Crash Course in Accounting and Financial Statement Analysis, Second Edition

Stock Options Expense

A stock option is the legal right to buy or sell shares of stock at a specific price and at a specific time. One share of common stock represents one unit of ownership of a public company.

Accordingly, many companies grant stock options to their employees, including top management, as compensation instead of cash, allowing employees to have a fractional ownership in their company.

Since the value of stock options is difficult to quantify, the Financial Accounting Standards Board (FASB) did not require companies to record a stock option expense on their income statements until 2006. After recent corporate scandals, FASB changed its mind. Beginning on January 1, 2006, companies will have to record stock option expense on their income statements. ^[1] Most companies will include the stock option expense within the SG&A line item.

^[1] See Appendix for a complete discussion of methodology governing stock options expensing.

Financial Analysis Implications Most income statements prior to 2006 did not include stock option expense. Since as of 2006 stock option expense is recorded (typically in the income statement within SG&A), we must now go back and include it in the SG&A prior to 2006 in order to be “apples to apples” with SG&A expense in 2006 and beyond (Exhibit 5.4). A company’s footnotes reveal that it recorded a stock option expense of $30m in 2006, but did not ...