Stock-Option Accounting Battle Resumes after Seven-Year Detente. (Trends in Financial Management)
Levinsohn, Alan, Strategic Finance
* WARREN BUFFETT'S rationale for expensing the cost of stock options has been appearing in the business press lately with increasing frequency. "If options aren't a form of compensation, what are they?' Buffett asks. "If compensation isn't an expense, what is it? And, if expenses shouldn't go into the calculation of earnings, where in the world should they go?"
Actually, Buffett did not say this. He wrote it in one of his famously instructive letters to shareholders of his holding company, Berkshire Hathaway. But this was in his 1992 letter (www.berkshierhathaway.com/letters/letters.html).
That was when the previous battle began over revising accounting rules for the cost of stock options. Because of intense opposition, primarily from cash-poor technology start-ups that use stock options heavily to compensate employees and would rather not deduct those costs from already meager earnings, the issue shifted from the Financial Accounting Standards Board to Congress. For all intent and purposes, it was defeated.
Today, following the dot-coin blowup, the tech meltdown, and Enron, the subject--along with Buffett's commentary--is gaining new currency. And again it has entered the political arena.
In February 2002, a bipartisan group of senators introduced a bill, "Ending the Double Standard for Stock Options Act." Likewise. members of the House in March 2002 introduced an identical bill. The "double standard" is deductibility from corporate taxable income of compensation from exercised stock options but not the requirement to expense the cost of any option from reported income.
The bills would limit the tax deductions that companies can take to the amount of money they estimate options cost on their income statement and not--as is the current practice--only in pro forma estimates of income minus stock option costs in the annual report's notes section.
Enron's demise helped put the issue in the spotlight because the company paid many managers largely through stock options, which helped earnings by having no reported cost. Enron then received tar deductions when its employees exercised their options, helping the company avoid paying income tar four of the last five years.
Some people say that unexercised options aren't a cost because they're cashless. But, of course, other noncash items such as depreciation and amortization are deducted from income. Moreover, the FASB has long argued that option grants must be accounted for as a cost because they're used to acquire a service--an employee's labor--whose value must be accounted for. Another way to look at it is that when companies issue a new share of stock, they receive all of the sale price except for underwriting expenses, but, with an option, they forfeit much of the value of the share to its owner. …