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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.
Hell, I'd just like to be paid overtime.
You have two hands and one brain, so always code twice as much as you think!
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.
This is important because companies that do not report this method of compensation (stock options) have inflated reported financials because options were not properly accounted for on the statements. So, what does that mean? Analysts and investors did not have full disclosure as to how future stock options being exercised would really affect the company in the long (or sometimes short) term.
This will not only change the way that tech companies operate and report, but other huge publically traded corporations. When a company lures a big name CEO/CFO, and promises hundreds of thousands or millions of stock options to be exercised at a later date, that dillution of equity (even though in the future) was not being properly declared on the financial statements. Now that the FASB (financial account standards board) has made this recommendation/ruling, companies must comply.
This is what one might call "truth in financial reporting", and I'm very glad to see that this has passed. This has been a very long existing loophole that large companies have used to the detriment of our investment community, and the general public (i.e. our domestic economy) as a whole. Don't be blindsided by the rhetoric that only "tech companies" will be affected by this -- there were a LOT of big corporate powers that did not want to see FASB rule, and whenever you have that, you always have to wonder what their reasons are. I encourage you to read the FAQ, and read any news articles you can regarding this ruling. I think you'll agree this is a very positive thing.
[Stock options result] 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...
Stock options amount to the company giving money to employees...
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.
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.