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Employee Stock Options Must be Treated as Expenses

michael posted more than 9 years ago | from the rated-b-for-bottom-line dept.

The Almighty Buck 325

currivan writes "In a move that's been in consideration for a long time, the Financial Accounting Standards Board (FASB) approved new rules requiring employee stock options to be treated as expenses for reporting purposes. One of the reasons so many tech companies have given options to IT/engineering workers is that until now, they haven't counted against profits in quarterly reports. If markets were truly efficient, this wouldn't make a difference, but in reality, the tech industry is strongly opposed to the rule, though it should please Warren Buffett."

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325 comments

WTF? (-1, Offtopic)

Anonymous Coward | more than 9 years ago | (#11115705)

This was on yahoo like 2 days ago.

I HAVE A GREASED UP FRUIT BASKET SHOVED UP MY ASS (-1, Troll)

Anonymous Coward | more than 9 years ago | (#11115711)

YEAH!

Hmmmm (3, Insightful)

dfn5 (524972) | more than 9 years ago | (#11115727)

If the stock options you get are worth nothing, is that really an expense?

Re:Hmmmm (2, Interesting)

Rude Turnip (49495) | more than 9 years ago | (#11115795)

The problem is that some of them are worth something, and they're not getting expensed.

Re:Hmmmm (1)

danheskett (178529) | more than 9 years ago | (#11115845)

Something only has value when it is bought or sold.

"Options" are just that - the promise of a future chance to make a sale or purchase.

Oher "options" that are provided for in business are not counted in the books: for example, if you sign a contract that allows you to buy a leased product at the end of the lease you do not have to count the eventual purchase price as an expense until (and only if) you exercise that option.

This is the kind of rule that people say is "common sense", but in fact, it's not very sensible.

Well, in my opinion that is.

Re:Hmmmm (1)

timster (32400) | more than 9 years ago | (#11116063)

First of all options are transferable, in that you can sell them or buy them, so they have value in the first sense.

But besides that, in the case of your contract example, if the price at which you are allowed to buy the product is lower than the value of that product, then the contract itself has value.

If Apple "rewarded" its employees by issuing coupons allowing them to buy iPods for $50, those coupons would be valuable.

Re:Hmmmm (1)

networkBoy (774728) | more than 9 years ago | (#11116088)

Normal NQOptions are not transferable (at least none of mine are).

Furthermore, now that this rule is taking effect I will no longer receive stock options. That really sucks.
-nB

Re:Hmmmm (2, Insightful)

eXtro (258933) | more than 9 years ago | (#11115864)

They should be expensed when they're exercised not when they're awarded because there's no guarantee that they ever will be exercised. So by taxing them before they are exercised you're creating work for accountants who'll have to keep track of them until their expiry date.

I've got a lot of options which I doubt will ever be exercised. The bulk of them were awarded when my company was trading at 14 dollars and change but now it's trading at near 2 bucks. They're expiring in 2 years and unless something miraculous happens they will not be exercised.

If something miraculous does happen then I will exercise them. Eventually they'll be sold and then taxed.

All this is going to do is ensure that non-executives don't get any options because of tax burdens. The twats at the top will still get them.

Re:Hmmmm (0)

Anonymous Coward | more than 9 years ago | (#11115949)

They should be expensed when they're exercised not when they're awarded because there's no guarantee that they ever will be exercised.

But the liability is created at the time they're issued. When they're exercised, the cash cost goes into the books for the amount that covered them, and the amount of the original liability is subtracted. In the accounting world you have to keep track of cash flow in addition to outstanding liability that may create an expense in the future.

Re:Hmmmm (0)

Anonymous Coward | more than 9 years ago | (#11115811)

An option has value whether it's currently worth something or not. There's a whole market in buying and selling options.

Re:Hmmmm (5, Informative)

HMA2000 (728266) | more than 9 years ago | (#11115843)

Yes. The opportunity is worth something all by itself. A stock option grant represents a potential dilution of ownership for current share holders. Think of it this way. Company A has 1 million shares of which you own 100K. You are entitled to a 10% share of the company's profits. The management of the company, in an effort to attract talent, grants 500K more shares. You're ownership now could fall as low as 6.67%. That potential dilution is a real expense to you. Even if it never comes to pass.

Re:Hmmmm (2, Insightful)

danheskett (178529) | more than 9 years ago | (#11115905)

That potential dilution is a real expense to you.
It is not a real expense. A real expense is something that actually costs you cash. Buying a new piece of equipment is a real expense.

This is a potential loss of value, that's what it is. In your example, that dilution of value for the owner still doesn't cost the company anything. The assets held by the company remain static. The value of the company remains static. The number of owners increases. That's all. There is no outlay of cash.

Stock options are both in effect and concept a gift among share holders. Options are promised at a price which is assumed to be less than the market price at a future point. You are promised the option to buy 10,000 shares at (usually) today's prices. When those options are available to you if the price is low enough you will exercise the options and the other stock holders effectively have given you the difference between market value and promised value: it's equity they used to have but is now transferred to the option holder.

Regardless, there is no expense to the company itself, only the individual stock holders.

Re:Hmmmm (2, Interesting)

HMA2000 (728266) | more than 9 years ago | (#11115946)

So you are saying if you were in the situation I described you wouldn't take actions to protect your investment? You wouldn't seek alternative arragnements to maintain your equity?

Of course you would. Hence it is a real expense. If it wasn't a big deal it wouldn't be a big deal.

Re:Hmmmm (1)

JPelorat (5320) | more than 9 years ago | (#11115974)

I'm going to give you $10.

No wait, I'm only going to give you $6.

Have you, at this point in time and because of the above two lines, lost $4 in real cash?

No.

Re:Hmmmm (0)

Anonymous Coward | more than 9 years ago | (#11116025)

Yes. Sort of...

He bought the stock, based on all assumptions he was going to gain $10.

Now because of your actions he only gains $6.

While he didn't pay out the $4 difference to you, he did lose $4.

Most of the time the biggest pinch is not the lost yield, but the lost value of the stock itself.

Thinking of money as what's in your wallet is not enough...

They're taking away his value, maybe that value wasn't money in his wallet, but it was his asset which is now not worth as much.

Of course, the same thing could be said by a reduction in the relative value of the dollar... you have a $10 bill... in 20 years although it's still a $10 bill, it won't buy what $10 used to buy, the market/government/iraqies/whatever have reduced the value of that dollar.

