Nice: Stock-Option Expensing

During this holiday season, some of us at The Motley Fool decided to help Santa Claus put together his list of who's been naughty and who's been nice. Although Santa might have to think twice about this one, I suggest he considers the final arrival of stock-option expensing as awfully nice.

Most companies are wrapping up their first full year of earnings under the new reporting requirements. No longer do investors and analysts have to go back and forth adjusting the results to an apples-to-apples basis -- or was that an oranges-to-oranges basis? Moving into the new fiscal year, numbers will all be apples: Stock options will be expensed.

It took long enough. Fellow Fool Bill Mann has chronicled the Financial Accounting Standards Board's saga, which began in 1994 to close the loophole that allowed companies to avoid expensing stock options. The change was a no-go back then. In 2004, FASB was ready to do battle again and reopened the proposal to account for stock options on the income statement. During that time, the U.S. House of Representatives attempted to strip FASB's powers. But after a slight delay, Statement of Financial Accounting Standards No. 123R finally went into effect on June 15, 2005.

The reality, however, is that SFAS 123R has changed nothing. The economics surely haven't changed. Stock options will still be used as a source of employee financing, especially for cash-strapped start-ups. It's just that the financial statements have been flip-flopped. What was in the notes is now on the income statement. If investors want to remove the accrual effect of the stock-option expense, all they have to do is go back to the footnotes. Many companies have prepared non-GAAP presentations in the footnotes, which remove the expensing effect. Regardless, we are just more formally recognizing what has been there all along -- employee financing.

And employee financing is not cheap. Companies need to be held accountable for all sources of financing, and issuing stock options can be more expensive to use than issuing shares directly.

Accounting for the more expensive employee financing often has a negative impact when valuing companies such as Maxim Integrated (Nasdaq: MXIM  ) , CiscoSystems (Nasdaq: CSCO  ) , and Intel (Nasdaq: INTC  ) , which have historically used this tactic liberally. And these are just the companies that were opposed to the new accounting rule. Now, if you want to talk about who was really naughty ...

Read more on this naughty-or-nice debate:

There's a whole world of naughty and nice out there!Take a lookat the rest of the bunch.

Intel is aMotley Fool Inside Valuerecommendation. Try out our newsletter service for value hounds free for 30 days.

Fool contributor Matthew Crews welcomes your feedback -- really! He has a financial position in both Maxim Integrated and Intel. The Motley Fool has an ironclad disclosure policy.


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