Employee Stock Option Accounting: Footnote or Expense?

Employee Stock Option Accounting: Footnote or Expense? 460469 Research Paper ACC 7100 Winter 2009

Introduction After the Google initial public offering (IPO) in 2004, hundreds of the employees became millionaires and some of the executives even became billionaires (Kopytoff, 2004). Almost overnight, the computer programmers, web designers and many others who worked for Google became considerably wealthy because of the stock options they received as employee compensation. Although most companies do not create as many millionaires as Google, many companies use stock options as an incentive in order to recruit the best talent and encourage top performance. Before 2005 accounting rules only required companies to disclose the fair value of stock options in a footnote on the financial reports. It was not mandatory for companies to report stock options as an expense, which made stock options a preferred form of employee compensation. For over a decade, the decision to either expense stock options on the income statement or disclose the underlying value in the footnotes was a controversial accounting topic. In 2005, the Federal Accounting Standards Board (FASB) established the Statement of Financial Accounting Standards (SFAS) 123(R) which made it mandatory that companies expense stock option based on the fair value. Many agreed with the FASB’s position to expense stock options, including Federal Reserve Chairman Alan Greenspan, Senator John McCain, and world renowned investor Warren Buffet (Baviera, 2004 and Expensing Stock Options, 2004). Of course many of the companies that used stock options heavily as employee compensation were upset with the change. The FASB’s final decision was driven by many weighing factors, but the question remained “Should the FASB make companies recognize stock options as a compensation expense?” At the time, the FASB made the

right decision based on the proper accounting principles, the appropriate business ethics, and the influential...