Re:Hmmmm (1)

JPelorat (5320) | more than 9 years ago | (#11116056)

No, he hasn't bought the stock yet. He has the option to buy the stock. That why they're called options.

Re:Hmmmm (1)

nelsonal (549144) | more than 9 years ago | (#11116065)

You have according to the rules of business, which require that you book $10 in revenue upon the promise to pay (and any associated costs or profits with the original $10 promise). The reduction would then be a writedown on the promise to pay. That is the heart of the difference between cash accounting and accrual accounting. If you sign a mortgage, have you not effectively given up spending $800/month for the next 30 years? Could you simply walk into the bank and expect to not pay them (without selling the house and paying off the mortgage)? Accounting says that your promise to pay should be reflected on the day you sign the mortgage rather than each month when the payment is due.

Re:Hmmmm (1)

JPelorat (5320) | more than 9 years ago | (#11116112)

Well, that may be. I don't know. Business accounting has some weird shit going on.

But the cold reality is that he would be up $6, not down $4. Writedowns and promise to pay notwithstanding.

You can't lose what you haven't got. Except in business accounting, apparently.

Re:Hmmmm (1)

networkBoy (774728) | more than 9 years ago | (#11116152)

Look, options are a potential dillution of the stock, not an actual dillution. Tax them when excercized.
If you all insist on taxing them up front then don't you dare tax them when I excercize them because that'll be double taxation and I will do my damndest to not pay those taxes including a court battle.
It's all a moot point though, now that my employer will be taxed on these I won't get them any more. This is going to directly result in a less educated population because that money was going into my kids 529b plan.
I'm rather pissed about that.
-nB

Re:Hmmmm (1)

caseydk (203763) | more than 9 years ago | (#11116084)

I'm going to give you $10.

No wait, I'm only going to give you $6.

Have you, at this point in time and because of the above two lines, lost $4 in real cash?

No.


This is why one political party always calls things "budget cuts" when they're actually "a smaller increase than requested".

Tell your wife that you're going to have an extra $10 and only bring home $6 and see what happens. ;)

Re:Hmmmm (2)

JPelorat (5320) | more than 9 years ago | (#11116143)

Bingo

Re:Hmmmm (1)

BridgeBum (11413) | more than 9 years ago | (#11116166)

Disclaimer: I am not an accountant or an options trader. I do know plenty of both though. ;-)

Parent is right, here's another way to think about it:

Suppose 1 share of stock X is trading today at $10. I offer you an option to sell a share of stock at $20 anytime within the next 3 months, but I charge you $10 for that right. If you went out and bought 1 share of stock for $10 and sold it to me for $20, you get the $10 profit from the stock sale, but you had to pay me $10 for the option to sell ('put') that stock in the first place. Net profit zero, even though the option itself is worth something today.

Let's change it around a little bit. Now the stock is still selling at $50 today. Now I sell you the right to purchase ('call') a share at $55, also expiring in 3 months for $5. Currently, this seems like a bad deal: I'm charging you $5 for something which you could do better on your own in the open market. Let's say you buy 1 option at the $5 price plus 1 share of stock at $50. Two scenarios: Company X discovers a brand new Widget and the stock price soars up to $100. For the option, you spend $55 plus your original $5 and sell your new share at $100. Total profit: $40. Your share was purchased at $50 and sold for $100, total profit $50. So why would anyone want to buy options? You make less money, right?

Turn to scenario #2: Company X has a major scandal releasing Dihydrogenmonoxoide into the air in mass quantities, causing the stock price to fall to $10. Your option is worthless, so you throw it away. Total loss: $5. Your share of stock was purchased at $50, but now is only worth $10, total loss of $40.

The advantage of options is that there is less risk. The person selling the option must price it appropriately, or they will take on too much risk themselves. The price of an option is an attempt to try to guess what is the likelihood the option will be exercised, plus how much the price differential will be at the time it is exercised.

Re:Hmmmm (1)

Herbmaster (1486) | more than 9 years ago | (#11115947)

If the stock options you get are worth nothing, is that really an expense?

Certainly. If a company give its employees worthless (underwater) stock options, they will likely find themselves in a bad position later on, when their employees realize they've been had. The company could be forced to buy back the stock options, reissue them at a lower strike price, exchange them for stock grants, or the lack of employees' confidence in the stock could simply force them to give out cheaper options or actual cash instead in the future. All of these represent a loss of value to the company. It shouldn't come as a surprise to investors because the company has been claiming the options it was giving out were "free" all along: the company should claim the expense up front when they issue the options.

Re:Hmmmm (1)

caseydk (203763) | more than 9 years ago | (#11116045)

If the stock options you get are worth nothing, is that really an expense?

Choosing numbers out of nowhere...

If a VC buys 5% of the company for $2M, then yes, the other stock would defnitely have some value as that puts an initial valuation on the company.

Of course that valuation can be wildly off...

Re:Hmmmm (1)

TheWizardOfCheese (256968) | more than 9 years ago | (#11116072)

There's no such thing as an option that's worth nothing. If you don't agree, then please write me some options for free.

How will it work? (3, Interesting)

gtrubetskoy (734033) | more than 9 years ago | (#11115731)


Can someone confirm how this really works? When options are granted, it is usually an option to buy a certain number of shares at today's market value. So on the day of the grant, the value is usually always 0.

Let's say an option is granted to buy N shares and a year from the date of the grant, the stock is up by 10 points - then the value is then 10 x N. So the company now needs to subtract 10 x N from its earnings for the fiscal year during which the stock was up by 10 points? Then next year it goes up again and the company adjusts earnings again? Ad infinitum?

OR does the company just make a speculation, something like "we think the stock will go up by 10 points this year, so lets just subtract 10 x N from earnings". But what about the value 10 years from now?

What happens with taxes? It is advantageous for a company not to ever show any profits, this seems like a simple way to reduce your taxable income as far as the IRS is concerned. Most corporations don't pay any taxes anyway, but now this just got easier: "Let's grant everyone a bunch of options that we deem are worth 10 bazillion"?

Lastly, I don't see how this rule will affect anything at all since more likely than not companies will just be publishing two numbers - earnings with stock option adjustment and without. Kinda like EBDTA.

