Slashdot Mirror
The Coming Expensing of Employee Stock Options
An anonymous reader writes "This accounting change will reverberate loudly throughout geekdom.
"Users of financial statements...expressed to the FASB their concerns that (the current handling of stock options) results in financial statements that do not faithfully represent the economic transactions affecting the issuer, namely, the receipt and consumption of employee services in exchange for equity instruments. Financial statements that do not faithfully represent those economic transactions can distort the issuer's reported financial condition and results of operations, which can lead to the inappropriate allocation of resources in the capital markets." Taken from FASB Statement of Financial Accounting Standards No. 123 (Dec 2004). A
FAQ has been published as well." Yes; the data is from 12/16/04, but this will be a huge change in how tech companies work.
That's so 1998, man.
Actually, with the tech implosion back in 2001, this affects technology companies less than we would expect. It was put in place to catch companies that were writing off massive amounts of tax through the issuance of options. However, with fewer companies doling them out, and employees less enthused about receiving them, this new regulation affects the old bricks and mortar companies more than those in the tech sector.
FASB is located in the USA.
In the USA, it's Month/Day/Year.
Of course, you knew that, you're just trying to be funny (and failing miserably.)
In the past, companies could issue stock options to employees essentially at no cost to themselves. This would tend to understate employment costs, making them look more profitable than they really were. In addition, the exercise of these options would dilute the value of the stock held by shareholders.
Now they have to expense them using "fair value", which is what an investor would currently pay for an equivalent option. This, in theory, will more effectively represent employment costs.
If you didnt get stock options before, you still get none.
Investors are affected, since over time the talent leaves a company and the company loses innovation and just maintains their current product.
Accountants in find new creative ways to fake out the investors. This still has no real advantage
Take my post with a grain of salt - as you can tell I am against the practice.
A stock option is a contract that lets you buy a share of stock after some point in the future at a specified price. Example, a Google employee might get paid an option to purchase Google at $50 / share exactly three years from today.
.... very misleading.
Three years later, when Google sells for $100 / share and you cash in your option, Google will pay the difference b/t the share price and the option price (in this example $50). This is an expense which is tax deductible. Such a deduction creates a GAIN. The gain can be classified as income from continueing operations
Also misleading is that a company can employ a bunch of people without incurring the usual payroll costs associated with employing people. Therefore, sales should rise, but costs of goods sold does not rise. This creates a misleading impression of profitability. However, the market will probably catch this and lower the value of the stock. And this can happen long before your option has reached its maturity.
YOU DO NOT HAVE TO ACCEPT OPTIONS IN LIEU OF CASH. This is a decision each employee makes. You can, in theory, accept a lower pay of pure cash instead of a "higher" pay composed of stock options.
Going back to the Google example, if three years from now Google traded at or below $50 / share, your option would be worthless and you would have nothing. That is why you might want to consider getting paid in cash VS. getting paid in options.
Yeah all you used to have to do is make a note in your accounts about the number of shares you have issued. I.e. do nothing.
It also allowed a fun little scam in that the tax man allowed you to expense your stock options and subtract it from your profits before paying tax. This is why MS and others spent several years not paying tax. What they were actually doing is NOT MAKING MONEY. All their profits were going straight to the employees, and noone noticed as it was coming back in as they were issuing extra shares. A lot of MS' cash pile came from selling shares.
Basically there were two very different ways of acocunting for the same thing. If you pay your employees in cash, then issue extra shares to have the money to pay for it, it comes off your bottom line as it should. But give them cheap shares instead and it doesn't. The end result is the same, x extra shares issued, y extra money to empoyees, but one means you are in trouble, the other is a sign of a really healthy company. Until now. It is a good change.
Anyway, how does it make sense that a company paid me 7 figures for a couple of years when I was making high 5 figures. They had to be expensed, it was a crazy situation where your compensation really revolved around luck, when you got hired, what company you went to work for and how many options they gave you.
Yes; the data is from 12/16/04, but this will be a huge change in how tech companies work.
It was mentioned in Slasdot on 12/17/04
Options are a hedge only if you are exposed to a pre-existing risk to rises in the stock price. It's hard to argue that any employee is exposed to a risk based on the stock price *rising*.
