Question

Why is the accounting for stock-based compensation so controversial?

Answer 1

WHAT IS STOCK-BASED COMPENSATION?

Most tech companies use stock-based compensation to attract employees.They typically take 2 forms : options which are granted at a given strike price or Restricted Stock Units, both which tends to have a cliff(before which the employees gets nothing) and vest over a period in order to align incentives and help retain employees.

WHY OFFER STOCK BASED COMPENSATION

Stock-based compensation has some clear benefits, One , they give employees and senior management some skin in the game and can help align incentives to focus on long term value creation. Two, since they come with vesting schedules(often 4 years), they help retain employees. Three, they allow for companies which are cash-poor to conserve cash and yet compensate employees in another form, and therefore attract and retain talent.

ACCOUNTING FOR STOCK-BASED COMPENSATION

Until 2004, companies were not required to expense the fair value of the option grants they gave employees.Instead, they had the option to just disclose the fair value of these options in footnote. However in 2004, the Federal Accounting Standards Board changed the standards  and required that companies value stock-based option on their fair value and record them as an expense on their grant date.

This move was controversial at the time as some people pointed to the fact that stock-based compensation is a non-cash expense. In addition, others mentioned that stock-based compensation dilutes shareholders and is therefore already accounted for by virtue of the number of shares outstanding increasing.

But GAAP rules are GAAP rules, and so companies have to expense stock-based compensation in GAAP accounting. However, many tech companies have chosen to remove stock-based compensation when they provide their non-GAAP estimates. In addition , many tend to provide quarterly and yearly guidance and long-term margin and other targets on non-GAAP rather than GAAP estimates.

actually Stock-based compensations are real expenses which should be accounted for and GAAP standards are correct on this front. The issue of whether to recognize stock-based compensation expenses is one of the most enduring controversies in accounting.

CONTROVERSIES OVER ACCOUNTING FOR STOCK-BASED COMPENSATION

The two general issues are
1) how option values should be determines and when

2) if stock options should be expensed or disclosed

1)MEASURING THE VALUE AND COST OF OPTION;- There are 2 problems with valuing it . one is at what date should it be measured and introduced into the accounting systems and other is how should it be measured.

2)DISCLOSURE OR RECOGNITION OF STOCK BASED COMPENSATION;-

Disclosure of stock option;-

One is that shareholders endogenously optimize disclosure policy, corporate governance, and management incentives in order to maximize firm value. however, this notion neglects one important phenomenon, perfectly credible disclosure is not optimal because it may be too costly. Second, until recently FASB allowed firms to provide information on the values of option in footnote or tabular form. An agreement in defense of this approach is that companies already disclose information about cot option grants in footnote to the financial statement and therefore have the necessary data readily about. Third , there is some concerns about putting the expense of option grants on the income statement and balance sheet without addressing other similar contingent assets and liabilities as well. Some experts argue that stock options are more like contingent liability than equity transaction since their ultimate cost of the company cannot be determined until employees either exercise or forfeit their options.

Recognition of stock options;-

liability stock option as a expenses, intangible assets ,and as equity and liabilities.

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reference: An empirical review of the benefits and controversies of employees stock options.

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