Equity Wins Out Over Liability in FASB Debate Over Options

The Financial Accounting Standards Board (FASB) on Wednesday ruled out the possibility that stock-option pay could be treated as a liability.

The decision ends the debate between the liability advocates and those who believe stock-option pay should be classified as equity.

Wall Street analysts have argued that employee options are an economic liability because the actual cost to shareholders is the difference between the strike price of the options versus the higher stock price when the options are exercised, the Associated Press reported. Therefore, they say, options should be booked as a liability. The liability would change as the value of the stock options changes with the movement of the stock price. The changes would be reflected on income statements.

“We believe a company should charge to expense each quarter, over the vesting period, the difference between the exercise price and market price,” Glass Lewis & Co., a shareholder proxy advisory firm, wrote in a letter to the FASB. “Each quarter as the (stock) price fluctuates, the value the employee is going to get also fluctuates.”

If booked as equity, the value wouldn't change. The FASB has proposed this approach and accountants have expressed agreement. The FASB is in the process of creating a final draft of the rule, which would require companies to deduct the value of the options from earnings. To come up with that value figure, FASB says companies should take a fixed-expense approach, estimating how much the options will cost them in the future. Critics say that approach relies on unknowns.

Some analysts may use the liability approach anyway. David Zion, an accounting analyst at Credit Suisse First Boston, says the
liability approach would enable companies to account for changes in the value of the options over time.

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