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Industry Warms To New Accounting Proposal
by Teri Rucker
Hearing the words "expensing" and "stock options" linked is enough to make most people in the technology industry apoplectic. However, industry representatives have voiced restrained praise for a voluntary expensing proposal before the body that sets the nation's accounting standards.
In response to requests from analysts and to a host of companies volunteering to record employee stock options as expenses on their balance sheets, the Financial Accounting Standards Board (FASB) this summer launched a proposal to establish an expensing transition period and rules for those companies that wish to expense. Currently, companies disclose information about options in the footnotes of their financial statements. The proposal would require companies to disclose the information quarterly rather than annually and place it more prominently in the footnotes.
Industry officials have turned a wary eye toward a second FASB proceeding that will launch before year's end. Even more troubling to the industry is the looming decision by the International Accounting Standards Board (IASB), which will release a proposal on "share-based payments" this month that will include language on stock options.
After the IASB proposal is released, FASB will issue another proposal comparing the international body's system with the U.S. system. The tech community fears that the proposal will open the door for mandating the expensing of options in the United States.
FASB separately is considering completely revising the approach to company balance sheets.
An Optional Accounting Of Options
After scandals that began with the disclosure of questionable accounting practices at the Enron energy firm and then swept across corporate America, FASB received requests to examine various accounting rules, including those governing stock options. "As long as there remains a heightened interest in financial reporting and accounting," FASB project manager Jeff Mahoney said, "then users will be asking us to look at things and rethink policies."
When large companies like the now-bankrupt WorldCom telecommunications firm buckled under mountains of debt and disclosed that their income was much lower than previously stated, attention turned to the CEOs who cashed in their stock options, making millions as their companies crumbled. Disclosure of that information prompted people to "scratch their heads and wonder why stock options are not being accounted for," Mahoney said.
Feedback from financial analysts and others who use the financial statements that companies file with the Securities and Exchange Commission (SEC) showed that they wanted firms to disclose stock-option information more often, he said. And FASB needed to establish a transition period for those companies wishing to expense options.
Comments are due Monday in the proceeding on the transition period, so technology industry groups most engaged on the issue did not want to detail their views. One source, however, stated cautionary praise. "I champion them for making voluntary this notion of expensing," the source said. "It is a concept that ought not be ramrodded down anyone's throat."
Reaction to the idea of disclosing stock-option information quarterly has been mixed. The source noted that attempts to value options is faulty, so reporting "an illusory number that is a best guess" may not be all that helpful for the users of financial statements. But another source supported the idea of increased disclosure, arguing that investors should receive the information quarterly, when companies must file reports with the SEC.
All About Value
More troublesome is what FASB might propose later this year. Mahoney said that once IASB issues its plan that is expected to require that all compensation, including stock options, be expensed at fair-market value on the day it is granted, FASB will seek comments comparing its U.S. approach with the international rules.
IASB "will require expensing while we only encourage it," he said. "They have different proposals than we do, so we will highlight those differences, explain them and ask for comments." Among other things, he said FASB will explore the method for calculating the options' value, whether the international model is better than the U.S. model, and if so, why.
One industry source hopes FASB will be satisfied with the transition proceeding, saying that it would "be an easier position than the battle royal they will face otherwise."
Jeff Peck, a partner at the Griffin, Johnson, Dover and Stewart law firm, said the problem is that "you cannot talk about expensing without talking about valuation." If FASB wants to mandate expensing, he said, it needs to craft a method to accurately value stock options, and if the methodology "is not accurate, it is clear [that] investors will not be helped in the long run."
"There is not today an accurate valuation method in our view," Peck added.
The Principle of the Matter
Even as it studies its rules on stock options, FASB also is exploring a sweeping change to accounting standards that would replace the rule-laden standards used today with a principles-based approach. The current rules are based on seven concepts, or principles, but the issue, Mahoney said, "is can we develop standards that have less detail in them than our current standards?" He believes it is possible but noted that FASB has not decided whether it will.
Instead of trying to address every eventuality in financial transactions, FASB would establish principles, give examples and give financial experts discretion to interpret the rules. Critics of current accounting rules said the rules have mutated to resemble the tax code. That level of complexity allows companies to use creative accounting practices, adhering to the letter of the law while avoiding the spirit of full and clear disclosure, they said.
"There is quite a bit of merit in moving toward a more principles-based approach," Peck said. "The question is, how do you define what the principles are, what level of detail is provided and how does a company prepare its financial statements in accordance with a principles-based approach."
Part of the reason accounting rules are so complex is that the SEC has demanded that companies with similar transactions account for them equally, Mahoney said. The legal system also has demanded detail in the accounting system, he added, noting that it is easier for a chief financial officer to point to a specific line in the rules to justify his actions than to point to a principle and then explain how good-faith judgment was used to reach an accounting decision.
The rules also are complex because they include myriad exceptions, he said. Once an exception is created, then rules must be created to prevent other applications of it, Mahoney said. "A principle-based system would allow for few if any exceptions."
The proposal was released Oct. 21 and Mahoney said he already has received comments from both supporters and those people categorically opposed on the grounds that the change would rely on the discretion and judgment of a profession badly battered by reports of ethical breaches.
Success of a principle-based system is largely dependent upon the ability of the new corporate oversight board created by Congress, Mahoney said. "We need a much better system of overseeing those auditors, as well as a better system of overseeing and disciplining corporate officers," he said.
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