Accounting for Share-Based Payments

Abstract

On December 16, 2004, the Financial Accounting Standards Board published FASB Statement No. 123 (revised 2004), which significantly changes the accounting for employee stock options. Under the new standard, equity-based compensation results in a cost to the issuing enterprise and should be measured at its fair value on the grant date, based on the estimated number of awards that are expected to vest. I contend that expensing stock or option grants is not responsive to either the needs of a corporation's creditors, or to the needs of equity investors since the cost of the share-based payments is borne only by the pre-existing shareholders; the corporation itself suffers no sacrifice in assets or other resources (unless its own shares are considered an asset, which is not the case under the present Conceptual Framework and GAAP). Hence I suggest the use of three separate statements instead of the single income statement now provided. Specifically, I propose that the first statement - the "Corporation Income Statement" - not include share-based payments as an expense. Rather, a "Statement of Costs and Benefits to Pre-existing Shareholders" would show the dilution cost to the pre-existing shareholders; this dilution cost would be determined as the amounts that, if accrued during each year throughout the vesting period and until exercise, would cumulatively sum to the intrinsic value at exercise (the price of the optioned share minus the exercise price). A combined "Statement of Enterprise Income" would then show the totals of the amounts reported in the other two statements. The combined statement would reflect the net income from operations with regard to both the corporation and its pre-existing shareholders; that is, it would reflect the cost of manufacturing products or rendering services.

This paper also discusses the implications of this proposal for the debate on the distinctions between liabilities and equities and for the treatment of inseparable compound securities such as convertible bonds.

Keywords: options, share-based payments, equities, liabilities, expensing

JEL Classification: M41