Re:How will it work? (0)

Anonymous Coward | more than 9 years ago | (#11115788)

Most likely they'll use an outside investment company to give them an estimate of what the options would sell for on the open market. That's a common method used by companies that have already been doing this.

Re:How will it work? (1, Insightful)

MyLongNickName (822545) | more than 9 years ago | (#11115806)

No, it is NOT a zero value. Take a look at your Wall Street Journal. People buy and sell options all the time. It is an educated guess about the direction of the company.

Often used to offset the risk of other investments (i.e. I buy Company A stock, but I want to protect against a big drop, so I buy the right to sell the stock at a certain, lower price). This helps you to get to a target risk level and still have a wide variety of stock to pick from.

Often, this is used by pure speculators too :)

For a large company, there is sufficient market information to make a good estimation of the value of a certain option. What is unclear, however, is how you do this for a small company without enough market activity to have an options market. or worse yet, a private company who's value is determined by a third party's valuation.

However, market valuations would take care of the vast majority of the bad accounting deals you ahve heard about on the news...

Re:How will it work? (1)

Otter (3800) | more than 9 years ago | (#11115902)

No, it is NOT a zero value. Take a look at your Wall Street Journal. People buy and sell options all the time. It is an educated guess about the direction of the company.

If I recall correctly, the old voluntary guideline from FASB was that the value of the options was calculated according to Black-Scholes and a resulting expense is declared. As you say, it's unclear how well that will work for small companies with no history of stock volatility.

Re:How will it work? (2, Informative)

twiddlingbits (707452) | more than 9 years ago | (#11116009)

FASB hasn't determined the guidelines for pricing the options, so who knows if they will stick to Black-Shcoles or go with some other valuation of thier own. Around 40% of the companies that issue options to employees already expense them. Also, the companies I worked for that granted options disallowed you to sell the options on the Options Market (after you vest). So, there really isn't access to a Market so Market price is kind of an academic exercise. You must buy and resell the stock to make your money.

Re:How will it work? (1)

Otter (3800) | more than 9 years ago | (#11116116)

Ah, the new policy is in the FAQ:
The Statement specifies that the fair value of an employee share option be based on an observable market price of an option with the same or similar terms and conditions if one is available. In the United States, equity instruments identical to employee share options are currently not traded (but may be in the future); hence, there are no observable market prices. The Statement requires that the fair value of those instruments be estimated using a valuation technique that (1) is applied in a manner consistent with the fair value measurement objective and the other requirements of the Statement, (2) is based on established principles of financial economic theory and generally applied in that field, and (3) reflects all substantive characteristics of the instrument (except for those explicitly excluded by the Statement, such as vesting conditions and reload features). The affect of vesting conditions are taken into account by requiring that compensation cost be recognized only for share options or restricted shares the entity expects to vest and that actually do vest. Additional information regarding estimating the fair value of an employee share option can be found in Appendix A of the Statement.

I'm not sure if "The affect of vesting conditions are taken into account..." is technical jargon or if CmdrTaco is moonlighting at FASB...

Re:How will it work? (3, Informative)

Rude Turnip (49495) | more than 9 years ago | (#11115889)

"When options are granted, it is usually an option to buy a certain number of shares at today's market value."

Yay...I get to show off my knowledge of finance on /.! When options are granted, you are getting an option to buy a certain number of shares before a certain expiration date. The option to buy shares is a "call" option.

The "exercise" or "strike" price is the price at which you may buy the stock. It could be below current prices, in which case you'd make an immediate profit. When the strike price is below the current stock price, the option is considered "in the money." When the strike price is above the current market price, you can't make a profit right away and the option would be considered "out of the money." However, just because an option is out of the money doesn't mean it's worthless. Between the growth in the value of the company and the volatility of the stock price, there is still a possibility that it could be in the money before expiration.

Re:How will it work? (2, Insightful)

rmcd (53236) | more than 9 years ago | (#11115898)

Companies will use standard option pricing techniques, such as the Black-Scholes formula or binomial option pricing. You can read about them here [barnesandnoble.com] .

You are incorrect in saying that the value of the option at grant is zero. If I flip a coin and you get $1 if heads and 0 if tails, that is worth something to you. An option is the same: you get a payoff if the stock goes up and nothing if the stock goes down. The valuation problem for standard options (like those traded on the CBOE [cboe.com] ) is well understood. There are tricky issues in applying option pricing to employee options, but their value is emphatically not zero.

Re:How will it work? (2, Informative)

twiddlingbits (707452) | more than 9 years ago | (#11115911)

Options DO have value to the FIRM, they will be expensed at the Market closing price of the stock on the day issued. If the company had sold that stock to Joe Public, they would have recorded the revenue, giving it to Joe Employee means they gave away something with value thus an Expense in Accounting terms. Joe Employees doesn't record any loss/gain until the options vest and are exercised. I'll have to read the rules but i hope FASB will let the companies expense the options as they vest not at the time they are given, and if the options never vest they are never expensed.

However, what the FASB rules say and what the IRS rule say can be different. I don't think the IRS has ruled on this area yet, they were seeing if FASB could work it out and maybe jump on that. And yes, companies DO pay taxes, but it's at a fixed rate. They however get lots of tax deductions you and I can't get.

I suspect you will start seeing some funky statements in earnings reports like you mention. I think the Stock Analysts will ignore it, as Earnings are only 1 component of what they measure to "estimate" the stock price. Cash Flow (which options do not affect) is a better measure of how strong a company is for the future.

By the way, I don't think the rank and file techie options are driving this FASB statement, it's more the massive options given to the techie (and other) EXECUTIVES that they are concerned with.

Re:How will it work? (0)

Anonymous Coward | more than 9 years ago | (#11116007)

Options DO have value to the FIRM, they will be expensed at the Market closing price of the stock on the day issued.

No they won't. They would be expensed at the market price of the option, if such a thing existed, which it typically does not. Realistically, the expense will be determined by an options pricing model.

Also, FASB has nothing to do with the IRS. This issue pertains to revenue for the purpose of stock analysis, not for taxation. If it had the potential to lower taxes companies would have been pleading for it.

Re:How will it work? (1)

mordors9 (665662) | more than 9 years ago | (#11115959)

There are few details and alot of it makes little sense. They are being forced to expense something that does not effect revenues or profits. The company is diluting ownership in the company by issuing additional stock. But the total value of the company remains the same. Granted it has been a few years since I studied this in college, but I am a bit confused. My company does not even allow any of the option to be excercised for a certain number of years and then it is on a sliding scale percentage wise. How are you going to expense that? Is it expensed in the year of issue even though none of it is excercisable. Is it expensed in the year it is excercised?

