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Author: TMFOtter Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 766  
Subject: Re: FASB option ugliness 5/20 Date: 5/22/2004 4:45 PM
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David -- Welcome to the Motley Fool. Since we're talking about stock options, let me describe another entity that doesn't agree with you on accounting of stock options. Here's some language from its 2003 10-K:

Fair values of cash equivalents approximate cost due to the short period of time to maturity. Fair values of short-term investments, trading assets, long-term investments, marketable strategic equity securities, certain non-marketable investments, short-term debt, long-term debt, swaps, currency forward contracts, equity options and warrants are based on quoted market prices or pricing models using current market rates. Debt securities are generally valued using discounted cash flows in a yield-curve model based on LIBOR. Equity options and warrants are priced using a Black-Scholes option pricing model. For the company's portfolio of non-marketable equity securities, management believes that the carrying value of the portfolio approximates the fair value at December 27, 2003 and December 28, 2002. This estimate takes into account the decline of the equity and venture capital markets over the last few years, the impairment analyses performed and the impairments recorded during 2003 and 2002. (emphasis added)

You might be interested to know that the above comes not from some old-school company that has already agreed to expense stock options, but from Intel. That's right -- the company that is fighting so hard to keep options from being expensed when they're granted to employees has no problem at all finding an expense for them when they're used in any other way.

Another company, Apple, issued options in 2001 as part of its purchase of PowerSchool. Once again, they knew how to expense these options-- it's listed right in the 10-K. The list of companies that says options can't be valued that are valuing them for every other use besides employee compensation is extraordinarily long. Should we assume that Apple got PowerSchool for free? No, that's silly.

In May 2001, the Company acquired PowerSchool, Inc. (PowerSchool), a provider of web-based student information systems for K-12 schools and districts that enable schools to record, access, report, and manage their student data and performance in real-time, and gives parents real-time web access to track their children's progress. The consolidated financial statements include the operating results of PowerSchool from the date of acquisition. The purchase price of approximately $66.1 million consisted of the issuance of approximately 2.4 million shares of the Company's common stock with a fair value of $61.2 million, the issuance of stock options with a fair value of $4.5 million, and $300,000 of direct transaction costs. The fair value of the common stock options issued was determined using a Black-Scholes option pricing model with the following assumptions: volatility of 67%, expected life of 4 years, dividend rate of 0%, and risk-free rate of 4.73%. (emphasis added)

The day you got your options, you were getting something for something. You received the right to buy Cisco at X dollars for Y amount of time. Basic financial theory states that this call option ITSELF has value. You accepted this variable compensation instead of other forms -- most likely a higher salary. What's the amount of other compensation that you were willing to forego in order to make this options package attractive? That's the *cost* that these models seek to capture. It isn't zero. Options are a currency. They have value, and in every other transaction other than employee costs this value is captured on the income statement at the moment of issue, not exercize.

This is a loophole, nothing more. Accounting does not allow for an instrument to be treated one way in one type of transaction and another way in another kind of transaction. It was a mistake that employee options got treated differently, and it ought to be corrected.

Accounting is not "outcome based." That stock options may inspire hard work doesn't hold any water at all in the question of whether they should be treated equally across the board. If Cisco or some other company changes its options policy just because the measurement functions change, then shame on them, not on those who worked to change the measurements.

Pay attention to that Intel and Apple language above -- that's where the truth lies. THEY'RE ALREADY EXPENSING OPTIONS.

Bill Mann
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