Accounting for Stock Options: Measuring the Real Cost Through Time

Accounting for stock options is a controversial issue. The FASB recognized that the “intrinsic value” method, which had been used for years, failed to adequately account for the costs involved. To rectify the problem they suggested the use of a “fair value” method. Their proposal met with strong objections from companies, which were concerned with the impact of the proposed standard on their reported profits. Consequently, the board relented and allowed the use of either method. Unfortunately, both the intrinsic value and fair value approaches have deficiencies, particularly in regard to how they measure compensation expense and gains and losses over time. This paper addresses these shortcomings by developing two alternative cost measurement approaches that apply an option‐pricing model on an iterative basis over the life of the option. Both approaches represent specific ways to implement exercise‐date measurement techniques for stock options. The paper argues that both approaches provide more relevant and reliable measures of an option’s cost than either intrinsic or fair value methods.