Re:How will it work? (1)

rmcd (53236) | more than 9 years ago | (#11116004)

Think about it this way: companies that *don't* use options as compensation will report lower profits because they will pay more cash to their employees. What the rule does is make reported income comparable between companies that do and don't use options.

Also, while you're right that the value of the company is the same, the distribution of that value is changed: existing shareholders get a smaller piece of the pie when the company grants options to employees.

Black-Scholes (2, Informative)

krysith (648105) | more than 9 years ago | (#11115975)

My guess is that they will most likely use The Black-Scholes Option pricing model [bradley.edu] with a few refinements.

Re:How will it work? (1)

nelsonal (549144) | more than 9 years ago | (#11116011)

The intrinsic value is currently 0, but the value of the right to buy stock at the current price is non-zero. The simplest model is binominal. Say you have a $10 stock with a 60% chance of rising 10% in each of two years, and a 40% chance of falling 10% in each year. So there is a 36% chance of the stock finishing at $12.10, a 48% chance of finishing at 9.9 and a 16% chance of the stock ending at $8. Your call is valuable at the end of two years if it finishes in the money. So there is a 36% chance that your call option will be worth $2.1 and a 54% chance it will be worth nothing, two years from now. This totals about $0.75 (which would be discounted back to the present at the risk free interest rate). Using a risk free rate of 5% givees a call premium of $0.68. Even though the current intrinsic value is $0 (right to buy $10 stock at $10 for the next two years).
Of course, this is a very simplistic model (two end states, and two years). The most common model (Black-Scholes) is the limit of the binomial model as time approaches 0. You can google around for black-scholes and see the model.
The IRS rules are very accurate, but do not square with the guiding principle of GAAP (try to keep costs and revenues in the most appropriate period). The IRS waits until an option is excercised and then counts the cost as the difference between strike and excercise price. So the IRS is not taxing companies based on options that were issued in the past, GAAP tries to keep options expense on options issued in the present, which is why the model must use uncertainty.
Finally, I fully agree that most companies that issue any signficant number of options will be issuing numbers with and without options expense (and guess which numbers analysts (and therefor investors) will be following. The other change that is likely to occur is a shift toward fewer numbers of share grants. Since most employees don't correctly value options (they also assume option value=intrinsic value) companies can greatly reduce dilution by granting employees shares that are equal in value to the options they would have granted. Say you were granting $10,000 in options that might have been for 1,000 shares, now companies will be more likely to grant 50 shares of stock (worth the same $10,000), but to the company the stock has considerably less dilution associated with it. The end of the accounting trickery (options have zero income statement effect, but stock grants have considerable effect) will bring about this change.

Re:How will it work? (1)

twiddlingbits (707452) | more than 9 years ago | (#11116083)

Say you were granting $10,000 in options that might have been for 1,000 shares, now companies will be more likely to grant 50 shares of stock (worth the same $10,000), but to the company the stock has considerably less dilution associated with it. The end of the accounting trickery (options have zero income statement effect, but stock grants have considerable effect) will bring about this change.....

I don't see companies moving to Grants. Options were used as a management motivation tool to encourage employees to help make the company more profitable via thier labors. If that happend the stock options came above water and the vested shares could be sold at a profit. Giving grants is more like an immediate reward, and it really DOES have costs in the period issued. I suppose they could restrict the sale of Granted Stock but the stock still belongs to the employee and they are now officially stockholders not stockholders to be as with options. Bottom line, I don't think we'll see more grants, but we will see less options and a move back to traditional cash compensation. That's NOT a bad thing IMHO.

Re:How will it work? (0)

Anonymous Coward | more than 9 years ago | (#11116117)

Say you were granting $10,000 in options

What does that mean? Options are not money, there is no such thing as "$10,000 in options" on the day of the grant.

A Couple of Articles on the Matter (2, Informative)

Prince Vegeta SSJ4 (718736) | more than 9 years ago | (#11116034)

link HERE [harvard.edu]

HERE [64.233.161.104]

Tax Implications? (3, Insightful)

TrollBridge (550878) | more than 9 years ago | (#11115733)

IANAA (accountant) but I would think this move might have some massive tax implications. Would this force companies to pay more in payroll taxes? Could it allow them to pay less?

Someone with more knowledge on this please reply. thanks!

Re:Tax Implications? (3, Insightful)

grub (11606) | more than 9 years ago | (#11115761)


Along the same lines I was wondering if the employee would have to file them as a taxable benefit/income.

Re:Tax Implications? (1)

TrollBridge (550878) | more than 9 years ago | (#11115837)

I'm pretty sure that income from stocks, be they employee options or simply purchased, are taxed as income AFTER they are sold. But again, IANAA.

They can't be taxed until the sale because their value is in constant flux.

Re:Tax Implications? (0)

Anonymous Coward | more than 9 years ago | (#11115948)

Perhaps, I'm really not sure. Of course I'm taking the Canadian perspective where we get taxed before, during and after. :)

Re:Tax Implications? (1)

sg3000 (87992) | more than 9 years ago | (#11116106)

> I'm pretty sure that income from stocks, be they employee
> options or simply purchased, are taxed as income AFTER they
> are sold.

I'm not an accountant either.

My understanding is that options are not taxed when they are granted. However, once they're exercised, they can be taxed in two ways:

1. If the option is exercised and the resulting shares are sold, either immediately or a year later, then the resulting income is subject to capital gains tax (either at the short term or long-term rate, depending on when they were sold).

2. If the option is exercised, but the resulting shares are not sold, then the person is possibly subject to the Alternative Minimum Tax (AMT) on the amount the shares are worth at a certain period of time. I believe the any AMT paid is can be applied towards long-term capital gains tax (if due later on), or it can be refunded in some cases.

The AMT killed a lot of people during the dot-com boom. People would be granted options at say $1 per share. Then the company would declare an initial public offering (IPO), and maybe the shares were sold at $10 per share. Then the shares climbed to $20 per share. You may have to pay AMT at $20 per share if you held the stocks. However, if you sold the shares for $15 (you held too long), then you would get to apply the overpaid AMT in the year you sold.

