Abstract: What is today's most controversial accounting issue? Adjusting investment securities to market value? Loss recognition for impaired loans? Surprisingly, the answer might be accounting for employee stock options. On the Financial Accounting Standards Board agenda since 1984, the stock compensation issue has been relatively dormant in the last few years. It now promises to be the subject of intense debate in the coming months. Interest runs high because much is at stake-over 90% of U.S. publicly held corporations offer top executives some form of stock options. THE CONTROVERSY One critic of executive pay practices, Senator Carl Levin (D-Mich.), described employee stock options as stealth compensation. That's because even though options intuitively have some value and many options result in an ordinary and necessary tax deduction to the company upon exercise, they typically result in no charge to a company's earnings. Senator Levin has held hearings on a proposed bill to mandate that the Securities and Exchange Commission require public companies to reduce earnings by the fair value of employee stock options. (No action was taken pending the outcome of SEC and FASB activities). Other proposed legislation, favored by President Bill Clinton, would limit executive pay tax deductions to some arbitrary level, such as $1 million. Companies are understandably concerned changes in stock option accounting could adversely affect net income, making options less attractive as employee incentives. The impact could be significant when options are key elements in the overall compensation package, as often is the case with start-up or high-technology companies. Just as many companies are reducing medical and other postretirement benefits in reaction to FASB Statement no. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions, so too might companies cut back on options. As an indication of the controversy surrounding stock options, the FASB already has received nearly 400 comment letters even though it has not yet published an exposure draft of the proposed standard. Many of the letters argue there is little demand for change by practitioners or by users or preparers of financial statements. Others believe that since accounting has no effect on cash flows or net equity and dilution already is reflected in earnings per share (EPS), the potential improvement in financial reporting is not worth the effort. The FASB's limited resources should be directed to more critical accounting issues. From an accounting standpoint, many believe option awards are capital transactions that should not result in expense and a reliable method of estimating option values does not exist. Is there any common ground between these diverse views? This article explores some of the criticisms of current accounting rules, highlights some of the central accounting issues and describes current developments at the FASB and SEC. CURRENT ACCOUNTING Under Accounting Principles Board Opinion no. 25, Accounting for Stock Issued to Employees, stock options and similar awards are fixed or variable. In both cases, expense is measured by the excess, if any, of the underlying stock value over the option exercise price (the intrinsic value). The key difference between fixed and variable plans is when expense is measured, which occurs only when the number of shares to be received and the exercise price are known. For fixed awards, expense can be measured when the option is granted. The typical result is no compensation expense, since employee stock options generally have no intrinsic value when granted. In a variable plan, expense isn't finalized at the grant date; the number of shares an employee receives might depend on achieving a future performance target or on future fluctuations in the stock's value (as is the case with stock appreciation rights [SARs]). For variable awards, expense must be estimated and accrued between the date of the grant and the final measurement date. …
Publication Year: 1993
Publication Date: 1993-06-01
Language: en
Type: article
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Cited By Count: 7
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