Don,
Stock options cannot possibly be an expense to the company unless stock itself is an expense, and, as I explained earlier, contrary to current accounting treatment, stock is not an expense except as directly to shareholders through dilution.
Just because you tried to explain something earlier doesn't mean you were right in the first place.
It will probably come as a shock to you, but according to current accounting treatment, stock based compensation IS an expense to the company!! In their Opinion 123, FASB is quite clear on this. However, lacking consensus as to how to most accurately determine the cost, the FASB allowed companies to choose between two methodologies when determining the cost: "intrinsic value" or "fair value". FASB even goes so far as to say that the "fair value" method is the preferred method as far as they are concerned.
Under the intrinsic (or "unfair") value method, if companies grant stock options with zero intrinsic value on the date of grant, the determined value turns out to be zero. Not surprisingly, and despite the clearly stated preference of the FASB, the vast majority of companies choose to determine the cost of options using the intrinsic value method. And they save ink by not reporting a strange looking "zero" on the income statement. Not only ink, they also save embarrassment trying to explain why things employees and managers are fighting tooth and nail to keep should be given a value of zero.
Curiously enough however, nothing in current accounting practice requires companies to use the same valuation methodology with the IRS as they do with shareholders. So companies turn around and report a different value of this same stock option benefit to the IRS, which results in much lower reported earnings, and thus much lower taxes. Which difference in perspective is reported back to shareholders as a nifty little line item somewhere on the cash flow statement to the effect of "taxes we told you we were paying but didn't really have to pay after all".
This may be far too subtle a point for whatever time of day it is for you right now, but it's not the stock that is the expense. Nor the option.
It's the BENEFIT that stock options represent to employees that is a cost to the company, even under current accounting principles. What is at issue is the value of this benefit. Once appraised of the facts, only a moron would agree that zero is the most accurate possible estimate of the value. Although a host of very smart people agree it sure is convenient! Particularly when it comes to shovelling money in their general direction.
These are facts. Don't take my word for it, check them out yourself. Here is an excerpt from FASB Opinion 123 which you can obtain if you so desire. I don't have a link, sorry, I just have a PDF copy. The whole document is 125 pages.
This Statement defines a fair value based method of accounting
for an employee stock option or similar equity instrument and
encourages all entities to adopt that method of accounting for all
of their employee stock compensation plans. However, it also allows
an entity to continue to measure compensation cost for those plans
using the intrinsic value based method of accounting prescribed
by APB Opinion No. 25, Accounting for Stock Issued to Employees.
The fair value based method is preferable to the Opinion 25 method
for purposes of justifying a change in accounting principle under APB
Opinion No. 20, Accounting Changes. Entities electing to remain
with the accounting in Opinion 25 must make pro forma disclosures
of net income and, if presented, earnings per share, as if the fair
value based method of accounting defined in this Statement had been
applied. Under the fair value based method, compensation cost is
measured at the grant date based on the value of the award and is
recognized over the service period, which is usually the vesting
period. Under the intrinsic value based method, compensation
cost is the excess, if any, of the quoted market price of the stock
at grant date or other measurement date over the amount an employee
must pay to acquire the stock. Most fixed stock option plans—the
most common type of stock compensation plan—have no intrinsic
value at grant date, and under Opinion 25 no compensation cost is
recognized for them. Compensation cost is recognized for other types
of stock-based compensation plans under Opinion 25, including
plans with variable, usually performance-based, features.
You wrote: You are simply mistaken. No, not this time Don. It's merely the other way around, 'cause the factual foundation on which you have based your opinion is... um... weak. To be kind.
This is a gnarly subject. In which facts and emotions and vested interests interfere with each other to create fantastic Moire patterns in thoughts and speech. But if we chase relentlessly after the truth and peel it away to the essence, the facts of the situation are clear.
The company engages employees and part of their compensation depends on the degree to which the stock goes up. This compensation is a benefit to the employees, the cost of which is incurred to shareholders on account of the company. Thus the benefit itself (not the issuing of the stock) is a cost that should be reported as an offset against profits.
The issuing of the stock (and possibly the buyback) are merely equity financing activities and neither of these have any business appearing on the profit and loss account.
Maybe thinking through the following example will help sort out the issues of compensation combined with equity financing.
Let's say I promise to pay you the difference in price of the stock as a "bonus" in return for you working for me. Let's say the stock was at $0.10 when I made the promise and is now at $1.00 when you call me on it. What's the difference between the following two scenarios?
Scenario (a) I print a share. I give it to you. You give me a dime. You sell the share for a dollar and pocket $0.90
Vs
Scenario (b) I print a share. I sell it for a dollar. I give you $0.90
Both involve printing shares, both involve me getting the cash flows of a dime from you and tax relief on $0.90 and both involve you getting $0.90 compensation.
But one of these should be accounted for as an expense, and the other one shouldn't?
Only by invoking one of those "the hands that don't touch the money are clean" arguments. Careful now, that slope is slippery indeed!
But even if you want to go there, you are faced with another dilemma. Two transactions which result in the same benefit to employees, the same cash flow for the company and the same gain-net-of-loss for shareholders should not result in a different apparent profitability of the same firm! Changing how we record identical transactions should not change the profit or loss along the way!
We resolve the dilemma and avoid the slippery slope with a very simple "aha!". There are two things going on here: one is you the employee getting your $0.90, and the other is me the company issuing a share of stock for $1.00!
If we separate the transactions into these two orthogonal components and account for the orthogonal components separately (one on the income statement, the other on the statement of cash flows, both of which trickle onto the balance sheet), then both scenarios suddenly end up with equal accounting treatment! Without any changes to any rules. Voila. Just what we should expect for two scenarios which deliver the same economic results to all of the parties: shareholder, company, employee.
The only contentious part with options comes because the $0.90 in this example isn't pre-determined at the time of grant. While it's pretty well unavoidable that zero isn't the most accurate value for something as valuable as stock options, experts are divided on how to "best" estimate an unknown future value. However, this is not as big a problem as some might want you to think. Estimating the present value of a contingent liability is nothing new for accountants. And there is no need to record the equity financing until such time as it actually occurs.
When you walk through what naturally falls out of these conclusions, a simple solution suggests itself. One which also accurately reflects the gain-net-of-cost (a.k.a. profitability) that the company is delivering to shareholders. Net of all compensation.
As far as: It is the repurchase of stock, of zero value to the company itself, that should be expensed dollar for dollar immediately and thus reduce reported earnings.
No. This is another area where you are confused. This is equity financing. Issue shares on a secondary offering or purchase them back... no impact on earnings. Where the shares came from in the first place or what the proceeds go towards has no bearing on whether the financing activities appear on the income statement. Share certificates have no memory and all shares are equal under the law. Furthermore, equity financing is a means of transferring wealth between shareholders and the company. Transferring wealth to or from shareholders does not change shareholder wealth, it just changes whether the wealth is held directly or indirectly. Thus there is no profit or loss in such a transaction. Thus it does not belong on the P&L (income) statement.
Seems to me that you have been taken in, hook, line and sinker, by the wizards of equity prestidigitation. Either that or have a Y chromosome. You'll get blamed for "Male Answer Syndrome" anyway, so you might as well deserve it once in a while. At least you picked a difficult topic.
John |
