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Nov 8, 2017 in Analysis
Accounting for Stock
In the emergence of dot-com and millennium change in general stock market which was caused by change in accounting and auditing weakenesses,the ``Oxley act of 2003” was passed and started receiving fairly good reviews from regulators, management and investors, it has restored trust in the stock markets. However market regulators and congress are still calling for action by financial accounting standards board to look into the matter of accounting principles in the stock market (Barry&Defter, 2000). A decade ago, Financial Accounting Standards Board (FASB) come up with a proposal that all companies are required to expense the cost of stock option, though after some time they went back due to the pressure from business such as high-tech firms .Recently Financial Accounting Standards Board (FASB) issued a proposal, which if adopted, it would much change the procedure for accounting stock-based compensation. This proposal brought up controversial opinions, which delayed the awaited plan.
Historically, accounting principles allow companies to report little compensation expense after stock options issued by companies to employees in exchange to services rendered. This is due to the fact that expense for stock options is based on an intrinsic value on the date of issue. Intrinsic value is defined as the different between the option price and the market price. The option price is the fair price that employees purchase company shares. When companies issue option to employees the intrinsic value is identified as zero and no compensation expense is accounted for (Barry &Defter2000).Surprisingly, most of stock options are given out as money and as a result, the expense associated with stock options is considered as the income in the financial statement.
To address this issue, the Financial Accounting Standard Board (FASB) has anticipated that all expense must be based on fair value of options. This expensing requirement would have a major impact to income. A recent research by Bear approximate that 2004 operating income of Microsoft company would have been 10% lower if stock options had been expensed.
Recently, Financial Accounting Standard Board (FASB) received opinions on its proposal and it appears heading towards granting a standard expensing on equity based compensation, However some individuals and companies are really opposing stock based compensation due to reasons such as, existing forms for calculating compensation are wrong hence misleading, secondly the argue that the expensing stock option may end up deforming the company performance since they do not charge any cash, thirdly ,the say that the cost of employee option is intensity to the existing shareholders equity therefore it should not be considered as an expense in the financial statement.
Changes in financial and economic reporting techniques in the past decade have also pushed to the need for updated accounting standard in stock options. Most outstanding are the current economic and financial drawbacks mentioned ealier.In 90s numerous auditing, business and accounting drawbacks were observed, which raised new concerns on the quality of accounting principles and practices (Hacker,2006). It was noted that accounting for stock based compensation is an example of a poor reporting accounting standard. Indeed by the start of 2000 many companies had willingly turned to the fair value way of recording compensation on stock options. On the other side many prominent companies such as Coca Cola, Ford and General Motors have opted to support expense stock options. The support by this companies have been contributed by two factors.First,they are trying to gain favor from the new investors by being open.Second,according to a recent research by Pour’s Quantitative Services printed in a Street Journal state that such companies face a serious shock earnings by going for an expense journal.
With regards to this argument there is a three way relationship between the stock holders, employee and entity. Issuing stock options is not only a rearrangement of interest but also an operation related to entity. Experts have pointed out that a number of indicators, together with entity market of shares arise when options are issued between managements and stockholders. The experts conclude that forms of stock option offers contribute more than rearrangements of the existing ownership.
The theoretical argument on accounting for options touches the entity concept. This debate point out a major challenge in applying the entity concept in its full form as it states operation of entity should be accounted separately from its owners. This argument is presented in details below.
The entity assumption: The entity assumption requires accountants regard a business as a separate entity, distinct from its owners and managers while relevance requires accounting information to be closely related to the business unit that is impacted by a transaction. For example accountants always prepare financial statements for a separate legal entity. Moreover sole proprietorship financial statements are usually separate from the personal information of the owner. In other words, business transactions are accredited to the proper unit of accountability.
In accounting for stock options some accountants always confound the legal processes of transactions, perhaps they may be not be aware of entity assumption in stock options. This may result to financial statements and reasoning being inconsistent. For example, Greenspan at the 2005 financial marketing conference stated “that a stock option is an independent issue of value from the existing stockholders to an employee” (Evans, B and Mark, 2009). Although this may be true to a given circumstance, it is perplexing since the entities Greenspan recognized in his statements were the employees and stockholders and not the company.