Stock options must be expensed

Stock options must be expensed


By Matt Krantz, USA TODAY (dec 2004)


Count one for the bean counters.
After years of heated debate between high-tech companies and accountants, the head accounting rule-setting body Thursday declared all companies must subtract the cost of stock options from their earnings starting in mid-2005.
It's a massive blow for companies, mainly in Silicon Valley, which had been doling out lucrative stock options to employees and executives for decades but not counting them as a cost. It also requires investors to rethink how they value companies: The new rule will affect everything from price-earnings ratios to earnings estimates.
Accountants, thinking companies had been enjoying a loophole that understated their costs, applauded the decision. The new rule will have "a big impact, but it's the right move," says Ed Nusbaum, CEO of accounting firm Grant Thornton.
The rule change, approved by the Financial Accounting Standards Board, represents a massive shift because it:
•Affects so many companies. Only 117 companies in the Standard & Poor's 500 index currently expense options, says David Zion, accounting analyst at Credit Suisse First Boston. That means a majority will need to start.
•Puts a big dent into reported earnings. Had all companies in the S&P 500 expensed the cost of options, reported earnings would have been 20% lower in 2001, 19% lower in 2002 and 8% lower last year, Zion says. He says the rule could dent 2005 earnings 3%.
•Has massive effects on individual companies. Not surprisingly, tech companies that have relied on stock options to retain employees stand to suffer a big hit to earnings.
Consider Internet site Yahoo. Had the company been required to expense stock options last year, it would have reported earnings of 5 cents a share, 86% less than the 37 cents a share profit it reported. That makes a giant change in Yahoo's P-E on 2003 earnings: 742 under the new rule, vs. 100 before.
•Affects earnings estimates. It's still unclear if Wall Street analysts will ignore the new charge, or include it in the earnings estimates that investors watch, says David Dropsey, analyst with First Call.
High-tech firms are not pleased. "We remain opposed to expensing and will continue to work with the Congress, the administration and the SEC to come to an accurate, auditable, transparent solution," says Cisco Systems' spokesman John Earnhardt.
Sen. Peter Fitzgerald, R.-Ill., one of the rule's champions, says he fears companies will wait for his retirement this year and try to derail the rule before it kicks in June 15.
Silicon Valley companies "will stop at nothing to stop this (rule) from going into effect," he says.