FASB Says Yes to Option Expensing

April 23, 2003 (PLANSPONSOR.com) - The seven-member Financial Accounting Standards Board (FASB) has unanimously agreed that companies should be required to treat stock option grants as expenses.

The Norwalk, Connecticut-based accounting rulemaker will now move on to determining how to value options. The board said it expects to have a new rule in place sometime next year, according to a Washington Post report.

This is the second go-around for mandatory stock option expensing.    In 1993, FASB attempted to mandate an expensing policy, backing down after Congress threatened to strip it of its power.     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 converts, most companies opt to record the expenses in their footnotes (See Fewer Companies Volunteer Stock Option Expenses).

Broad Support

Support for option expensing has come from retail investors incited by a raft of accounting debacles in the past year, with 76% of retail investors writing letter of support to the board (See Investors Voice Support For Option Expensing ).   Chairman Robert Herz candidly referred to the support e-mails as his “daily love notes.”

Further, many institutional investors and other financial organizations are throwing their weight behind FASB’s latest proposal partly because it is now seen as a corporate governance issue rather than just a technical accounting issue. Organizations such as the International Accounting Standards Board (IASB) (See   IASB Releases Option Expensing Proposal) and Moody’s have come out in favor of option expensing (See   Moody’s Calls Out Stock Options).

Not All For

However, 88% of letters written to the FASB by corporations expressed disapproval of the move. Most notably have been technology companies that contend the expensing of stock options will cut into their bottom line.      NASDAQ, the primary stock exchange for technology companies, has said expensing stock options could hurt small companies that do not have earnings but need to attract qualified employees as the companies in particular rely on stock options as a form of compensation.  Currently, these companies utilize the intrinsic value method to account for the value of the options.  Under this method, options are accounted for by taking the difference between the market price of the stock and the exercise price at which the employee may buy that stock.

Two such companies are Adobe (See  Adobe Takes Snapshot of Life With Option Expensing ) and Analog Devices (See  Analog Shareholders Defeat Option Expensing Proposal ).   These two revealed their bottom lines would take a major hit should option expensing be implemented in the near future. 

Taking it one step further, some corporations have threatened to mount a fee embargo to funding both the FASB and the newly formed Public Company Accounting Oversight Board (PCAOB) created under the Sarbanes-Oxley Act if mandatory option expensing became the law.   Under the new system, corporations would be required to pay regular fees to support the national accounting standards-setter.  Previously, FASB relied heavily on voluntary contributions to fund its operations.

“There are some companies who think (the fee) is an unfair tax and others who couldn’t care less about that, but who believe that may be a way to throw a monkey wrench into what we’re doing,” Herz said (See  Companies Prepare FASB Fee Boycott ).

Also, members of Congress have also joined in the push to dissuade mandatory option expensing.   Representative David Dreier (R-California), chairman of the House Rules Committee, and Representative Anna Eshoo (D-California) introduced a bill last month that would prohibit the US Securities and Exchange Commission (SEC) from enforcing a new stock-option rule until it studied the issue for three years. The bill also would require that the secretary of commerce spend a year studying the corporate and economic impact.

Senator Barbara Boxer (D-California) said she and Senator John Ensign (R-Nevada) plan to introduce a similar bill when Congress returns next week from its spring recess.   “Given FASB’s history on stock options, I am not surprised that they ruled to expense them,” Boxer said in a news release. “However, FASB admits that it doesn’t take into account the economic impact of its decision. . . . This bill will send this whole matter to the SEC for review before the proposed rule goes into place and we are dealing with its unintended negative economic consequences.”

However, a recent Towers Perrin study that found stock option expensing has little effect on corporate bottom lines (See     Expensing Options Has Little Effect On Stock Price).  Towers concluded from that study that the economic costs of using options had been known to investors before companies began showing profit & loss (P&L) expenses.