Financial Accounting Standards:

Accounting for Stock Options and Other Share-Based Payments

GAO-04-962T: Published: Jul 8, 2004. Publicly Released: Jul 8, 2004.

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Jeanette M. Franzel
(202) 512-9471


Office of Public Affairs
(202) 512-4800

GAO discussed its perspective on the process for establishing accounting standards for private-sector entities and then, more specifically, the current proposals for accounting for stock options. We recognize that accounting for stock options is a complex and controversial issue on which reasonable people can and do disagree. As a result, in light of the Financial Accounting Standards Board's (FASB) current proposed standard for accounting for stock options and other share-based compensation, there has been a renewed interest for the Congress to possibly legislate accounting rules for stock options. FASB is a non-governmental organization empowered to establish financial accounting and reporting standards for private-sector entities. Although this function legally resides with the Securities and Exchange Commission (SEC) for public companies as part of its mandate to administer and enforce the provisions of the federal securities laws, the SEC has traditionally relied on FASB since 1973 to fulfill this function. The U.S. capital markets depend on a system of continuously improving financial information about the underlying economic activities of companies. This information is fostered and framed by independently established financial accounting and reporting standards, collectively referred to as generally accepted accounting principles (GAAP).

On March 31, 2004, FASB issued an exposure document on a proposed Statement, Share-Based Payment, an Amendment of FASB Statements No. 123 and 95, which addresses the accounting for compensation to employees in the form of stock options and other forms of equity. The FASB's proposed Statement would generally eliminate the ability for public companies to account for share-based services using the intrinsic method (which generally results in no expense being recognized) and would require instead the use of a fair-value-based method, which would generally result in companies treating stock options granted to employees as an expense based on their fair value when granted. In our view, stock options and other forms of share-based payment have economic value and represent a form of compensation expense. Therefore, we believe that the economic substance of such transactions should be reflected as compensation expense in the calculation of a company's net income to accurately portray its financial results. We also support the four principal reasons FASB cited for issuing the new proposal: (1) addressing concerns of users and others that the use of the intrinsic value method results in financial statements that do not faithfully represent economic transactions and can distort the financial condition and operations of the issuer; (2) improving the comparability of reported financial information through the elimination of alternative accounting methods; (3) simplifying U.S. generally accepted accounting principles by requiring the use of a single method of accounting for share-based payment; and (4) enabling international convergence and greater international comparability in the accounting for share-based payment. Notwithstanding our and others' views on the merits of various accounting methods for stock options, we believe that the principle of independence, both in fact and in appearance, is essential to the credibility of and confidence in any authoritative standard-setting processes. With respect to the role of FASB in this and other areas, we support its efforts, as the SEC's designated independent non-governmental standard-setting body, to identify issues for consideration, prepare exposure documents, conduct outreach efforts and solicit comments on exposure documents, and consider the resulting comments in finalizing and issuing new accounting standards. FASB, in carrying out its standard-setting activities, has an established process in place to obtain and consider feedback from its constituent groups. This time-tested and proven deliberative process has served to strengthen financial reporting and ensure general acceptance of the nation's accounting standards. This process is especially important given the complexity and controversial nature of some accounting standards, including the accounting for stock options and other share-based payments. We believe it is critical that FASB complete its analysis of comments received on its exposure document on share-based payment and finalize its proposed Statement in accordance with its established independent standard-setting process. Standard setting is, by its nature, an iterative process and the standard setter needs a high degree of independence to make decisions on what represents the best standard in the public interest.

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