Hi Richard Tsang; Okay. I agree that derivatives are
complicated. Especially with the accounting and
mathematical complexities. But with some effort this
is a subject that can be understood by most people.
"Fair value" at grant is the approximate value of the option
at time of grant. This is computed using some standard
equations. These values are never "charged to profit"
at all, but instead companies are required to compute a
pro forma income statement which shows what profit would
be if the fair values were charged to profit. This calculation
is shown in the annual reports, and that is what I gave a
link to. No, employees are never told the fair value of
their options. My experience is that management basically
tries to convince you that the company stock is about to
rocket up, and that you will make lots of money from your
options, you lucky dog. It is true that the value of the
options if the stock does go up, is much, much, much,
much, more than "fair value", but it is also true that if
the stock goes down, the value of the options will be
much, much, much, much, much less than "fair value."
That is the nature of fair value. DELL stock recently
has only gone up. Someday it will go down, and all
those (call) option holders will be left holding the bag.
(Until the company restrikes their options, but that is
another story, and a real beef for the other stockholders.)
Nobody is financing the extra cost, any more than the
holder of any other option granted by the company
needs to be financed. In fact, stock issued by the
company also goes up in value, but doesn't need to be
financed. So nobody is financing, or needs to be
financing the change in values of these financial
instruments. If the instruments were debts that the
company had to someday repay, the change in debt
would show up as a charge to the profits, but there
is no debt, nothing has to be repaid, and so there is
no expense, and thus no charge to profits.
It is true that the cost of buying back stock for DELL was
high. This has nothing to do with the value of options
granted to employees at the time of grant. It has only
to do with the choices that DELL as a company has
made regarding how many shares to buy back.
Personally, I think it is very stupid of them to buy back
stock. They have very little book value relative to stock
value, and I think their CFO should be placed in a mental
asylum for buying company shares at such a high price.
The only explanation I can give is the infamous hubris of
the wealthy. They think the stock price is going to keep
going up. In this they will be wrong. Anyway, the two
events, (1) the granting of the options, (2) the buying
back of shares, are two completely separate events,
and need not be bundled into one transaction for the
purpose of accounting analysis. In fact, the shares the
company buys back are (likely) not the same ones that
they issued to the option grantee. Instead, all shares
are essentially equivalent. This is why the two accounting
events are separated. Granting options (using the pro
forma accounting rules) is mostly an income sheet action.
Buying back shares has no interaction with income at all,
and is entirely a balance sheet action. There is no
direct expense associated.
There is no future liability regarding stock options. There
is no guarantee that the company will buy back any options,
ever. Thus there is no liability. A liability is a cost a
company may have to pay. On the contrary,
DELL never has to buy back any shares at all.
If they wrote an contract to the effect that
they would do so, you could probably argue for it as an
expense, but no such contract exists. Thus there is
no liability.
Buying back shares is not an expense. It has the effect
of reducing cash, (a balance sheet item) and decreasing
the number of shares (a balance sheet item). Expenses
occur on the income statement only.
As long as I'm giving lectures in first year college accounting,
I might note that taking on a debt has no direct effect on
the income statement, nor does paying the debt back.
(Except bank charges and such.) On the other hand,
getting someone to cancel a debt does have an income
sheet effect, as does ending up with a debt from a lawsuit,
for instance. In addition, buying and selling their own
shares are not expenses. Selling the shares of another
company could be a profit or loss depending on whether
the stock went up or down, but your own stock just doesn't
have expenses associated with it.
I hope that the above explanations have helped. Surely
there are some web references that explain the accounting
of stock and option transactions by publicly held companies...
I'll look around...
Until then, surely there are some accountants following
DELL? Please help me. I find accounting fascinating,
and have read books on the subject, but I am sure a
college degree in the subject helps one to explain these
things a lot more clearly.
-- Carl |
