Financial Accounting Standards: Accounting for Stock Options and 
Other Share-Based Payments (08-JUL-04, GAO-04-962T).		 
                                                                 
GAO discussed its perspective on the process for establishing	 
accounting standards for private-sector entities and then, more  
specifically, the current proposals for accounting for stock	 
options. We recognize that accounting for stock options is a	 
complex and controversial issue on which reasonable people can	 
and do disagree. As a result, in light of the Financial 	 
Accounting Standards Board's (FASB) current proposed standard for
accounting for stock options and other share-based compensation, 
there has been a renewed interest for the Congress to possibly	 
legislate accounting rules for stock options. FASB is a 	 
non-governmental organization empowered to establish financial	 
accounting and reporting standards for private-sector entities.  
Although this function legally resides with the Securities and	 
Exchange Commission (SEC) for public companies as part of its	 
mandate to administer and enforce the provisions of the federal  
securities laws, the SEC has traditionally relied on FASB since  
1973 to fulfill this function. The U.S. capital markets depend on
a system of continuously improving financial information about	 
the underlying economic activities of companies. This information
is fostered and framed by independently established financial	 
accounting and reporting standards, collectively referred to as  
generally accepted accounting principles (GAAP).		 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-04-962T					        
    ACCNO:   A10871						        
  TITLE:     Financial Accounting Standards: Accounting for Stock     
Options and Other Share-Based Payments				 
     DATE:   07/08/2004 
  SUBJECT:   Accounting standards				 
	     Stocks (securities)				 
	     Fair market value					 
	     Cost accounting					 
	     Standards evaluation				 
	     Financial statements				 
	     Compensation					 
	     Employee incentives				 
	     Private sector practices				 
	     Standards and standardization			 

******************************************************************
** This file contains an ASCII representation of the text of a  **
** GAO Product.                                                 **
**                                                              **
** No attempt has been made to display graphic images, although **
** figure captions are reproduced.  Tables are included, but    **
** may not resemble those in the printed version.               **
**                                                              **
** Please see the PDF (Portable Document Format) file, when     **
** available, for a complete electronic file of the printed     **
** document's contents.                                         **
**                                                              **
******************************************************************
GAO-04-962T

United States General Accounting Office

GAO Testimony

Before the Subcommittee on Commerce, Trade, and Consumer Protection, House
Committee on Energy and Commerce

For Release on Delivery Expected at 1:30 p.m. EDT Thursday July 8, 2004

FINANCIAL ACCOUNTING STANDARDS

          Accounting for Stock Options and Other Share-Based Payments

Statement of David M. Walker Comptroller General of the United States

                                       a

GAO-04-962T

Dear Mr. Chairman and Members of the Subcommittee:

I appreciate the opportunity to discuss with the subcommittee GAO's
perspective on the process for establishing accounting standards for
private-sector entities and then, more specifically, the current proposals
for accounting for stock options. We recognize that accounting for stock
options is a complex and controversial issue on which reasonable people
can and do disagree. As a result, in light of the Financial Accounting
Standards Board's (FASB) current proposed standard for accounting for
stock options and other share-based compensation, there has been a renewed
interest for the Congress to possibly legislate accounting rules for stock
options. On June 28, 2004, we sent a letter to FASB commenting on its
proposed standard and a letter discussing the accounting standardsetting
process to the Senate Committee on Banking, Housing, and Urban Affairs.1

FASB is a non-governmental organization empowered to establish financial
accounting and reporting standards for private-sector entities. Although
this function legally resides with the Securities and Exchange Commission
(SEC) for public companies as part of its mandate to administer and
enforce the provisions of the federal securities laws, the SEC has
traditionally relied on FASB since 1973 to fulfill this function. The U.S.
capital markets depend on a system of continuously improving financial
information about the underlying economic activities of companies. This
information is fostered and framed by independently established financial
accounting and reporting standards, collectively referred to as generally
accepted accounting principles (GAAP).

On March 31, 2004, FASB issued an exposure document on a proposed
Statement, Share-Based Payment, an Amendment of FASB Statements No. 123
and 95, which addresses the accounting for compensation to employees in
the form of stock options and other forms of equity. The FASB's proposed
Statement would generally eliminate the ability for public companies to
account for share-based services using the intrinsic method (which
generally results in no expense being recognized) and would require
instead the use of a fair-value-based method, which would generally result
in companies treating stock options granted to employees as an

1U.S. General Accounting Office, Independent Standard-Setting Process for
Establishing Accounting Standards for Private-Sector Entities, GAO-04-480R
(Washington, D.C.: June 28, 2004). This letter contained as an enclosure
our comment letter to FASB.

                               Page 1 GAO-04-962T

expense based on their fair value when granted. 2 It is important to note
that in 1995, when issuing the current standard that is in place, FASB
clearly stated that the fair market value is the preferable method. The
current standard also includes guidance to that effect and requires that
if the fair market value method is not used, then disclosure must be made
of pro forma net income and earnings per share presented as if the fair
market value method had been used.

We support the concepts behind FASB's current proposed Statement requiring
companies to use the fair market value method, which essentially results
in companies recording stock options and other share-based arrangements as
an expense. In our view, stock options and other forms of share-based
payment have economic value and represent a form of compensation expense.
Therefore, we believe that the economic substance of such transactions
should be reflected as compensation expense in the calculation of a
company's net income to accurately portray its financial results. The
current standard, which permits companies to choose between the intrinsic
and fair value methods, allows companies to select the impact on net
income. It also creates a barrier to comparable financial information,
both domestically and internationally, because the choice of methods used
will result in differences in reported amounts across companies due to the
different methods of accounting. We believe that a requirement to expense
stock options and other share-based payment will provide additional
transparency, clarity, and comparability in financial reporting.

