Employee Stock Options Must be Treated as Expenses

currivan writes "In a move that's been in consideration for a long time, the Financial Accounting Standards Board (FASB) approved new rules requiring employee stock options to be treated as expenses for reporting purposes. One of the reasons so many tech companies have given options to IT/engineering workers is that until now, they haven't counted against profits in quarterly reports. If markets were truly efficient, this wouldn't make a difference, but in reality, the tech industry is strongly opposed to the rule, though it should please Warren Buffett."

Comments

Hmmmm

[dfn5]

If the stock options you get are worth nothing, is that really an expense?

Re:Hmmmm

[eXtro]

They should be expensed when they're exercised not when they're awarded because there's no guarantee that they ever will be exercised. So by taxing them before they are exercised you're creating work for accountants who'll have to keep track of them until their expiry date.

I've got a lot of options which I doubt will ever be exercised. The bulk of them were awarded when my company was trading at 14 dollars and change but now it's trading at near 2 bucks. They're expiring in 2 years and unless something miraculous happens they will not be exercised.

If something miraculous does happen then I will exercise them. Eventually they'll be sold and then taxed.

All this is going to do is ensure that non-executives don't get any options because of tax burdens. The twats at the top will still get them.

Re:Hmmmm

[danheskett]

That potential dilution is a real expense to you.
It is not a real expense. A real expense is something that actually costs you cash. Buying a new piece of equipment is a real expense.

This is a potential loss of value, that's what it is. In your example, that dilution of value for the owner still doesn't cost the company anything. The assets held by the company remain static. The value of the company remains static. The number of owners increases. That's all. There is no outlay of cash.

Stock options are both in effect and concept a gift among share holders. Options are promised at a price which is assumed to be less than the market price at a future point. You are promised the option to buy 10,000 shares at (usually) today's prices. When those options are available to you if the price is low enough you will exercise the options and the other stock holders effectively have given you the difference between market value and promised value: it's equity they used to have but is now transferred to the option holder.

Regardless, there is no expense to the company itself, only the individual stock holders.

Re:Hmmmm

[Jerf]

Accounting isn't about "real cash" and hasn't been for a while. What you say is literally true, but in accounting terms, there was a real change to your assets, assuming of course that the $10 and $6 were commitments and not just some Slashdot guy saying something for a demonstration (because then the assets are $0 and $0, and no change of any kind takes place) :-)

I've had to learn some accounting to implement accounting systems, and the disconnection from real money is on the one hand powerful; it gives a better view of the functioning of the business than the bottom line "how much did we make or lose?" But it is, as usual with power, correspondingly more dangerous, if you start believing the numbers are too real; the phrase "bottom line" has entered our vernacular for a reason.

In double-entry bookkeeping, you change in promise would cause a debit for us (and the corresponding credit for you), causing a drop in our assets of $4. Our cash wouldn't budge an inch, but the accounting changes.

It's worth looking into (google "double-entry bookkeeping"); I find it similar in some ways to physics, in the way that it is sort of based on a "conservation of assets & liabilities" law. Treated properly it will improve your understanding of money. Misunderstood and it will make it worse.

Re:Hmmmm

[EnderWiggnz]

i think that you are looking at this wrong.

options are part of compensation, just like health insurance, 401k matching contributions, and free caffeine.

these are, absolutely, positively part of my compensation package, just as much as my bi-weekly check.

its an incentive plan, similar to at-risk compensation schedules where you can earn an ext $FOO% of your salary if you perform, or the company performs to certain guidelines.

generally, because of the risky nature (i.e. they could be worth zero) there is a higher reward if the options work out.

over the past 3 years, my options have been worth about 30% of my annual salary. yes, i sold.

if i no longer received comparable options, or got a commeserate base salary increase, i would immediately start looking for a new job, as my gross compensation package is reduced drastically.

Re:Hmmmm

[Moofie]

Go read up on the notion of depreciation, and then explain to me again what corporate accounting has to do with cash in pockets.

Tax Implications?

[TrollBridge]

IANAA (accountant) but I would think this move might have some massive tax implications. Would this force companies to pay more in payroll taxes? Could it allow them to pay less?

Someone with more knowledge on this please reply. thanks!

Re:Tax Implications?

[grub]

Along the same lines I was wondering if the employee would have to file them as a taxable benefit/income.

dismal option

[Doc Ruby]

Stock options don't require the company to spend any of its revenue. So giving them reduces profit on the books, while it doesn't affect the profit of which the stock represents a share. How does this make sense at all?

What does it matter...

