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The Accounting for Stock Options
A company that owns its own shares should not recognize them as corporate asset in its financial statements but as treasury stock (Keith, 2003). When a company offers stock options, it is not distributing its assets, nor building a corporate liability; it is compensating the issuer with treasury stock. Because there is no liability creation, those who oppose expensing argue that stock option grant does not meet the explanation as identified in statement of financial accounting concept no.5.Instead in this opinion the existing stockholders are redistributing ownership units, with the company being the medium through which the transactions are made.
Financial accounting standards boards (FASB) have argued the above approach in a contrary opinion: No individual or corporation would argue that if a given company issued shares to public, and gave the collected cash to an employer, then the cash would be expensed. Now if the same amounts of shares are instead given to an employee who the sell them for cash, then all parties are put into equal position, hence the value of the stock should be expensed (Dack &Timothy, 2004)
Consider the following case: suppose an entrepreneur began a new business, having 100% of stock. The owner of the business promises the director 20% of business stock provided the business income exceeds business expenses by Z amount. Upon the business income exceeding business expense by Z, would it be fair for the owner of the business declaring that no stock should be given to the manager because Z means ‘’Z plus reasonable value of stock”?. This is the same as saying that the cost of stock must be incorporated in the business expense;
‘Revenue-Expense=Income +Stock’ is the same as“ Revenue-Expenses-Stock=Income’’(Keith, F. 2003)
Each one is entitled to bring out his/ her opinion about the logic of the above outcome, but important to say, the director would argue that the entity assumption was incorporated to differentiate the income determination from capital transactions. Bringing out the value of stock redistribution in this outlook will lead to misreporting of business performance. To demonstrate this lets consider a person who starts a business with $1,000 investment. The business then makes a profit of $2,000 and intrinsic value of $ 20,000 .It then pays the owner of the business a $2,000 divided.10% ownership equivalent to $2,000 is the used to reward employees. Financial Accounting Board Standard (FABS) would argue that the business has broken (profit-stock award) i.e. ($2,000-$2, 000), although the business owner had withdrawn more that what was invested. (Evans Mark, 2009).
Stock options are a way of compensation to employees, though people seem to differ in their opinions regarding whether this compensation comes from entity or from an existing owner. In case where the stock option is not expensed, it does not mean they should be overlooked in financial reporting (Evans& Mark, 2009).Unfortunately, the current financial reporting has not looked deeply into this matter.
It is useful to recognize stock based compensation expense in financial reporting. This issue should not be criticized since companies will end up reporting lower income in their financial statements. It may not be likeable on what financial statements reports, but it is good when financial statements are presented faithfully to the fundamental economic transactions. As learnt from WorldCom and Enron credibility of financial statements is important to efficient operate in stock markets.
Once Financial Accounting Standard Board (FASB) proposal on stock option expensing is adopted it will help to strengthen investor confidence in the financial reporting for all companies, thus lowering the cost of capital. Proficient and efficient allotment of capital depends on the quality of accounting.
This paper has provided a deep and great learning opportunity on the accounting for stock options. This topic has brought out an important case study on the fundamentals of accounting concepts such as reliability and relevance that assist to in reporting financial statements. This issue also contribute to the importance of continuing learning of accounting principles and how the apply in real life situations.
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