However, for many people, the amount they had to pay in AMT was tens of thousands of dollars (or more, in one case I knew of), and it was completely unexpected. The problem came from the fact that AMT is set to an absolute number, and has not been scaled to match inflation.

Re:Tax Implications? (1)

CountBrass (590228) | more than 9 years ago | (#11115943)

There are three kinds of stock related benefit:

The first is where the company outright gives you some stock. In the UK this counts as a benefit in kind and is taxed as income.

The second is a share purchase scheme. How this is treated depends on whether or not it's approved. Let's assume not (as all the ones I've been haven't been): then it the value of the purchase when you first "buy" the shares is taxed as a benefit in kind, again income, for example a typical scheme gives you a 15% discount you pay that tax on that benefit. Then when you sell the shares any gain is treated as capital gain (which has a separate allowance from your income tax) and anything above that allowance (7000 GPB for all capital gains) is taxed as un-earned income at 40%. The major difference with an approved scheme is that you must hold the shares for a minimum period and you only pay 10% capital gains.

The third is share options and, assuming they're priced at the current market rate, then you pay tax on them as a capital gain (see above). YMMV, IANAA and this is only the UK based on my participation in such schemes. And regardless of how they do any kind of share scheme is an expense as at the very least it dilutes the existing shares. Edward

No (1)

Kohath (38547) | more than 9 years ago | (#11115813)

There are no tax implications. The FASB is not the IRS. The IRS would have to make a seperate rule.

Re:Tax Implications? (1)

Bimo_Dude (178966) | more than 9 years ago | (#11115921)

Would this force companies to pay more in payroll taxes?

I sincerely hope not, since payroll taxes are those that are deducted from the worker's pay. If they did that, then the workers would be paying the taxes, not the corporations.

dismal option (2, Insightful)

Doc Ruby (173196) | more than 9 years ago | (#11115741)

Stock options don't require the company to spend any of its revenue. So giving them reduces profit on the books, while it doesn't affect the profit of which the stock represents a share. How does this make sense at all?

Re:dismal option (1)

guidryp (702488) | more than 9 years ago | (#11115787)

But this does dilute share holder value. It is the equivalent of printing more money. It dilutes your share in the company. IMO companies shouldn't be able to just create more shares at a whim.

Re:dismal option (1)

Tanktalus (794810) | more than 9 years ago | (#11115901)

Maybe.

Some companies actually have stock "on hand" to sell as options. That is, if they "print" 50,000,000 shares, they keep back enough shares to "sell" in options, with expired options going back to the corporate-owned pool.

Then, if you were a regular investor owning, say, 50,000 shares, you would own 0.01% of the company. The fact that the company owns maybe 1% of itself means that you own 0.01% of that as well. So, until your duly elected officers (board of directors) sell these shares to its employees in a shareholder-approved stock option offering (well, a bit more complicated than that), your shareholder vote is worth more.

But that's not really that different from your electoral vote in government: people who show up to the polls dilute your vote. If everyone stayed home, your vote is suddenly "worth" more. And all those other damned voters keep creating more voters at a whim. (Well, it takes 18 years to mature into a voter, but that's a minor detail ;-})

Re:dismal option (1)

Doc Ruby (173196) | more than 9 years ago | (#11116076)

But if the company can print more money, it isn't money. Doesn't this mean that companies now can purely artificially create fake "value" in the economy by issuing stock options, thereby changing the value of the issued currency? Doesn't this give the DJIA Top 100 the same kind of power over the money supply as the Federal Reserve? Isn't that a total catastrophe?

Re:dismal option (1)

samael (12612) | more than 9 years ago | (#11115836)

Either they have to create new shares out of nowhere (diluting existing ones) or they have to go out and buy shares at market prices and sell them at the option price, which _is_ an expense.

Either way round this should be reflected in the accounts of the company, and a notional value which reflects the effect on the companies stock seems to be the easiest way to get this across to your average investor.

Re:dismal option (0)

Anonymous Coward | more than 9 years ago | (#11115865)

It doesn't really matter if it costs money right now. It's an outstanding liability because it may cost them cash in the future.

Re:dismal option (1)

jedidiah (1196) | more than 9 years ago | (#11115918)

However, stock options are in effect a promisory note so they should at the very least be treated like a debt. Options should not be completely free for the corporation offering them.

Re:dismal option (1)

stratjakt (596332) | more than 9 years ago | (#11115985)

It keeps companies from treating stock like their own private money printing press. Whats that? You want a raise? Well, how about a billion shares instead! Two billion!

The .com bubble was inflated with "stock options", and everyone found out that their 100,000 shares of ComputerCo weren't worth shit after they'd given away 100 ga-jillion shares.

I'm not sure how a company calculates the value of the expense, though, since the shares are generally given away when they have nil, or practically nil value. Usually as soon as the stock is worth anything at all they just print up another jillion shares.

I'm no accountant though.

I'm just in favor of making it harder for corporations to think up "creative" ways to "compensate" employees without actually paying them. The "promotion in title only" as an alternative to a real raise is something else I wish something could be done about.

Expensing Matters (1)

smack.addict (116174) | more than 9 years ago | (#11115743)

It should make a difference since failing to expense them hides an actual corporate expense. By expensing them, you can read a company's financials and have a better picture of the state of the business.

Enron (1)

b0lt (729408) | more than 9 years ago | (#11115744)

If only this happened before Enron...

Re:Enron (0)

Anonymous Coward | more than 9 years ago | (#11115938)

This has nothing whatsoever to do with Enron's accounting issues.

I'm a former Enron employee (1)

GodBlessTexas (737029) | more than 9 years ago | (#11116049)

As a former Enron employee and stock option holder, it wouldn't have made any difference for us. What brought the financial issues to light was the failed Blockbuster Video on Demand project that Enron Broadband (the company I worked for) booked profits for when there were none. Then, when the deal failed, it was hard to cover that up. They were putting profits on the books that didn't exist, and would have continued to do so even if they had been forced to record the stock options as an expense. It's likely that they might have lied to an even greater extent in that case.

Enron, specifically Jeff Skilling, wanted to drive the stock like an Internet stock during the .com boom. And that's exactly what got them in trouble. Now the stock is worthless, unless you have the actual printed stock certificates, which have collectors value now.

Ripple Effect? (1)

Locdonan (804414) | more than 9 years ago | (#11115754)

The IT economy is only starting to recover. DOes this make the prospects of aquiring a well-paying job even more difficult?

