asking a selection of merchant banks to bid for them.

Controversies and arguments

The adoption of this accounting standard by the FASB has been supported by many of the 'activists' of the socially responsible investment movement. It has been opposed by a range of business leaders.

The crux of the argument against expensing company issued stock options on the income statement is that the effect has already been accounted for on the balance sheet and cash flow statement. Essentially, this argument states that when options issued by a company are expensed on the income statement, they are double expensed, or expensed twice.

When an option issued by a company is exercised, the company receives cash equal to the exercise price of that option and issues shares to the exerciser. Those who claim that it is a double expense to place this information on the income statement, balance sheet, and cash flow statement say that the loss from the exercise is accounted for by noting the difference between the market price (if one exists) of the shares and the cash received, the exercise price, for issuing those shares through the option.

Opponents of considering options an expense say that the real loss- due to the difference between the exercise price and the market price of the shares- is already stated on the cash flow statement. They would also point out that a separate loss in earnings per share (due to the existence of more shares outstanding) is also recorded on the balance sheet by noting the dilution of shares outstanding. Simply, accounting for this on the income statement is believed to be redundant to them.

Note: Currently, the future appreciation of all shares issued are not accounted for on the income statement but can be noted upon examination of the balance sheet and cash flow statement.

Practicalities

Opponents of the system note that the eventual value of the reward to the recipient of the option (hence the eventual value of the incentive payment made by the company) is difficult to account for in advance of its realisation.

Intrinsic value or fair value

The FASB has moved against "Opinion 25", which left it open to businesses to monetise options according to their 'intrinsic value', rather than their 'fair value'. The preference for fair value appears to be motivated by its voluntary adoption by several major listed businesses, and the need for a common standard of accounting.

Accountabilities of FASB

Opposition to the adoption of expensing has provoked some challenges towards the unusual, independent status of the FASB as a non-governmental regulatory body, notably a motion put to the US Senate to strike down "statement 123".

ee also

Warren Buffett

Sources

* [http://www.fasb.org/st/summary/stsum123r.shtml FASB statement 123]