Stock options are not an expense.

• Author: Wolk, Harry I.
• Position: Viewpoint

Once again, the Financial Accounting Standards Board is at odds with the business community, and the latest skirmish is over accounting for stock options. The board's exposure draft on stock options$follows several complex standards involving pensions, other postretirement benefits and income tax allocation, but, as we see it, the stock-option ED isn't an example of even-handed standard-setting. Who's right and who's wrong? And what's driving the FASB's decision-making?

The FASB's attempt to extend expense accounting to all fixed stock options has some serious problems, the primary one of which is that fixed stock options simply do not easily fit the expense mold. The FASB's conceptual framework states that "expenses are outflows or other using up of assets or incurrences of liabilities (or a combination of both) from delivering or producing goods, rendering services, or carrying out other activities. ..."

Of course, a stock option has value to the recipient. However, that value is an indirect measurement of the actual value of employment services, and you can't easily measure that when a company offers stock options in lieu of cash remuneration. A direct measurement takes into account the difference between cash salaries with and without stock options. Nevertheless, concentrating on the employment services helps you to understand the nature of the stock-option transaction.

If the option price is greater than the market price throughout the exercise period, recipients probably won't exercise the options. If beneficial services stem from the stock option, these services will have a limited, even nominal, value. But, unlike with usual expenses, there's no real cost to the stock option in this case. Under the proposed new rules, there would be a charge to income for this phantom expense with an offsetting rise in paid-in capital. So, has a loss really occurred, since the stock options apparently have been unsuccessful? You can't justify this because you made no expenditures for employment services; they were compensated with stock options. Our present accounting (under APB Opinion 25), however, is symmetrical: You record no expense and ultimately receive no real benefits, although the stock options may have had value at the grant date.

When the options are exercised, the increase in the share price above the exercise price may well result from the stock-option incentive, which, of course, was what the company intended. Therefore, the "expense" itself arises from the very benefit it was supposed to create. The expense is as much effect as it is cause, unlike any other expense. When security prices rise, thinking of stock options as an expense is a real paradox.

The problem stems from this: The fixed stock option, as an equity instrument, differs significantly from performance plans and stock appreciation rights. In the two latter situations, both involving expenses, the firm actually gives employees either stock or cash. The rationale is to...