1) What exactly is the expense that would be recorded? Is it the difference between the option price and the current market price or something else?
it is an expense equal to the option value as calculated by the Black-Scholes formula, amortized over the option's life. this is analogous to the expense you would encounter if you purchased an option on the open market, and is different from the option's "intrinsic value", which is the term denoting "the difference between the option price and the current market price". an option with time left on it has value over and above the intrinsic value. this excess amount of value is called "time premium", and that is what Black-Scholes calculates. it just so happens that many options issued by cos as compensation last for six to ten years, which means they have a heckuva lotta time premium.
just to give you an idea of the going rate for time premium on the open market, QCOM's 40-strike call of 2005 (symbol ZLUAH), which now has zero intrinsic value with QCOM closing at 39.98, nevertheless closed today at a price of $13.70, with the ask at $13.80. so the market rate just to have two years and a month of time premium on QCOM calls right now is over 34% of the value of QCOM shares. naturally, the more time in an options life, the more valuable it is. so just imagine the value of options with a 10-year life.
of course, people who don't want to expense options will tell you that this $13.70 should not be expensed by company XYZ (if they were granting an option analogous to the 2005 40-strike call, and their stock was at $40), even though the open market says that's what it's worth. in fact, according to the option apologists, this $13.70 is actually worth zero. nice work if you can get it!
2) Where else in the accounting for revenues and expenses does one transaction - the exercise (actual or implied) of options - get counted twice against EPS (earnings/shares outstanding)?
it doesn't get counted twice. see, the options dilution which happens today is based on past options issuances. whereas the options which are issued today, which may not dilute EPS for many years if ever, are nevertheless compensation which is delivered today, for services which the co receives today. that is to say, they are an expense which is to be incurred today.
the analogy i have mentioned several times (first mentioned by an accounting Nobel Laureate in the WSJ) is, if everything were "accounted for" just by EPS dilution, then a co could theoretically pay every single expense via options to all its payees (e.g., utilities, raw materials suppliers, landlords... heck, maybe even the IRS!), with the absurd result that the company would have zero cash costs and 100% margins!
however, this would tell us nothing about the economic situation of the co (a grocery store stock with this approach could have higher margins than QCOM or MSFT!). that is why option expenses should be booked on the income statement. as an accountant, you surely know about the value of looking at both the income and cash flow statements to gain an understanding of a company's economic reality. |
