Final Project

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Abstract
Stock options are famous utilities applied by companies to draw, retain and inspire their employees. They too are effective mechanisms to align the interests of the management more intimately with those of shareholders, with favorable connotations of long-term business performance. However, the appropriate accounting treatment of these options has been a matter of much discussion and little agreement. This paper provides main issues, recent studies and future applications of stock options to the business world.
Introduction
The triumph of businesses relies on its human resource capabilities, within the motivations of the system understood as one of the critical mechanisms affecting its performance.
Agency theory proposes that reward policies should be in a way to provide management with rewards to choose and implement decisions that improve shareholders wealth (Jensen and Murphy, 1990). An executive’s overall compensation package includes benefits, wages and incentives. Incentives are essential packages because they motivate managers.
In the latest years, alternative premium methods to premium cash payments have been monitored. It is in these lines that the matter of stock options arises. As a matter of fact, stock options have been in use both for managers and employees. Employee stock options provides rewards for both executives and employees for them to make decisions that only and only improve the share prices of the company. This is meant to improve the shareholders and management interests hence reducing the agency costs. They are considered efficient because they give a direct link between the shareholder wealth and the expected utility. However, accounting for stock options is a controversial case that has received attention by some supervisory bodies.
Issues affecting the stock options
Stock options give the owner a warrant to obtain a precise number of the company’s shares at a set time in the future at the exercise price. It therefore follows that, employee stock options give an employee a warrant to purchase his company’s shares at a future date known as the exercise date. From the above definition, it is clear that employee stock options are call options and only call options. Traded stock options differ from ESOs in three ways (Hemmer et al., 1994). First, an employee is not obligated to pay a premium in order to earn the option. In addition, ESOs always have a longer time to maturity as compared to the traded stock options. As a matte of fact, Employee stock options can never be sold to a third party. If you were to consider Mehran and Tracy, it can be argued that stock options have a vesting period. This obligates the employee to work for the company in question until the maturity date is due. If one opts to quit before the vesting period, he will forfeit the options. Thus, ESOs are use to maintain staff in corporations. However, in both traded and employee stock options the owner has the warrant but not the obligation to exercise the option.
The controversy in accounting for employee stock options is around three crucial issues. When is the stock to be measured? Are stock options an expense? If so how can they be valued? As debated in Poitras (2004), a critical insight of S 1890 and HR 3574 in the study is that there are two distinctive aspects in option expensing debate. One aspect relates to corporate authority and has an impact on revealing the fair value of these stock options (ExSOs). The other aspect communicates to the economic task of ESOs and the discouragements that expensing would inflict on companies that use this compensation for lowly ranked employees. The IASB frameworks definition clarifies beyond any reasonable doubt that stock options can never be considered an expense. According to IASB, an expense is a decrease in economic benefits for the duration of the accounting time in the outpourings or exhaustion of assets or incurrence of losses that bring about decreases in equity apart from those relating to allocations in equity partakers. The main argument in this matter that stock options do not result in increases in liabilities neither does it result to reduction in assets. A common stock by its definition is not an asset of the issuing company but because of applying it in exchange for service does not cost the company (Schirger, 1994). It is considered that treating stock options as expense can lead to insufficient measurement of the net income. This is because their ascription does not imply an outflow of cash but provide cash flows when cashed by employees (Revsine et al., 1999). However, one has to consider that the company is paying its employees with a financial instrument hence a cost to the entity.
Others view these options as a capital transaction which should not create the detection of any expense (Rouse and Barton, 1993). This implies an option should not be identified in the profit and loss statement because using shares to mend the exercise of options is considered as an assets transaction. This brings about a shift in the Shareholders’ value of the company. Thus, it is argued that these options do not cost the entity but rather result in a dilutive cost to the individual shareholder. Some consider that the dilution effect reflected in earnings for every share is satisfactory (Rouse and Barton, 1993). If an expense were to be identified in the profit and loss income, then, the statement would “double count” the impact of the stock options. This implies that, earnings for every share would be hit twice.
Others argue that disclosure of these options costs in the notes to statements is enough. The reason being no valuation method that can present shareholders with exact and consistent numbers exists. So, full exposé of these options would be superior for shareholders than expensing these options. In this sense, it is the amalgamation of the tentative character of measurement and vague effects of detection that results in the wrapping up that disclosure is preferred to recognition (Derieux, 1941). It is argued that, if disclosure is done, then the investors will compute the true economic profit that will reflect in the share price. Balsam et al. (2003) reports that, disclosure of adjusted inco...