The Financial Analyst: The Great Stock Option Debate

by CFA Institute

Proper accounting for stock options is a moving target that has challenged the accounting industry for many years, since it is a benefit that both may be exercised in the future and is based on the ever-changing value of a stock.

The recent corporate accounting scandals like Enron, WorldCom and Tyco have publicly shed light on a long-standing flaw in the use of intrinsic value as the standard accounting method for employee stock options—typically, little or no compensation cost shows up on a company’s balance sheet. Intrinsic value recognizes only the difference between the price offered to the employee and the current market value. When the stock option price is equal to or greater than the market value, it is not recorded on the income statement as an expense. However, this valuation method does not reflect either the time value of money or the likelihood that the stock’s price will go up during the period when the employee can exercise the option.

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The Financial Accounting Standards Board (FASB) in mid-December issued new accounting standards requiring that stock options appear on income statements using a fair value–based method over the time of the employee’s service; the calculated fair value of the stock options would be deducted from net income.

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