We also support the four principal reasons FASB cited for issuing the new
proposal: (1) addressing concerns of users and others that the use of the
intrinsic value method results in financial statements that do not
faithfully represent economic transactions and can distort the financial
condition and operations of the issuer; (2) improving the comparability of
reported financial information through the elimination of alternative
accounting methods; (3) simplifying U.S. generally accepted accounting
principles by requiring the use of a single method of accounting for
share-based payment; and (4) enabling international convergence and
greater international comparability in the accounting for share-based
payment.

2The proposed standard would permit nonpublic companies to measure
compensation costs based on the intrinsic method of accounting at each
reporting date until options are exercised or otherwise settled.

                               Page 2 GAO-04-962T

Notwithstanding our and others' views on the merits of various accounting
methods for stock options, we believe that the principle of independence,
both in fact and in appearance, is essential to the credibility of and
confidence in any authoritative standard-setting processes. With respect
to the role of FASB in this and other areas, we support its efforts, as
the SEC's designated independent non-governmental standard-setting body,
to identify issues for consideration, prepare exposure documents, conduct
outreach efforts and solicit comments on exposure documents, and consider
the resulting comments in finalizing and issuing new accounting standards.
FASB, in carrying out its standard-setting activities, has an established
process in place to obtain and consider feedback from its constituent
groups, including financial statement preparers, auditors, and users such
as individual investors, institutional investors, lenders, creditors,
professional analysts, and various other parties. These processes were
established in order to balance the competing interests and demands of the
various groups while providing standards that promote transparent,
credible, and comparable financial information. This time-tested and
proven deliberative process has served to strengthen financial reporting
and ensure general acceptance of the nation's accounting standards. This
process is especially important given the complexity and controversial
nature of some accounting standards, including the accounting for stock
options and other share-based payments.

We believe it is critical that FASB complete its analysis of comments
received on its exposure document on share-based payment and finalize its
proposed Statement in accordance with its established independent
standard-setting process. In enacting the Sarbanes-Oxley Act of 2002, the
Congress recognized the importance of having an independent
standardsetting process that facilitates accurate and effective financial
reporting and protects investors. As a safeguard, the Act specified
criteria for the SEC to use for determining whether a private-sector
accounting standard setter's principles will be considered as generally
accepted. The SEC determined that FASB met the statutory criteria
established in the Sarbanes-Oxley Act of 2002. In our opinion, the FASB's
independent standard-setting process, subject to SEC oversight, should be
allowed to proceed in its consideration of accounting for stock options.

I would like to add that GAO is involved in setting government auditing
standards and accounting standards for federal agencies. We have also
implemented deliberative processes to obtain and consider the perspectives
of affected parties on exposure drafts of proposed standards. Standard
setting is, by its nature, an iterative process and the standard

                               Page 3 GAO-04-962T

setter needs a high degree of independence to make decisions on what
represents the best standard in the public interest.

Mr. Chairman, this concludes my statement. I would be pleased to answer
any questions you or other members of the subcommittee may have at this
time.

For further information regarding this testimony, please contact Jeanette
M. Franzel, Director, Financial Management and Assurance, at 202-512-9471
or [email protected]. Michael C. Hrapsky also made key contributions to
this testimony.

                          (194460) Page 4 GAO-04-962T

This is a work of the U.S. government and is not subject to copyright
protection in the United States. It may be reproduced and distributed in
its entirety without further permission from GAO. However, because this
work may contain copyrighted images or other material, permission from the
copyright holder may be necessary if you wish to reproduce this material
separately.

GAO's Mission	The General Accounting Office, the audit, evaluation and
investigative arm of Congress, exists to support Congress in meeting its
constitutional responsibilities and to help improve the performance and
accountability of the federal government for the American people. GAO
examines the use of public funds; evaluates federal programs and policies;
and provides analyses, recommendations, and other assistance to help
Congress make informed oversight, policy, and funding decisions. GAO's
commitment to good government is reflected in its core values of
accountability, integrity, and reliability.

Obtaining Copies of The fastest and easiest way to obtain copies of GAO
documents at no cost

is through GAO's Web site (www.gao.gov). Each weekday, GAO postsGAO
Reports and newly released reports, testimony, and correspondence on its
Web site. To Testimony have GAO e-mail you a list of newly posted products
every afternoon, go to

www.gao.gov and select "Subscribe to Updates."

Order by Mail or Phone	The first copy of each printed report is free.
Additional copies are $2 each. A check or money order should be made out
to the Superintendent of Documents. GAO also accepts VISA and Mastercard.
Orders for 100 or more copies mailed to a single address are discounted 25
percent. Orders should be sent to:

U.S. General Accounting Office 441 G Street NW, Room LM Washington, D.C.
20548

To order by Phone:	Voice: (202) 512-6000 TDD: (202) 512-2537 Fax: (202)
512-6061

To Report Fraud, Contact:
Waste, and Abuse in Web site: www.gao.gov/fraudnet/fraudnet.htm

E-mail: [email protected] Programs Automated answering system: (800)
424-5454 or (202) 512-7470

Congressional	Gloria Jarmon, Managing Director, [email protected] (202)
512-4400 U.S. General Accounting Office, 441 G Street NW, Room 7125

Relations Washington, D.C. 20548

Public Affairs	Jeff Nelligan, Managing Director, [email protected] (202)
512-4800 U.S. General Accounting Office, 441 G Street NW, Room 7149
Washington, D.C. 20548

                               Presorted Standard
                              Postage & Fees Paid
                                      GAO
                                Permit No. GI00

United States
General Accounting Office
Washington, D.C. 20548-0001

  Official Business
  Penalty for Private Use $300

Address Service Requested
*** End of document. ***