GAO Supports Option Expensing Mandate

July 9, 2004 ( - The General Accounting Office (GAO), has thrown its support behind the Financial Accounting Standards Board's (FASB) independent efforts to require the mandatory expensing of stock options.

“We support the concepts behind FASB’s current proposed Statement requiring companies to use the fair market value method, which essentially results in companies recording stock options and other share-based arrangements as an expense,”Comptroller General of the United States David Walker said in testimony before the US House of Representatives Subcommittee on Commerce, Trade and Consumer Protection and Committee on Energy and Commerce. “In our view, stock options and other forms of share-based payment have economic value and represent a form of compensation expense. Therefore, we believe that the economic substance of such transactions should be reflected as compensation expense in the calculation of a company’s net income to accurately portray its financial results.”

In addition to supporting FASB’s work on the Exposure Draft, the GAO also supported the “four principal reasons FASB cited for issuing the new proposal,” Walker said.   Those are:

  • addressing concerns of users and others that the use of the intrinsic value method results in financial statements that do not faithfully represent economic transactions and can distort the financial condition and operations of the issuer;
  • improving the comparability of reported financial information through the elimination of alternative accounting methods
  • simplifying US generally accepted accounting principles by requiring the use of a single method of accounting for share-based payment;
  • enabling international convergence and greater international comparability in the accounting for share-based payment.

Under FASB’s Exposure Draft issued on March 31, all forms of share-based payments to employees would be treated the same as other forms of compensation by recognizing the related cost in the income statement. The expense of the award generally would be measured at fair value at the grant date (See The Bottom Line: Expensing Proposition ).  To arrive at this cost, FASB provided several valuation techniques in the Exposure Draft, including a lattice model (an example of which is a binomial model) and a closed-form model (an example of which is the Black-Scholes-Merton formula) that would meet the criteria for estimating the fair values of employee share options.

Public Comment

Following FASB’s release of the Exposure Draft, the Norwalk, Connecticut-based agency opened a public comment period on the mandate that ended June 30.   This comment period allowed various parties to submit suggestions to FASB on the best way to handle stock option expensing before a final version of the proposal goes to the Securities and Exchange Commission (SEC) for ratification,a process Walker says is crucial to be run to completion.  

“We believe it is critical that FASB complete its analysis of comments received on its exposure document on share-based payment and finalize its proposed Statement in accordance with its established independent standard-setting process,” Walker said.   By allowing this process to run to completion, “Congress recognized the importance of having an independent standard setting process that facilitates accurate and effective financial reporting and protects investors. “

Board Independence

Also testifying before the committee wasFASB chairman Robert Herz , and Rick White, chairman of the International Employee Stock Options Coalition (IESOC).   The additional testimony on any Congressional action on stock option expensing came as the Energy and Commerce committees staked their claim to joint jurisdiction over a bill to impose limits on the impact of a stock option expensing mandate (See  Expensing Limitation Bill’s March Through Congress Slowed ).   Earlier this month, the House Financial Services Committee approved the bill to delay implementing any standard for a year, until completion of an economic impact study by the federal departments of Labor and Commerce.  The bill would also restrict any option-expensing standard from FASB to options granted to the top five officers of a company (See   FASB Options Expensing Limit Bill Gets Committee OK).

The bill’s sponsor, Representative Richard Baker (R-Louisiana), said the measure was aimed at protecting broad-based stock option plans that start-up companies often use to attract workers.   But opponents contend federal lawmakers need to stay out of setting accounting standards, especially just two years after voting to increase FASB’s independence in the Sarbanes-Oxley Act crackdown on corporate corruption, a view that Walker agreed with in his testimony.

“[W]e believe that the principle of independence, both in fact and in appearance, is essential to the credibility of and confidence in any authoritative standard-setting processes,” Walker said.   In part, this support is drawn from previous precedent set for FASB’s independence by the SEC, which Walker said has relied on FASB to establish financial accounting and reporting standards for private-sector entities.

“With respect to the role of FASB in this and other areas, we support its efforts, as the SEC’s designated independent non-governmental standard-setting body, to identify issues for consideration, prepare exposure documents, conduct outreach efforts and solicit comments on exposure documents, and consider the resulting comments in finalizing and issuing new accounting standards,” Walker continued.

“These processes were established in order to balance the competing interests and demands of the various groups while providing standards that promote transparent, credible, and comparable financial information,” said Walker.   “This time-tested and proven deliberative process has served to strengthen financial reporting and ensure general acceptance of the nation’s accounting standards. “

A copy of Walker’s full testimony is available at