Abstract In the Financial Accounting Standards Board (EASB) Exposure Draft "Accounting for Stock-Based Compensation," (June 1993) the FASB advocates valuing employee stock options using the fair value at the grant date. This paper discusses and illustrates the FASB approach, and presents as an alternative the method used to account for stock appreciation rights (SARs), which it shows are economically equivalent to stock options. Theoretically the SAR approach (1) reconciles accounting for economically equivalent transactions, (2) produces accounting results that are objective and verifiable, (3) recognizes as expense an amount equal to the benefit to the employee and opportunity cost to the firm, and (4) matches expenses to the period(s) in which the benefits are received. Practically, when compared to the FASB proposal, compensation expense is easier to compute and understand If the SAR method is extended to stock options. The FASB's Exposure Draft rejects this approach. The board concludes that stock-based compensation settled in cash (SARs) differs from stock-based compensation settled in stock. The key difference is the former requires expenditure of an asset and is therefore defined as a liability, whereas the latter requires issuance of stock, which is not viewed as an asset of the company. Therefore the FASB concludes a stock option is an equity instrument. This paper argues that the FASB should look beyond the definitions of liabilities and equities to the substance of the transaction. Since SARs and stock options are economically equivalent, the amount of compensation recognized should be the same whether a SAR or stock option is issued.
Steven Balsam (Thu,) studied this question.