Accounting for Stock Options: The Debate Continues

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The accounting treatment of stock options issued to employees, not just those options issued to top executives, is one of many issues in the accounting profession being challenged and changed today. The debate regarding how to account for stock options has many nuances. For example, if stock options are a part of a compensation package, then their accounting treatment should be as a compensation expense. However, many start-ups who use stock options to lure and retain talented employees disagree. Their contention is twofold: 1) they simply cannot support expensing employee stock options because of the effect on Net Income and 2) since a benefit is only derived by the employee if the stocks' value increases after the grant date, there is no expense to the company. The anti-expense proponents conveniently omit the tax benefit from employee stock options from their argument; tax savings that would partially offset the compensation expense. Also, opponents of expensing employee stock options tend to over simplify the issue in many ways, the most egregious is by concluding that these expenses are somehow imaginary or not real. The debate has spurred Congress's involvement in the promulgating of accounting standards, which challenges the independence of the Financial Accounting Standards Board (FASB). A bill that was before Congress in early 2004 was amended by the House to limit stock options expense to the top five officers. In response to the proposed amendment, Securities and Exchange Commissioner, William Donaldson, in his letter to Congress, emphasized the need for Congress to allow the FASB to do the work for which it is intended, namely setting accounting standards without Congressional interference (Soloman 2004). This paper discusses the current accounting treatment and the current environment of the stock options debate. We also point out the complexities of the stock option reporting process and how employee stock options effect the statement of cash flows. Our comprehensive analysis of data that has been compiled from selected companies' financial statements shows the reality of employee stock option grants and exercises, and why stock options should take their rightful place in the income statement.

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