E&Y Reverses Course on Options Expensing

February 14, 2003 (PLANSPONSOR.com) - In a move that will likely generate controversy among employers, Ernst & Young now says it believes that stock options should be reflected as an expense on financial statements.

Ernst & Young reversed course in a letter on Tuesday to the Financial Accounting Standards Board (FASB), the organization that makes the rules for the accounting profession, according to the NY Times.   Major US accounting firms, including Ernst & Young, have for years maintained that options should not be reflected on company financial statements.

Sprint “Glint?”

The accounting firm, currently drawing criticism for their role in recommending a special tax shelter to Sprint executives (see  Sprint Board Forces Execs Out Under Tax Scrutiny ), was the first of the so-called Big Four accounting firms to embrace expensing, though the firm claims its stance has been under discussion for months, and is not related to the current controversy.  

FASB is currently working with their international counterpart, the International Accounting Standards Board, or IASB, to develop standards that are compatible for domestic and international companies (see  FASB, IASB Study Convergence Items ). Both organizations agree that the approach on options needs to be aligned, and both have asked the industry to comment on proposals to change current accounting methods (see  Global Accounting Rules Could be Ahead ).  

In a letter provided to the FASB, Ernst & Young said it strongly supported efforts by both groups to develop a method to ensure that "stock-based compensation is reflected in the financial statements of issuing enterprises." As have many experts, the firm expressed reservations about methods that might be used to value the options, but it noted that the current environment requires that the accounting for options provide relevant information to investors, according to the NYT report.

Last November the IASB released a proposal for stock option accounting that would require companies to estimate the fair market value of stock options from the date of grant.   Companies would then have to disclose how they arrived at the fair value measurement (see  IASB Releases Option Expensing Proposal ).

Under current US guidelines, companies can choose to subtract the expense of stock options from their income statements or disclose their theoretical value in the footnotes of their financial statements.   With the exception of a handful of early volunteers and the approximately 130 recent coverts, most companies opt to record the expenses in their footnotes (see  Fewer Companies Volunteer Stock Option Expenses ).

Relevant Disclosures

Ernst & Young admits that its new position could create problems since many of its clients   strongly oppose the idea, according to the NYT report.   Still, Ernst & Young, in its letter, said: "The need for more relevant compensation expense information exceeds the risks associated with the reliability and comparability of the measurement of compensation expense."

On the other hand, technology firms, which have relied heavily on option grants to attract workers, continue to oppose the deduction of stock option costs. The NY Times report cites a letter to the Financial Accounting Standards Board from TechNet, a lobbying organization made up of executives at 200 top technology companies.   That letter said, "While there is virtually uniform agreement that an employee stock option represents something of value to an employee, there is absolutely no agreement among accounting experts that the issuance of employee stock options represents a corporate expense. We believe that requiring employee stock options to be treated as an expense would lead to misleading financial statements because no accurate, reliable and tested method of valuing stock options currently exists."