Guidance for Revenue and Expense Term Paper

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Expensing of Stock Options

Expensing of stock options is a far more complicated issue. The Federal Accounting Standards Board (FAS) strongly recommends expensing of options and is trying to make it a legal requirement (Rash, 2004).

The pros of expensing options include providing a level playing field so that companies that use cash bonuses and companies that use stock options each have an expense on the income statement (McPeak). and, some believe it will improve corporate governance by reducing the incentives to inflate income and earnings per share.

However, there are many significant challenges for a company that expenses options (McPeak). Many companies have issued options to multiple levels of employees to attract high quality employees and to motivate them. If companies expense options at the time they are granted, it will be difficult to continue to grant options to as many employees. Some feel that there is already a level field between companies that use cash bonuses and companies that use stock options because the shares awarded become outstanding for purposes of calculating earnings per share. Therefore, a company recording an expense for the option as well as upping the number of shares outstanding is taking a double hit to earnings per share.

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Still others argue that it is futile to make a company record stock option expenses as accounting entries because they have no cash impact and that the behavior of unscrupulous management will never change. Further, there is no universally accepted method to determine the value of a stock option

Recommendations

The manufacturing company should use accrual basis accounting and follow GAAP guidelines for revenue and expense recognition. Stage of completion of the transaction applied to revenue recognition is desirable in circumstances where the company wishes to record revenue as soon as possible to meet earnings forecasts and to have a smoother flow of revenue and expenses over time when there are large contracts, provided the company meets the guidelines for this method.

With regards to expensing stock options, the company might explore the use of stock awards instead of stock options. Unlike stock options, which gain value only if the company's stock price rises, restricted stock awards represent an actual gift of shares. This would keep the company from becoming a victim of corporate governance critics and being subject to possible forthcoming FASB requirements to expense the options, an expensive and complicated endeavor......

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