a

GAO

United States General Accounting Office

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

GAO-04-962T
Page 1 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 

1

U.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 2 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. 

2

The 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 3 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 4 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 franzelj@gao.gov. Michael C. Hrapsky also made key contributions to 

this testimony.

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