There is a lot of misunderstanding about SBC, some based on ignorance, some based on investing strategy, and it is a confusing issue until you analyse it based on proper accounting procedures. At the crux of the matter is the issue whether it should or should not be expensed. GAAP is for expensing which I consider an error but there is a case that can be made for expensing – maybe.
While working at NCR selling accounting machines my boss, Sr. Hansen, asked me if I knew accounting. “No.” “Then how can you sell accounting machines?” I signed up for what I though was accounting but it turned out to be book keeping, the clerical aspect of accounting but not the science, if you can call it that. Sr. Hansen suggested an extension course by mail at an Argentinian university. The notion that accounting was boring as hell soon disappeared. Accounting has been most useful.
At SA I was asked whether I believed paying workers and suppliers wholly with SBC would result in 100% margins if not expensed. “Yes!” But to verify my conclusion I had to go through the accounting procedure in detail. And I also had to go back in time before the Joint Stock laws were legislated.
Before these laws were enacted the way to create business societies was via partnerships. There were two kinds of partners…
- Capitalist partner. A partner who contributes money or property to the capital of the company
- Industrial partner. A partner who contributes services instead of money or property.
In Joint Stock corporations, SBC is the equivalent of Industrial partnership. Based on this principle it is easy to set up the proper bookkeeping procedure.
Issuing the stock option
Since the options may or may not be exercised, at the time they are issued it is enough to note them in the comments to the Financial Statements. Some argue that the options have value that should be accounted for. I’ll discuss this later.
Exercising the stock option
If the options lapse there is nothing more to do than note it in the comments to the Financial Statements.
Exercised or not - cost of goods = ZERO
Looks like a micro secondary offering
Looks like an Industrial partner
Accounting for the option value
One could use the Black-Scholes option pricing model to figure the value of the stock option. Say its $1,500.00 and it would be charged to Cost of Goods Sold (COGS)
Option not exercised
The above entry needs to be reversed as the option is now worthless.
Cost of goods = ZERO
Exercising the stock option
Same as above except we have to reverse the value of the outstanding options. What account should we credit? ???
Either COGS or some new phantom account, say Stock Based Compensation which exactly reverses the COGS debit amount. In other words, its just an accounting illusion or as I would call it, an accounting absurdity.
The whole point of SBC is to shift the cost to the shareholders! I.e. cost of goods = ZERO.
The Captain