Questions:
1) a) What arguments would support accounting for the stock option transactions by creating an intangible asset on the balance sheet, as the FASB originally proposed 20+ years ago?
b) What specific information from the Form 4 and the proxy statement would help accountants to properly measure and account for the intangible asset over time?
2) a) What arguments support accounting for the stock option transaction under its current GAAP treatment: reporting compensation expense as incurred, based on the grant date fair value, over the service (vesting) period, but not capitalizing an asset?
b) What specific information from the Form 4 and the proxy statement would accountants use for this accounting treatment?
3) a) As accountants, we make adjustments in the stock option compensation measurement for certain items, using management’s judgment. According to the Codification, what
are the items managements must adjust for, based on their judgments, for the transaction?
b) Why must management make these adjustments to measured compensation expense and option-based equity?
4) Are investors and other users better served by:
(i) a more complex accounting treatment using more of the grant information and more management judgment, or
(ii) a simple accounting treatment using less of the grant information, leaving the interpretation of the rest of the disclosed information to them?
Answers:
1.a) Employee stock option is considered as call (or buy) option on the common equity of an organization. It is granted by the organization to the employees as part of the employees’ remuneration package. The purpose is to provide employees an incentive to behave is ways that will help in increasing the stock price of the company (McEnroe, Martens and Du 2013). Most of the companies provide employee stock option to management as part of their executive compensation package. But measuring and recognition of employee stock option are very difficult. There are certain issues related to the recognition of employee stock option in the financial statements. Before 1990, FASB proposed to report the stock option transaction by creating an intangible asset. At that time, intrinsic value method is used for measuring employee stock option. There is no significant transfer of cash at the time of making grant (Lobo and Rue, 2011). So, it cannot be considered as the economically significant transaction. Companies need to use the fair value approach and recognize the expenses to shows its effect on the income and earnings.
(b) Form 4 can provide details information for measuring the employee stock option as intangible assets such as exercise price, transaction date, the number of stocks, expiry date and intrinsic value, etc.
2. a) There are several benefits of recognizing of employee stock option as the expense in the income statement. The reporting of the stock option as an expense at the point of the grant would level the playing between organizations that issue stock option and organizations that pay cash to the employees. Otherwise, the amount of profit paid by the organization to employees in stock options can be inflated to an organization that pays its employees in cash (Placid, Rue and Volkan 2011). So, this option helps to provide a level playing field so that organizations that use cash bonuses and organizations that use stock options each has expense on the income statement. The basic purpose of accounting is that accounting principle should be economically significant. Employee stock option transactions are not considered as economically significant; the argument goes, because there is no hand to hand transfer of cash. On the other side, it also helps to provide necessary information to the investors, shareholders and creditors for assessing the present and future economic effects that stock options have on the organizations. It should be realized that employee stock options are associated with the employee labor. So, it is required to consider the expense as other labor costs. Otherwise, it leads to the mispricing of stocks because it will indicate that investors have bypassed the stock option expense.
(b) Form 4 provides specific information related to the accounting treatment of employee stock option as according to GAAP such as intrinsic value, fair value, amount of vested option shares and unvested option shares.
3. (a) The management should do adjustment of certain items in the transaction such making of grant, award any other acquisition, taking place of sale back to the issuer of the stocks, making of payment of exercise price, discretionary transaction, and exercise or conversion of derivative security (Best, Rue and Volkan 2011).
(b) The adjustment is important for showing the useful information to the users of financial statement. On the other side, adjustment is required to account for differences between the controlled and uncontrolled transactions that can create impact of income statement and stock price (Dimson, Karakaş and Li 2015). The purpose of financial accounting is to reduce the measurement error to zero and generate reliable information. So, proper adjustment is essential for reducing the error in measurement and generating reliable information.
4. (a) The purpose of accounting is to provide clear understanding of the information to the users of financial statement. The information should reliable and accurate which can provide real picture about the business organization. So, investors need more information related to an organization for understanding about the strength and weakness. Information provided by the organization also helps to provide whether they are maintaining accounting principle properly or not. Simple accounting treat is not able to provide true result or effect due to the employee stock options (Hayes, Lemmon and Qiu 2012). It will also be complex to the users and investors to understand the information if organizations do not provide management judge regarding the treatment of accounting. Only disclosing of information will not provide clear understanding of the measurement and the effect of stock option transaction. So, complex and advanced accounting treatment should be applied using more of the grant information and more management judgment.
Reference List
Best, R., Rue, J.C. and Volkan, A., 2011. Impact of stock options on quarterly EPS: A proposal for change. International Business & Economics Research Journal (IBER), 1(1).
Dimson, E., Karakaş, O. and Li, X., 2015. Active ownership. Review of Financial Studies, 28(12), pp.3225-3268.
Hayes, R.M., Lemmon, M. and Qiu, M., 2012. Stock options and managerial incentives for risk taking: Evidence from FAS 123R. Journal of Financial Economics, 105(1), pp.174-190.
Lobo, G.J. and Rue, J.C., 2011. Accounting for stock options: comparison of alternative approaches. Journal of Applied Business Research (JABR),16(3).
McEnroe, J.E., Martens, S.C. and Du, N., 2013. Accounting for Employee Stock Options. The CPA Journal, 83(11), p.10.
Placid, R., Rue, J.C. and Volkan, A.G., 2011. GAAP/Tax Differences In Accounting For Nonqualified Employee Stock Options: The Gathering Storm.Journal of Applied Business Research (JABR), 24(3).
