Investors Call for Changes to Stock Option Accounting Rules

A recent Wall Street Journal article highlighted company practices around adjusting for stock-compensation expense; namely, the practice of excluding this expense from cash flow when reporting financials for the year. Although FASB updated its standard to require companies to recognize stock-option compensation as an expense on income statements in 2004, cash-flow reporting does not require this. Therefore, companies like Snap. Inc. (as the article pointed out) may show a large positive cash flow when option expense is excluded, versus a negative cash flow if option expense is included. Since cash-flow metrics are frequently used in executive incentive plans as well as company valuations, this so-called “loophole” has attracted attention over the years. Most recently, the SEC’s Investor Advisory Committee mentioned that cash-flow reporting needs updating, and FASB has stated it is working on this issue.

The article cites some research showing that six companies in the S&P 500 “flip from positive to negative cash flow from operations if stock compensation isn’t added back,” while 238 companies total fall into this category. A much larger number of companies have negative cash flows that become even more negative if stock compensation was disregarded.

As FASB standards for cash-flow reporting have not been significantly updated since 1987, they may be a target for the SEC to tighten oversight and require modernization of the rules around what belongs where in the cash-flow statement, including potential changes to how stock-compensation expense is handled.