Intel set to announce accounting changes (Refuses to call stock options an expense)

The Inquirer ^ | 8-8-2002 | Inquirer Staff

[JameRetief]

Intel set to announce accounting changes

Grove refuses to call stock options an expense

By INQUIRER staff: Thursday 08 August 2002, 10:35

REPORTS STATE THAT INTEL is set to buck the trend relating to the reporting of stock options in its accounting procedures.

Reuters says Intel will announce today that it will not count stock options as an expense. Instead, the company will seek to provide a different level of detail about its stock-option programmes, which, the chipmaker reckons, will help make executives’ remuneration packages more transparent to shareholders.

Company chief Andy Grove reckons that calling stock options an expense won’t help shareholders spot when top executives are being over compensated.

Like many technology companies, Intel has been keen on offering staff the option to buy shares in the company at a reduced rate. In the old days, when anything computer related was expected to be successful, the lure of stock options was a tasty carrot in the recruitment process.

Grove has complained, in a recent interview, that the options held by senior executives in some companies are excessive. He says that, Intel's top five executives held 2 per cent of the options granted by the company last year. He says in other companies this figure lies between 18 and 30 per cent.

Grove himself is thought to have earned around $160 million through selling his own stock options, accrued over thirty years with the company.

The decison not to call stock options an expense is the outcome of lengthy discussions between Grove and his accountant Andy Bryant, which Bryant seems to have won.

"He screwed my head up right," Grove is reported to have said. µ

[VRWCmember]

Good for them. Equity options represent a balance sheet account transaction, not an income statement account transaction. Keeping them off the income statement is sound financial and accounting practice.

[mlocher]

Good for them. Equity options represent a balance sheet account transaction, not an income statement account transaction. Keeping them off the income statement is sound financial and accounting practice.

i agree with your statement. there is no corporate expense incurred when options are granted.

there is one thing that bothers me, though, and perhaps you can educate me. when the option is exercised, the stock shares are diluting the shares of existing shareholders, unless the company buys them back. if the company buys them back (and many in fact do), what is the accounting practice for this?

if the company does not buy the shares back, then it would seem to me that management has decided to give a portio of shareholder equity to those who exercised their options. taken to the limit, this says that management can 'take away' my equity stake in a company by creating too many options as compensation. i know that this must be covered in the accounting practices or elsewhere, but how is it covered?

thanks

[mykej]

As long as they don't tell the IRS that options ARE an expense, I don't care. They shouldn't be allowed to tell investors one thing and the IRS another.

[VRWCmember]

I see three possibilities if new shares are issued, and similar possibilities if outstanding shares are used:

1. The company issues the shares that are purchased by the options (these would have to be authorized but unissued shares) and the option-holder retains the shares. The difference between the par value and option exercise price is Capital Surplus on the equity accounts. There is some dilution of equity for existing shareholders since there are now more shares outstanding so their ownership interest is diminished.

2. The firm issues new shares when the option exercise is executed and the shares are sold immediately in the market (the company does not buy them back). The difference between the par value and option-exercise price is capital surplus on the equity accounts, and the difference between the exercise price and the market price is a capital gain to the option holder. Again, some dilution of equity position of existing shareholders takes place, as in the first case.

3. The firm issues new shares for the option exercise and buys them back. The capital surplus account would initially increase, then immediately decrease when the firm buys back the "treasury stock". The cash for the option holder's capital gain would be an outflow of cash for the firm, so the asset account (cash) would decrease and the equity account (capital surplus) would decrease by an equal amount.

In the first two examples, the firm receives a cash inflow from the option exercise equal to the option exercise amount times the shares purchased. In the third case, the firm makes a cash outflow equal to the difference between the market price and the option exercise price.

If the firm uses outstanding shares, the firm would have to buy the shares at the existing market price when the option is exercised. Then the option holder could either retain the shares for a future capital gain, or sell them immediately for an immediate capital gain. In this case, the number of shares outstanding will not change, so the equity position of other shareholders is not diluted. In most cases, the firm has a brokerage firm to effect the transactions so that the firm simply makes up the difference between the option price and the exercise price and the capital surplus account on the balance sheet would be affected accordingly.

These transactions belong on the balance sheet and the statement of cash flows, but not on the income statement.

[NeoCaveman]

As long as they don't tell the IRS that options ARE an expense, I don't care. They shouldn't be allowed to tell investors one thing and the IRS another.

For IRS tax forms expenses better called deductions, kind of like personal deductions, are what ever the law says they are. IRS tax forms are for raising revenue NOT for providing valuable information to investors...that's what GAAP Accounting is for.

[CPT Clay]

Good post!!!

I like executives to have a stake in the business. It should be a major source of their compensation. As a shareholder(Kudlow's investor class) I don't want my shares diluted. Could the shares be bought on the existing market?

[Pistolshot]

Intel also has the type of setup that thwarts raiding by the officers. The Board is made up of mostly people from other industries, with a few from the Intel pool. The Accounting and auditing are completely seperate entities without ties to the company.

As far as the options go, the company can write off the costs of keeping that stock in holding until the option has expired. When sold the charge is passed on to the shareholder along with the taxes associated. These can be written off by the shareholder at the end of the year.

[mlocher]

thanks. i know just enough about accounting to understand that this is a cash flow issue and not an income stmt (expense) issue. your explanation helped a lot.

thanks

[mlocher]

just to follow up: if the company issues shares to cover for the option sale in case 1 and 2, these have been authorized already -- as i recall all stock issueances must be authorized, for options, to raise capital, whatever.

that fully addresses my concern. stock options ARE NOT done in a vacuum and are merely a tool for management to use.