A question we often get is how qualified employee stock options (QESOs) should be booked. A QESO is a promise by the company to issues shares in the future, often at a price which is below the current market price, and the question is whether this should be booked as a personell cost when it is issued, or not booked at all to start with, and then booked as a share issue when the actual shares are eventually issued.
The argument for booking them as a cost is that QESOs often are issued in exchange for paying a somewhat lower salary. In an alternative scenario, where no QESOs were issued and a higher salary paid, the costs of the company would be higher. Against this background, booking the QESOs as a cost makes sense, and should give a more truthful picture of the financial state of the company. This is a line of argument used by some auditors and accountants in favour of booking QESOs as a cost.
But there are also strong arguments against. No money will actually be paid out, neither now nor later. The “cost” only manifests itself by the shareholders being diluted when the option is exchanged for new shares. But to incur an artificial cost on the company which does not correspond to any actual money flowing out of the company is a peculiar way of communicating to the shareholders that they may be diluted in the future.
Booking QESOs as costs also leads to other anomalies. What happens if a person who has received QESOs leaves and thus is not eligible to redeem the options into shares? Logically, the transaction should be reversed, and the company would book this as a profit. But to book the loss of a key person as a profit is misleading.
We have discussed the issue with a number of different accountants and auditors, and our conclusion is that there is no consensus regarding this issue. For example, there is no recommendation from the Swedish Accounting Standards Board (Sw. “Bokföringsnämnden“), which is a government authority tasked with developed generally accepted accounting principles. When we asked two auditors from the same large auditing firm, we got opposing opinions.
Our recommendation is therefore not to book QESOs as a cost, but of course to note that they have been issued in the annual report. This gives a good balance between stating relevant facts, and not adding artificial costs into the accounts.
But what do you do if your auditor insists on booking them as costs? Firstly, argue why that it should not be so, but if the auditor won’t budge, then accept booking them as costs. Properly booked it should not affect the tax that the company pays, so the main effect is to make the result for the company look a bit worse than if they had not been booked as a cost.