It is hard enough with the current situation, but how will this affect companies wanted to expand IT? If they cannot offer such options, they may not hire that extra person here or there. This could cause stagnation of the IT rebound.

Besides, what benifits could you give Indian guy who took the job? another cow? ohhh! Omaha Steaks! I bet he'd love that.

Well, that's that (1)

TippyTwoShoes (773707) | more than 9 years ago | (#11115766)

My options at $95 (currently trading around $15) are still worthless. The options I just got are a little under the water too. Can't say I'm upset that options might stop coming, my employer might finally have to start giving our raises!

stock options are already accounted for (1)

dh003i (203189) | more than 9 years ago | (#11115773)

Stock options are already accounted for [mises.org] in the dilution of shareholder ownership:
However, in one case the shareholders suffer dilution in their proportional ownership of Intel, and in the other case they suffer a reduction in the value of the company itself as it has given up an economic asset. OTOH, a company cannot count its own shares among its economic assets. ...

Shareholders can be diluted in their ownership, OR they can experience a loss in the value of what it is that they own, but trying to pile one loss upon the other is simply absurd.

Re:stock options are already accounted for (0)

Anonymous Coward | more than 9 years ago | (#11115893)

Thank you for that! God, I love mises.org. I can't remember where I read this, but someone was saying something like, "The problem with redistributing wealth is that the people who know how to do it, aren't inclined to do it."

In this case, the problem is that the people who know how to properly account for stock options, aren't inclined to force companies to follow government-imposed rules.

Efficient markets, flat earth and other theories (1)

magictongue (603212) | more than 9 years ago | (#11115774)

Exactly, "If markets were truely efficient this wouldn't make a difference" - why not expense the option. It would make the math easier. Logically, when the market takes options into account by being truely effiecent then actually taking them on paper should not change anything. The only reason to hide the expense of stock option is if markets are really not efficient.

Pleasing Warren Buffett (0)

Anonymous Coward | more than 9 years ago | (#11115780)

"...the tech industry is strongly opposed to the rule, though it should please Warren Buffett."

There is something to be said for corporate governance and accounting being in line with what investors want -- they *do* have an equity stake in the company, right? -- so why is the tech industry so opposed? Because they realize too many inveestors are so myopic that they cannot tell the difference between stock prices and the viability of a company? I've wondered for a long time if it might not be a better idea for direct stock ownership be limited and for the masses to only buy things like mutual funds for exactly this reason. When too much emphasis is placed on earning per share, then anything and EVERYTHING to boost that number, including taking expenses that don't have to be listed as expenses, are employed by myopic CEO trying to please myopic investors drones...

Re:Pleasing Warren Buffett (1)

smack.addict (116174) | more than 9 years ago | (#11115839)

It tends to be the institutional investor who focuses on EPS. Home investors tend to do so for a variety of reasons, including having a pretty logo.

Ah, the wailing and gnashing of teeth. (5, Funny)

AltGrendel (175092) | more than 9 years ago | (#11115784)

As all the geeks on /. try to figure out what this means.

Re:Ah, the wailing and gnashing of teeth. (1)

hsmith (818216) | more than 9 years ago | (#11115801)

i have read it four times and i have no idea what it means accounting is not in my future, i shall stick with programming

Re:Ah, the wailing and gnashing of teeth. (5, Funny)

Eccles (932) | more than 9 years ago | (#11116021)

i have read it four times and i have no idea what it means

So accounting is a lot like Perl...

Re:Ah, the wailing and gnashing of teeth. (0)

Anonymous Coward | more than 9 years ago | (#11115909)

As all the geeks on /. try to figure out what this means.

But it won't stop them from pretending like they know what it means.

Re:Ah, the wailing and gnashing of teeth. (0)

Anonymous Coward | more than 9 years ago | (#11115998)

To which Jesus replies: "It's weeping, not wailing you insensitive clod."

It's about god damn time. (2, Informative)

xxxJonBoyxxx (565205) | more than 9 years ago | (#11115785)

For all of the privately held companies who compete against publicly traded companies who pay out stock options like Monopoly money...this rocks.

The surest way you know a company knows what its doing is if it's turning a profit. This should take one more accounting trick away from the pretenders out there.

What does it matter... (2, Insightful)

Emperor Shaddam IV (199709) | more than 9 years ago | (#11115786)


I haven't received any stock options that ended up being worth a crap since the 1990's. Who cares anymore. Be a contractor and make more money then the employees. Then you can buy your own stock!

So assholes like George Soros can profit (-1, Offtopic)

Anonymous Coward | more than 9 years ago | (#11115793)

and spend their money pissing off the American public to such a degree they reelected President Bush? Excellent keep spewing the hate you fatass Michael Moore and the rest of you Hollywood fools.

Option value (5, Informative)

Anonymous Coward | more than 9 years ago | (#11115809)

When it's granted the option has an intrinsic value of zero, but it's *extrinsic* value is more. Let's say the stock price S is 100, and the option exercise price K is 100 too. You could exercise the option today and make a profit of S-K = 0. That's the intrinsic.

In a year's time, the stock could be worth more than K, in which case the option's intrinsic value will be S-K, or it could be worth less, in which case the intrinsic value will be 0.

The extrinsic value of the option is what it's worth in the market, and presumably what it will be charged at in the accounts. It's calculated by taking the expected intrinsic value at expiry.

For our example, let's imaging there's a 25% change of the stock being worth each of 70, 90, 110 or 130 in on year's time (we'll assume it can't take any other value). The expected value of the stock in a year's time is 100 just as it is now:

E[S] = 0.25 x (70 + 90 + 110 + 130)
= 100

However, the expected intrinsic is...

E[max(S-K,0)] = 0.25 x (0 + 0 + 10 + 30)
= 10

So the value of the option is 10.

Of course, there's more to it than that. The distribution of possible stock prices is continuous. We've also ignored the fact that I'd a dollar today is worth more than a dollar in a year's time. There are theories on how to value these things...

Re:Option value (3, Insightful)

Ignignot (782335) | more than 9 years ago | (#11115993)

The distribution of stock prices is not continuous. They are generally quoted in cents, so you can't trade for less than a cent. This is important when you have an option that is far out of the money (nowhere near the underlying price, and intrinsic value zero).

Not to mention that you neglected the expected return of the stock, but that's ok for this crowd.

