The three options are (1) the existing approach that permits a business enterprise to expense options granted starting at the beginning of the year in which the firm begins expensing options, (2) a method that expenses options granted starting at the beginning of the year in which the firm begins expensing options plus the unvested portion of previous options, and (3) a retroactive technique in which the corporation would restate the prior three years for options granted plus the unvested portion of previous options. Unfortunately, the FASB is focusing on a trivial issue; I just don’t understand why it refuses to adopt a more strategic review of FAS 123. Further, there are too many options. The Board should adopt one of these methods to improve comparability across business enterprises and be done with this insignificant matter.
 
The main point remains the disappointment resulting from the lack of accounting leadership. This failure arises either from incompetence by the board members, political naiveté on their part, or a lack of courage.
 
In case board members don't understand the accounting issue, let’s review the matter for them. According to CON 6 (Statement of Financial Accounting Concepts): "Expenses are outflows or other using up of assets or incurrences of liabilities … from delivering or producing goods, rendering services, or carrying out other activities that constitute the entity's ongoing major or central operations."

 

Notice that the definition does not require cash outlays, so arguments against expensing because there are no cash outlays merely show the ignorance of the proponents of such a position. Stock options have value to the recipients, and they are given as part of the compensation package for work that is clearly an ongoing central operation. Finally, stock options eventually use up assets in either of two ways. The firm might take cash to purchase treasury stock and then transfer the stock to the employees. More subtly, the entity could issue new stock to the employees, which deprives it of the assets it normally receives when the firm issues stock. Either way, the company has consumed assets. For more details, board members should read Appendix A of FAS 123 as well as the dissent by FASB member Neel Foster and former member James Leisenring.*
 
As to political naiveté, the board refuses to grab the chance of a lifetime. The political climate is ripe for change, and the board could easily pass a standard requiring all business entities to expense stock-based compensation. In this election year, few Congressmen would censure the board, fearing that their opponents would employ the criticism as campaign fodder accusing them of siding with the corporate looters. The FASB should seize this Enron/GlobalCrossing/Adelphia/WorldCom/Xerox/Kmart moment and pass good (though unpopular) standards while the opposition can be held at bay. This tactical advantage will soon pass, and corporations will again employ campaign contributions to browbeat Congressmen into doing their bidding.
 
The last possibility for the FASB's inaction is that collectively members lack the courage to strike a blow in favor of good accounting. I previously have criticized the board for not requiring expensing of stock options when it issued FAS 123. The dissents by Foster and Leisenring say it well: "Disclosure is not a substitute for recognition in financial statements for items that meet recognition criteria," and "a high level of controversy and a perceived threat to accounting standard setting in the private sector … are inappropriate reasons for not requiring recognition." Perhaps the members of the current board are greater cowards than the members of the previous board.
 
Fortunately, not all news is bad. The International Accounting Standards Board has concluded that stock-based compensation should be expensed. I never thought the day would come when the international body would push for good accounting principles which the FASB rejected, but that day has come. This too points out the shallow thinking of the current board, because this contrast may very well seal the fate of FASB. On the other hand, given the incompetence, political naiveté, or the cowardice of the board members, maybe it's time for FASB to fade into history.

 

For further information, FASB has posted Project Update: Amendment of the Transition and Disclosure Provisions of Statement 123 on its Web site.

 

J. EDWARD KETZ is associate professor of accounting in Penn State's Smeal College of Business Administration. Check out his column, where you'll find more articles on controversial, cutting-edge topics.