Copyright 2002 The Chronicle Publishing Co.  

The San Francisco Chronicle
AUGUST 8, 2002, THURSDAY, FINAL EDITION
SECTION: BUSINESS; Pg. B1; NET WORTH

LENGTH: 888 words

HEADLINE: Options rules near adoption

BYLINE: Kathleen Pender

BODY:
The Financial Accounting Standards Board met Wednesday to debate how companies that expense stock options in the future should treat options granted in the past.

The board considered three alternatives but rejected one and told the FASB staff to investigate the remaining two. It could make a final decision on the matter at its next meeting on Wednesday.

FASB is moving with unusual haste because the movement to expense employee stock options is gaining steam.

Companies can show the estimated cost of employee stock options granted each year in one of two ways: as an expense on their income statement or in a footnote only.

Until recently, virtually all companies chose the footnote-only method, but a growing number are starting to expense options. Doing so reduces a company's reported earnings, but some think it makes financial statements more credible.

General Electric made the switch last week, and General Motors and Citigroup jumped on the bandwagon this week.

Under FASB's current rule, a company that switches to expensing can only expense options that are granted after the date of change. Previously issued options, including ones that haven't vested yet, continue to show up only in the footnotes.

Some businesses and shareholders weren't happy with that treatment and asked FASB to consider other options.

It's hard to believe, but some companies want to expense old options as well as new ones.

That would take an even bigger bite out of earnings, but there could be benefits, says Ken Bertsch, director of corporate governance at TIAA-CREF.

One, it brings a company's existing options onto the income statement at a time when options are in the news and easy to explain to shareholders.

Two, it could reduce or eliminate the ramp-up problem that occurs when companies write off new option grants only.

The ramp-up problem arises because companies spread out the cost of option grants over time, typically the vesting period. If an option grant vests over four years, the company will write off one-fourth of the cost each year for four years.

As a result, the expense is minimal the first year, but grows as the company piles new grants on top of old ones.

For example, last year Coca-Cola did not expense options, but if it had, its earnings per share would have been 9 cents less.

Starting this year, Coca-Cola will expense new option grants over their four-year vesting period.

That will reduce per-share earnings by about 1 cent this year, 3 cents next year, 5 cents in 2004 and 9 cents in 2005.

If Coke expensed all option grants -- new and old -- the cost would be around 9 cents the first year, spokeswoman Kari Bjorhus says.

But from that point on, the cost would level off, assuming Coke issues roughly the same number of options each year.

Bertsch says Coke is one of the companies that approached FASB about expensing old options. Coke's Bjorhus had not heard that and could not confirm it.

Some companies would prefer a steady options expense even if it means taking a bigger earnings hit up front, Bertsch says. It makes year-over-year comparisons cleaner, and the company doesn't have to re-explain to shareholders each year why its options expense is going up.

On the other hand, some companies would rather write off only new options to minimize the initial hit to earnings.

It looks as if FASB will give companies a choice for new options, including the status quo.

On Wednesday, the board considered three new alternatives for expensing previously issued options:

-- Write off the unvested portion of prior awards along with new awards. This "tries to avoid the ramp-up problem," says Patrick Durbin, a FASB practice fellow. "You start off from day one with a full complement of options."

-- Restate prior financial statements as though the company had been expensing options. The restatement could go back as far as 1996, when FASB first required companies to either expense options or show them in a footnote. Durbin says the exact time period for restatement would have to be determined.

-- During the first year the company switches to expensing, recognize an expense for all previously issued options. This expense could be listed as a "cumulative effect of a change in accounting principles," an expense category that is "afforded some special treatment and presentation" in a company's financial statements, Durbin says. (In other words, most investors ignore it.)

The board Wednesday eliminated the last alternative and directed the FASB staff to explore the first two. Durbin says the board might reach a decision at next week's meeting.

Some groups that favor stock-option expensing were thrown off guard last week when FASB announced it would consider the expensing of old options. They thought FASB might require companies that expense options to expense old ones as well as new ones.

That might have discouraged some companies from voluntarily expensing options. But Durbin made it clear that FASB -- which has long favored stock option expensing over footnoting -- plans to give companies a choice of accounting options, one of which would be the existing treatment.

Board members "were not interested in creating a penalty for companies who are voluntarily adopting the preferable method," Durbin says.



LOAD-DATE: August 8, 2002