, how to account for employee stock options is a $483 million question.
As the company revealed in its annual report issued Friday, Yahoo!'s reported $42.8 million net profit for 2002 would have swung to a $440.1 million loss under the accounting treatment that a growing number of U.S. companies have adopted since mid-2002.
The difference once again illustrates the vast impact that different accounting procedures, including those covering options-based compensation expense, can have on a company's bottom line.
Yahoo!'s illustration of the consequences of various options accounting methods -- disclosed, like similar data from other companies, in a
Securities and Exchange Commission
-mandated footnote in its annual 10-K filing -- is emblematic of the issue's importance, says Patrick McGurn, senior vice president of advisory firm Institutional Shareholder Services.
"It's a good argument for getting this stuff out of the footnotes into the financial statement," says McGurn, "because every investor should be able to instantly see the impact of the cost of compensation on the financial statement and interpret the information as they see fit."
Yahoo! shares, trading near a 52-week high and more than double the level of their yearlong lows, fell 62 cents Monday to close at $23.35.
Stock options accounting has drawn an increasing amount of attention over the past year. Whatever value options might have as a tool for democratically allowing employees to share in a company's success has been outweighed by options' guilt by association with highly compensated executives of poorly performing companies.
Supporters of the commonplace "intrinsic value" method of options accounting -- used at Yahoo! and most other companies -- argue that the alternative "fair value" method is both flawed and injurious for start-ups and for companies whose stock has sunk since options were granted. Critics of intrinsic value, in contrast, say it understates compensation expense.
Whatever the merits, the fair-value method is likely to enjoy a greater profile over the coming years. Since June 2002, more than 175 companies -- including firms representing 29% of the
market cap -- have adopted or announced their intentions to adopt the fair-value reporting method. Those include both old-line companies such as
and relative newcomers such as
The difference is that the intrinsic-value method assigns options no cost for companies if their strike price is the same as the company's stock price when issued, while the fair-value method assesses a value based on the Black-Scholes method.
The bottom line is that companies that continue to use the intrinsic-value method will have to report the discrepancy with the fair-value method more often than they have in the past. New rules require these companies to report their pro forma results as if they were using fair value instead of intrinsic value on a quarterly basis rather than an annual basis, with the first big wave of quarterly reports due for the quarter ending next week.
Furthermore, the adoption of the fair-value method, or some variation thereof, as the only permissible method for options accounting remains a possibility. Bear Stearns notes that the Financial Accounting Standards Board -- which is responsible for setting accounting standards in the U.S. -- launched a project earlier this month on stock options accounting. Bear Stearns suspects that FASB, which has identified fair value as its preferred method of accounting for stock options, will make the fair-value method mandatory by 2005.
In the meantime, the effect of implementing fair-value stock options accounting is widely variable but potentially large. The $483 million pro forma options expense for Yahoo! in 2002 amounts to more than half of the company's revenue for the year. Another media company,
, would have reported $143 million in additional expenses, roughly 1% of its revenue of $12.5 billion.
"We actually do believe that expensing stock options is an important step in recognizing what is a compensation cost to companies," says a Yahoo! spokeswoman. "However, Yahoo! is concerned that the current rules that cover options accounting misstate option expense. We believe that accounting policymakers and companies must develop a more appropriate way to estimate the annual cost of options before deciding to expense them."
The spokeswoman says the company is looking into what that appropriate way might be and will continue to participate in ongoing industry discussions about options accounting.