The Politics of Accounting Standards

The Politics of Accounting Standards

Over the past two decades there has been a growing controversy over the rules set forth involving the expensing of stock options. The big debate is between whether companies should have to expense stock options on their income statement, or just disclose the cost of the options in the footnotes and not actually record an expense. FASB has been pushing toward making it mandatory to expense stock options at the time they are awarded. Their reasoning for this is that if companies give their management cash bonuses they are required to record a compensation expense which would in turn reduce net income. Now if companies reward their management with stock options they do not have to record an expense which would reduce net income in the same way a cash bonus would. Basically if the company had sold the option to the public they would receive a cash payment in exchange. So if the company gave the option to an employee they were giving up the cash they would have received if they had sold it. With this understanding FASB wanted the options to be recorded at their fair value as an expense so company's financial statements would accurately reflect the compensation that they gave out.

Congress on the other did not agree with FASB's views on this topic. At the time of this debate many high-tech companies were beginning to form. These companies had little startup capital so most of them paid their employees in stock options. Congress sided with these companies because if stock options were expensed then most of these businesses with no startup capital would have no way to recruit or pay their employees. This issue was finally resolved when companies like Enron went bankrupt for using the intrinsic value method to their advantage to inflate stock market valuations and commit accounting fraud. In 2002 Senator Levin introduced a bill which made it mandatory for companies to expense stock options. By the end of 2004 this finally lead to FASB issuing SFAS 123R which required companies to record options using the fair value method and hopefully put an end to this whole mess.

This isn't the first time that stock option expensing has caused an argument between FASB and Congress. As far back as 1988 FASB started to look into this problem by beginning a compensation project and taking in comment letters. In 1993 FASB issued the "Exposure Draft" which requires companies to record stock options at their estimated fair value. Congress fought back with Senator Joe Lieberman who introduced a bill that canceled and made the "Exposure Draft" basically useless. If you didn't know the FASB was established in 1973 with a staff of seven members. FASB was designed to guarantee its independence from the private sector so that there was no bias in creating a set of neutral accounting rules. How can FASB remain independent when congress just passed a bill to reverse their initial rule? In response to this FASB backed down and made a compromise with SFAS 123 which gave businesses the choice to expense stock options either way. The SEC has only overturned FASB one other time during its history involving the rules dealing with oil and gas reporting requirements. This happened in 1979 when the SEC allowed the