Tell The Truth, Unless it Hurts - Stock Option Accounting

The following is a guest editorial by, Raymond L. Dever, CPA (Retired)

Tell the Truth, Unless it Hurts - Stock Option Accounting. Or, unless it is politically dangerous. "We can't stand by and let accountants wearing green eyeshades decide who is going to get the American dream," says Senator Barbara Boxer (D-California) before a Silicon Valley lobbying organization. And, in a letter jointly written with 14 other senators, Senator Mike Enzi (R-Wyoming) says the board's [Financial Accounting Standards Board or FASB] procedures are "seriously flawed" and [the board] should "back up a step and do the critical thinking and analysis that we should expect" before changing the rules. The letter further says that a rule that requires companies to deduct stock option costs from earnings would "eviscerate" compensation plans that distribute options to all employees. These quotes were reported by Bloomberg in the press on March 12, in the wake of the FASB's decision to consider adding stock option accounting (yet again) to its agenda.

Since then, the FASB has decided to add stock option accounting to its agenda, I applaud the decision and fully support its members. If, however, the FASB had decided not to add this issue to its agenda, I also would have understood. It would have been because of the concern over the political pressure rearing its head again as it did in the mid-90s when this issue was last debated and "compromise" was reached requiring disclosure only rather than proper accounting. Now that the FASB has decided to add the topic to its agenda, there again will be significant political pressure brought to bear to keep the FASB from changing the antiquated current accounting rules. Senator Enzi says "do the critical thinking...." I cannot think of any accounting subject that has been thought about critically more than the issue of stock option accounting. Moreover, unlike many legitimate debates on accounting issues, I've never heard an accountant convincingly support, on the merits of the accounting, the current rules for stock option accounting. Rather, the Senator's comments are nothing more than another threat, not so closely veiled.

I do not in any way mean to speak disrespectfully of the FASB members who reached the "compromise" the last time. I believe they did the only practical thing at the time in the face of Congressional leaders (among them Senator and Vice-Presidential Candidate Joe Lieberman, D-Connecticut) and others who threatened to put them out of business. Because of this pressure, the SEC even gave up its support of changing a rule that it knew needed to change.

Why the pressure? The high-tech (and other) companies said they liked the current rule which was written in 1972 and, itself, a compromise. (As a retired member of the accounting profession, I admit that most accounting firms also supported this view.) The companies liked the current rule because it was well understood, it had served the public well for many years, and it was simple to apply.

Not so! First, it was not well understood. In fact, only a few professionals in the National offices of large accounting firms really understood it. It was so "well understood" that the FASB issued its longest-ever interpretation of an accounting rule in 2000 to assist understanding and to curb abuses.

Was it then well understood? No. The Emerging Issues Task Force (EITF) of the FASB has since had to consider and conclude on over 50 implementation issues regarding this interpretation. At this point, even the National office professionals wondered if they had truly understood the rules!

Second, it had not served the public well. It encouraged companies to develop stock option plans for its executives that were less economic for the company and its current stockholders. Those plans often led to the executives realizing significant increases in wealth for reasons that had little, if anything, to do with their efforts. Simple they say. The only thing simple about this issue is the real reason these companies wanted to maintain the current rules: To avoid recording a major expense in their income statements.

If these companies had to record as an expense in their income statements the cost of the options given to employees (this being in many cases a very significant part of their compensation cost of doing business), they feared their stock price would drop - the market reaction to lower earnings (or larger losses). Is this a reason to mislead current investors by not recording a significant cost of doing business? No.

A changed stock option accounting rule, requiring that the options be measured and recorded as an expense in the income statement, would only be recording for investors to see what management has given to the employees. The investors have a right to know; it is their company. It is unfortunate if the stock price drops, but maybe the answer is to give away less.

In the mid-90s, these companies made these arguments and prevailed because of the political support they were able to attract. Politicians championed the views of their constituents. In this day and age when Congress is increasingly scrutinizing and criticizing accounting, these politicians should change sides in the battle or, better yet, lay down their arms. After all, as required by Congress, corporate officers now have to certify as to the accuracy of their company's financial statements.

Congress has chosen to constantly bash auditors (partly justified I will admit) for performing less-than-careful audits and for yielding to the pressures of their clients. Congress and others are also criticizing the FASB for inadequate accounting standards because they don't tell the truth about a company's financial affairs. Well, current stock option accounting certainly does not tell the truth!

It would seem that Congress would be compelled by its own words and actions to fully support the FASB in changing the rules for stock option accounting, thus requiring companies to "tell the truth," but I doubt that that will happen. Rather, now that the FASB has courageously decided to engage in the battle to change the rules, I expect that it will continue to face the wrath of those who are content to not tell the truth when it hurts (in the case of the companies) or when it is politically dangerous (in the case of politicians). I would not expect anything different from the companies; they view continuing to misstate income as a survival measure. Very disappointing, however, are the politicians. These are the same politicians who criticize accounting standard-setters for not developing standards that lead to fair financial reporting. These are the same politicians who criticize auditors for not standing up against inappropriate pressures from their clients. I see much of the same thing going on here. What a shame.

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