[Emperor Shaddam IV]

I haven't received any stock options that ended up being worth a crap since the 1990's. Who cares anymore. Be a contractor and make more money then the employees. Then you can buy your own stock!

Re:How will it work?

[MyLongNickName]

No, it is NOT a zero value. Take a look at your Wall Street Journal. People buy and sell options all the time. It is an educated guess about the direction of the company.

Often used to offset the risk of other investments (i.e. I buy Company A stock, but I want to protect against a big drop, so I buy the right to sell the stock at a certain, lower price). This helps you to get to a target risk level and still have a wide variety of stock to pick from.

Often, this is used by pure speculators too :)

For a large company, there is sufficient market information to make a good estimation of the value of a certain option. What is unclear, however, is how you do this for a small company without enough market activity to have an options market. or worse yet, a private company who's value is determined by a third party's valuation.

However, market valuations would take care of the vast majority of the bad accounting deals you ahve heard about on the news...

Re:How will it work?

[rmcd]

Companies will use standard option pricing techniques, such as the Black-Scholes formula or binomial option pricing. You can read about them here.

You are incorrect in saying that the value of the option at grant is zero. If I flip a coin and you get $1 if heads and 0 if tails, that is worth something to you. An option is the same: you get a payoff if the stock goes up and nothing if the stock goes down. The valuation problem for standard options (like those traded on the CBOE) is well understood. There are tricky issues in applying option pricing to employee options, but their value is emphatically not zero.

Good news

[Degrees]

The place I used to work for gave its employees a 15% discount on buying stock (once per fiscal quarter). Every year during open enrollment for benefits, management pointed out that this program lets one buy $100 dollars of stock for the price of $85, and then turn around and dump it the next day for market price (or hold onto it, as might be your want) I'm told quite a few people did the immediate dump plan.

The people who lose in this scheme are the purchasers of stock at full price. The cash flow out of the company dilutes the value of the company, making each share of stock worth (a tiny bit) less. Some people pay full price, others (insiders) reap a benefit at a discount.

The requirement that these discounts are accounted as expenses, puts a dollar amount on them. Thus, someone (and outsider) looking at the company financial statements gets a clearer picture of where the money is going. They get to make a more informed choice.

Its a good thing.

Re:Option value

[Ignignot]

The distribution of stock prices is not continuous. They are generally quoted in cents, so you can't trade for less than a cent. This is important when you have an option that is far out of the money (nowhere near the underlying price, and intrinsic value zero).

Not to mention that you neglected the expected return of the stock, but that's ok for this crowd.

Re:Option value

[Anonymous Coward]

Strong explanation from the parent who's obviously been through a corporate finance class.

This is exactly why the options should be expensed. The company gave away options that a normal investor would have paid $10 for today.

Some people say that the options are hard to value, and no one knows what they're worth. It is extremely easy to value things when there is a ready market for them:

Chicago Board Options Exchange quotes

If the stock price plummets, the company gets an unexpected boost, because the call options will be worthless. If the price shoots up, then the company has to take a charge when the execs cash in. Simple.

Employee stock options and the lottery...

[human bean]

have much in common, particularly the part about options expiring at zero value. It's interesting that the FASB considers this in the same light.

Of course, we all know who gets rich from the lottery, don't we? I never understood people who accepted company stock as bonuses, payment, etc. From where I stand, when the company starts handing out shares instead of cash, it's time to start looking around.

Does this mean *all* stock options?

[whitroth]

If so, then I'm not interested in us peasants, 90% of whom get little-to-no stocks, but I want to know that Bill the Gates, and Kenny-boy Lay, and Eisner, and all the rest of the CEOs with tens of *millions* in stock options have to be expensed.

Gee, what might happen to all that money if it didn't go to CEOs? Maybe it would get wasted on utterly frivilous things, like better employee salries and benfits, and maybe even capital plant development!

Nahhh, never happen, ship it all off to India.

mark

I think it means...

[Spy der Mann]

Maybe we can relate this to something that is happening in Mexico recently. Instead of being given a share, employees are given other "comodities" (i.e. food/expense tickets, etc) that are NOT reported as the worker's salary. This means the reported salary is much lower than it actually is.

When the employee retires, they only give him a compensation regarding his REPORTED income, not the real one. This way the company saves millions by giving its employees money in a different denomination.

I *THINK* that somehow, this is what happens with stock shares... that the company is saving taxes / other payments because they give their employees other kind of money, and not cash. That's why the shares must be reported now. Obviously, companies don't like it because they see lost profit in it.

Someone correct me if I'm wrong, please.