Stock options without the pre-existing risk are speculative securities, just like stock or any other financial instrument. Employees earn income from stock options; hence, the company should record expense.
While it's true that options may not be cashed out, the accounting standard allows for companies to adjust the expense based on changes in expected redemption rates due to the factors you list (employee attrition or stock price behavior).
Accounting records anything with cash implications to companies. Options have such implications, and the presentation in income underscores this.
Except that a stock option is not really a "cost"; it does not deplete the company's assets to issue them. If any dilution occurs, it is when shares are issued and/or set aside for the purpose of issuing stock options
Not true. At the risk of repeating myself from my other post. Compare two cases. Company share price is $100 dollars a share
Case 1 : Company issues 100 extra shares at $100 (total $10,000), gives $5,000 cash bonus to employees, keeps other $5,000
Case 2 : Company gives 100 share options to employee with a strike price of $50. Employee pays $5,000, then sells shares for $10,000
In both cases 100 extra shares are issued, the company gets $5,000 and the employee gets $5,000. Yet the accounting treatment is completely different. In case 1 they have to make a note that they have issed 100 new shares, and take a hit of $5,000 additional expenses. Under the previous rules all they had to do was make a note that they had issued 100 extra shares. The company IS losing money as they are not getting full value for the extra shares issued. The real loser are the other share holders. with the diluted value of their holding. Say a company has 100 shares outstanding share price $100. The company is worth $10,000. I own 10 shares, value $1,000. Now they give the share options above out. The company is now worth $15,000, the value before plus the $5,000 extra cash they made. But I have only 5% of the company, not the 10% I had before. So my shareholding is now only worth $750. Clearly in the real world the numbers are different, and it can take a while for the market value to converge with the "real" value, but the principle applies. Giving out share options is an expense, they should be treated as such. Clearly accuratly costing these things is damn hard (there are rather a lot of books on how much share options should be worth). But it is only real money going out when the option is exercised so it *should* all come out in the wash. There are lots of things that are hard to put a price on in accounting, where they just guess until they know the real number, so there is no real problem with that.
Similarly for corporations. If payment A (cash) looks like an expense on the balance sheet and payment B (options) doesn't (yet), then which one will they pick?
I guess one of the other questions is, how does the company handle options when due? If they just issue new shares, they dilute existing shareholder value - which those shareholders might want to know about. If they buy back shares the company incurrs an expense which should be noted. Issuing shares is the least painful method to the bottom line, if the excutives are no longer majority shareholders, and the existing shareholders have little clout.
The Accounting profession (IANAA) is generally conservative. Income should not be recorded until it's earned, expenses should be recorded as soon as you're contractually obligated to pay. (I.e., you can't back out unilaterally). It's rules probably demand that shares be treated as costs at current market value - since there is no easy way to predict future share prices. And once the "promise" (option) is there, it has to be accounted for in case it IS exercised.
Presumably, if the option is not exercised, then the liability dissappears as a nice bonus for an ailing company (and another employee ripped off by the system).
Presumably, now, too, the employee really hasn't earned anything until they either exercise the option for a profit or sell the option (if allowed!). So they shouldn'tpay taxes until the option is exercised.
Watch for the IRS someday soon to assign value to options and tax them as current income. After all, you CAN buy futures options on some listed stocks (and commodities) so there is a value there. Maybe they'll make you restate all previous years' income tax once the value of the option is determined on exercising it. After all, they are the government.
Why it's a scam is that they didn't have to report it as an expense to their shareholders. So while they were telling the IRS that they didn't make money, they were telling their investors that the stock options were free, and that they were making money hand-over-fist.
I think your post shows a misunderstanding of how tax brackets work. There is no benefit to "dropping down to a lower tax bracket." It sounds like you assume that if you are just into a higher bracket that you pay that rate on all your income. This is not true. You would pay that rate on just the amount of income that puts you over the limit into that bracket.
For example, $70k is in the 25% bracket. $80k would be in the 28% bracket. One would only pay 28% on that last $10k and then pay 25% on about $10k and then pay 15% on about $40k and then nothing below that.
Using stock losses to increase deductions and save taxes is a good idea that may work for some people. But it's not because it drops them down to a lower tax bracket.