Stock Options Expense

A stock option is the legal right to buy or sell shares of stock at a specific price and at a specific time. One share of common stock represents one unit of ownership of a public company.

Accordingly, many companies grant stock options to their employees, including top management, as compensation instead of cash, allowing employees to have a fractional ownership in their company.

Since the value of stock options is difficult to quantify, the Financial Accounting Standards Board (FASB) did not require companies to record a stock option expense on their income statements until 2006. After recent corporate scandals, FASB changed its mind. Beginning on January 1, 2006, companies will have to record stock option expense on their income statements. [1] Most companies will include the stock option expense within the SG&A line item.

[1] See Appendix for a complete discussion of methodology governing stock options expensing.

Financial Analysis Implications

Most income statements prior to 2006 did not include stock option expense. Since as of 2006 stock option expense is recorded (typically in the income statement within SG&A), we must now go back and include it in the SG&A prior to 2006 in order to be “apples to apples” with SG&A expense in 2006 and beyond (Exhibit 5.4).

A company’s footnotes reveal that it recorded a stock option expense of $30m in 2006, but did not record it in prior years. Had it recorded stock option expense in the 2003–2005 period, stock option expense would have been $25m, $27m, and $28m in 2003, 2004, and 2005, respectively. Accordingly, for an “apples to apples” comparison, stock option expense should be included in SG&A prior to 2006. Prior to attempting to include stock options expense in the SG&A line item for financial analysis purposes, note that:

  • Some companies, like Wal-Mart, have retroactively restated their income statements to include stock option expensing (Exhibit 5.5), so they have already established an “apples to apples” framework (no work needs to be done on the readers’part).

  • Other companies, like Exxon Mobil, have decided to indicate in their footnotes the impact that stock option expensing would have had on their income statement had it been adopted in prior years. This is the information that should be used to include stock options expensing in the SG&A expense prior to 2006.

Although FASB has mandated the adoption of stock options expensing beginning after January 1, 2006, many companies have voluntarily begun to expense them as early as January 1, 2002. Accordingly, make sure you understand for what years the income statement does not contain stock options expense (and therefore must be adjusted to include it) and when it already includes their impact (no adjustment needed).


Exhibit 5.4. Stock Option Expense Must be Included for Financial Analysis

[View full size image]

Exhibit 5.5. Some Companies Like Wal-Mart Have Retroactively Restated Their Income Statements To Include Stock Options Expensing
7 Share-Based Compensation Plans
As of January 31, 2006, the Company has awarded share-based compensation to executives and other associates of the Company through various share-based compensation plans. The compensation cost recognized for all plans was $244 million, $204 million, and $183 million for fiscal 2006, 2005, and 2004, respectively. The total income tax benefit recognized for all share-based compensation plans was $82 million, $71 million, and $66 million for fiscal 2006, 2005, and 2004, respectively.
On February 1, 2003, the Company adopted the expense recognition provisions of Statement of Financial Accounting Standards No. 123 (“SFAS 123”), restating results for prior periods. In December 2004, the Financial Accounting Standards Board issued a revision of SFAS 123 (“SFAS 123(R)”). The Company adopted the provisions of SFAS 123(R) upon its release. The adoption of SFAS 123(R) did not have a material impact on our results of operations, financial position or cash flows. All share-based compensation is accounted for in accordance with the fair-value based method of SFAS 123(R).

Source: Used with permission of Wal-Mart Inc.


..................Content has been hidden....................

You can't read the all page of ebook, please click here login for view all page.
Reset