Re:Option value (1, Insightful)

Anonymous Coward | more than 9 years ago | (#11116030)

Strong explanation from the parent who's obviously been through a corporate finance class.

This is exactly why the options should be expensed. The company gave away options that a normal investor would have paid $10 for today.

Some people say that the options are hard to value, and no one knows what they're worth. It is extremely easy to value things when there is a ready market for them:

Chicago Board Options Exchange quotes [cboe.com]

If the stock price plummets, the company gets an unexpected boost, because the call options will be worthless. If the price shoots up, then the company has to take a charge when the execs cash in. Simple.

Here is the FASB's FAQ (4, Informative)

rmcd (53236) | more than 9 years ago | (#11115825)

The FAQ from the Financial Accouting Standards Board is here [fasb.org] . You can download the actual statement from this page. [fasb.org]

This change would have occurred 10 years ago if Congress hadn't interfered on behalf of companies trying to hide their largesse from shareholders. The rest of the world is in the process of implementing a similar accounting treatment of options. The US would have looked idiotic to have delayed this further.

Re:Here is the FASB's FAQ (1)

stevesliva (648202) | more than 9 years ago | (#11115957)

The US would have looked idiotic to have delayed this further.
That's never stopped us before.

Money,,, (1)

t_allardyce (48447) | more than 9 years ago | (#11115842)

I seriously think I should have gone into the finance industry instead of tech. After all its just another stupid system with rules you can learn and twist to your advantage, damnit I should have realised early on that the only job that matters is the one that makes the most money - hope its not too late to get some good profits..

Re:Money,,, (1)

Kaduco (651385) | more than 9 years ago | (#11115925)

I'm just graduating from a master program in information systems, and we interact a lot with the accoutants. The interesting part is that the systems people earn about $10,000 more per year than the accountants (and I'm at a top school for accounting). So yeah, there are rules, and it's a system, but it doesn't pay as well as tech.

Re:Money,,, (1)

smack.addict (116174) | more than 9 years ago | (#11116019)

You might want to get educated on the finance industry before you go off making idiotic comments like this.

Buffet's pi reference (0)

Anonymous Coward | more than 9 years ago | (#11115846)

http://www.snopes.com/religion/pi.htm

It wasn't Indiana. It was Alabama.

Re:Buffet's pi reference (2, Informative)

hab136 (30884) | more than 9 years ago | (#11116104)

It wasn't Indiana. It was Alabama.

It was Indiana [purdue.edu] . The reference you cite is talking about a hoax; Indiana actually did present a bill.

Choices (1)

Migraineman (632203) | more than 9 years ago | (#11115891)

As with all things accounting, the company will probably be given a bunch of choices as to how they do their accounting. All choices are "acceptable," as long as they're consistent. That'll guarantee another set of confusing and essentially meaningless statistics for the bean-counters to mull over.

When an option is granted, the strike price is supposed to be the FMV of the share, possibly minus some discount absorbed by the company. If the company isn't trading yet, they pretty much have the ability to define the price by consulting the ouiji board. Now, the option may have an exercise restriction on it - you, Joe Peon, can't exercise the option until X years have passed. That means the option has zero-value to you, but doesn't necessarily mean that it has zero-value to either the company or to the IRS. I envision two choices - Choice A: the company can expense the option at the time of grant; Choice B: the company can expense the option at the time of exercise. The former has the penalty that the company may expense options that ultimately aren't exercised (i.e. the employee quites before the restriciton period expires.) They'd probably have the opportunity to de-expense unexercised options at that point. The latter choice only taxes exercised options, but tends to defer the accounting event to a point later than what I think was intended.

I'm sure there will be much heated discussion amongst the bean-counters to choose the method that will benefit their industry the best.

Good intentions, poor execution (1)

groberts65 (261083) | more than 9 years ago | (#11115903)

I understand the intentions behind this - keep the fatcats from padding their wallets. However, this really punishes those companies that do share the wealth, such as the one I work for. Companies which reward options throughout the ranks will be much less likely to do so now and that really penalizes the little guy. Options will become only a tool of the well to do now.

Re:Good intentions, poor execution (1)

smack.addict (116174) | more than 9 years ago | (#11116003)

You are deluded if you think this is a good idea. Except for small start-ups, options are always worth more to the company giving them out than the employee receiving them. You are much better getting the equivalent in cash or some other form.

Good news (2, Insightful)

Degrees (220395) | more than 9 years ago | (#11115940)

The place I used to work for gave its employees a 15% discount on buying stock (once per fiscal quarter). Every year during open enrollment for benefits, management pointed out that this program lets one buy $100 dollars of stock for the price of $85, and then turn around and dump it the next day for market price (or hold onto it, as might be your want) I'm told quite a few people did the immediate dump plan.

The people who lose in this scheme are the purchasers of stock at full price. The cash flow out of the company dilutes the value of the company, making each share of stock worth (a tiny bit) less. Some people pay full price, others (insiders) reap a benefit at a discount.

The requirement that these discounts are accounted as expenses, puts a dollar amount on them. Thus, someone (and outsider) looking at the company financial statements gets a clearer picture of where the money is going. They get to make a more informed choice.

Its a good thing.

Easy answer for those it matters to: (2, Interesting)

mzwaterski (802371) | more than 9 years ago | (#11115951)

For those employees receiving stock options, I'll break this matter down to simple terms for you:

If you liked receiving stock options: This is bad for you.

If you didn't like receiving stock options: This might be good for you.

This basically makes the disbursement of stock options to employees cost as much as giving cash. If you liked receiving stock options, you will be probably be disappointed because companies do not have the incentive to give them that previously existed. However, I only said that this might be good for you if you didn't like receiving stock options. Whether you like them or not, stock options do have the potential of being very profitable for you. If the expense to the company is very low, they will not have too much trouble handing them out as bonuses and such. Now, with an expense tied to giving stock options and with as tight as companies are currently, these stock options may begin to try up only to be replaced by...nothing. IANAEA (economic analyst) but as far as I can tell, we are still in employer's market or possibly close to a balance, thus, large bonuses to attract employees are not currently in force.

Translation (1)

segfault7375 (135849) | more than 9 years ago | (#11115999)

What this means is that unless you are an executive of the company, you can kiss stock options goodbye as part of yearly salary increases and/or signing bonuses. I have just found out recently that my company has stopped giving options to new hires, it will be interesting to see if we get blocks of options when annual reviews come around. If they don't, I'll bet we don't get better raises either :-/

Re:Translation (1)

stratjakt (596332) | more than 9 years ago | (#11116077)

Good, I'm tired of worthless stock options or meaningless "promotions" in lieu of real raises measured in cold hard cash.

These are scams invented by corporate HR departments to get away with paying you less without you realizing it.

Ever go into a yearly review, hear how awesome you are.. So awesome in fact, they're promoting you to "vice-manager-general"!

Your job duties are the same, but you get a nifty new title. Oh and sorry, you dont qualify for a raise. Sure you've been there two years, but now you have a new "title" so you have to wait a year to be reviewed in your new position.

Wait.. wait.. Dont quit. Here, take a bajillion shares of stock instead! They're worth 0 now, but in a year they could be worth 10 points (of course, if that happens we'll print up seven bajillion more to make sure that WE keep our cash).

They used to be able to pay employees with worthless stock and not even have to call it an expense. How is that compensation if it's not even an expense to the company?

This is a good thing, corporate america needs more rules.

Honest book keeping is all we ask (1)

amightywind (691887) | more than 9 years ago | (#11116035)

Expensing stock options is simply honest book keeping. Companies who ignore option payouts simply dilute the value of shares purchased honestly in the market. It is a slimy practice that used to go unnoticed. Real shareholders have been ripped of by option holders long enough. This is a good thing for anyone who is not an insider and purchases stocks will real money.

Black Scholes (1)

dnadig (414126) | more than 9 years ago | (#11116037)

Out of the money options are FAR from worthless, and there's a very large body of economics devoted to this:

http://bradley.bradley.edu/~arr/bsm/model.html

Most companies use black scholes (or the public options markets) to price their options for accounting purposes.

Sorry, the math is a LITTLE more complicated than everyone's making it out to be.

The Microsoft Story, case in point (5, Interesting)

freality (324306) | more than 9 years ago | (#11116039)

In case you haven't heard [billparish.com] , Microsoft (MSFT [yahoo.com] ) has been deeply unprofitable [economist.com] since 1996, when it began to rely on holes in the GAAP accounting standards that allowed it to report historic profits in its NASDAQ filings. Large fund managers bought into it to the tune of hundreds of billions of dollars, making MS at its peak ($700B [billparish.com] ) which for comparison made it the largest component of the S&P 500, the equivalent of the 16th largest country [cia.gov] or ~1.5% of the GDP of Earth. Though billed (no pun intended) as a success story, when the bubble burst investors lost billions.

Who cares? The biggest funds involved were pension funds of large social programs across the US, e.g. the California Teachers Union, who automatically invest in S&P components at rates proportional to the components' value. MS paid for its bottom line with those peoples' money, so much so that pensioners are majority owners of MS today. Too bad for them that the bottom fell out of MS stock and their savings are worthless. But it did help create two of the richest personal accounts on Earth [nwsource.com] .

You could argue that this was all legal and that they won the king of the hill prize. Perhaps. But is it ethical to block GAAP reforms via corporate shills in Congress (e.g. Joe Lieberman) [portlandtribune.com] so your huge losses won't be exposed? Enron execs are being hung out to dry [alwayson-network.com] for being only slightly on the other side of that thin line in the sand. No, it's likely MS knew what it was up to. As Bill Parish, who broke the story, tells:

"Microsoft's perspective is best reflected by Bob Herbold, Chief Operating Officer, to whom the CFO reports. Bob very sincerely [explained the situation to Gates], "Bill, everyone is doing it.""

This is a great vindication for Bill Parish, and another step towards reigning in widespread corrupt accounting practices. http://freality.org/~pablo/essays/microsoft.html

startups win! (1)

ngreenfeld (321295) | more than 9 years ago | (#11116067)

Options in a large, established company, especially a public one, have a clear value and those companies will probably curtail use of options.

However, startups usually have no profit early on anyway, so options still make sense for them! More loss looks OK, because later when (hopefully) they turn a profit and it just looks like they grew more.

So the bottom line is: get into a startup very early, before they really have to worry about "profit" in the accounting sense.

Dodgy Accounting (2, Interesting)

Anonymous Coward | more than 9 years ago | (#11116102)

The problem with this proposal is that it attempts to fix dodgy accounting by introducing more dodgy accounting.

Stock options are not granted by the company. They are granted by the shareholders. Every stock option grant I recieved, even from a small, no longer here startup, was granted by the board of directors, not the executives of the company.

The shareholders of the company basically offered me a deal that if the stock price of the company is greater than the strike price, then they would allow me to purchase shares of the company at some strike price. Essentially the shareholders of the company incurred a future liability equal to the number of shares times the difference between the actual price of the stock and the strike price.

HOWEVER, rather than show this liability on the books of their investment business, investors shift the potential future cost of the options back to the company. Remember a corporation is a legal entity, so what we have is a shift of liability from one legal entity, the shareholders or venture capital firm, to another legal entity, the corporation.

Interestingly enough this is exactly how Enron worked. Enron created a large number of shell corporations and made Enron's books look better by shifting income to the parent corporation and shifting liabilities to the subsidiaries. This is a classic technique in fradulant business practices, namely moving liabilities off of the books of one corporation. But I digress...

Back to the issue at hand. Institutional investors, rightly, are annoyed that these future liabilities aren't accounted for properly. Unfortunately, their mechanism, is flawed. Ideally, the liability of future options would be shown directly on the books of the owners of the company, not on the company itself. The investors aren't going to do that as it makes their investment business financials look bad.

Given that the shareholders shift the burdon of funding exercised options to the company, then this liability should be treated as a future debt, not like a current expense. When a company takes a loan, they expense the payments as they are made, not the entire amount of the loan up front.

Stock options are not an expense. They are a debt instrument, like a loan and should be accounted for as a liability on the balance sheet and expensed when the options are excercised and paid off. At that point, you remove the options from the liability side of the balance sheet.

Employee stock options and the lottery... (2, Insightful)

human bean (222811) | more than 9 years ago | (#11116135)

have much in common, particularly the part about options expiring at zero value. It's interesting that the FASB considers this in the same light.

Of course, we all know who gets rich from the lottery, don't we? I never understood people who accepted company stock as bonuses, payment, etc. From where I stand, when the company starts handing out shares instead of cash, it's time to start looking around.

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