International accounting regulator cracks down on treatment of options

Share options will have to be treated as an expense in companies' financial statements under far-reaching proposals made by the International Accounting Standards Board today.

If implemented in full the changes will end accounting practices which the IASB says inflates profits, lowers costs and presents a misleading impression to investors. The proposals are an attempt to clean up company accounting in the wake of corporate financial scandals such as the Enron affair.

Sir David Tweedie, the chairman of the IASB, said: "Typically, transactions in which share options are granted to employees are not recognised in an entity's financial statements. As a result, the entity's expenses are understated and its profits are overstated. The time has come to close this gap in accounting standards."

Noting that 75 per cent of all options are awarded to the top five executives in most companies, he said: "They're going home with millions, these guys. And yet it is shown in the accounts as zero."

The changes are expected to meet with a hostile reaction from large companies, particularly in the United States, which has blocked similar moves before.

In the UK, the National Association of Pension Funds supports the initiative. David Gould, head of investment, said: "Some of the bigger companies may be concerned. But they should recognise that anything that improves disclosure and transparency is helpful."

The consultation process on the changes runs until March next year. The IASB cannot force other international jurisdictions to accept its proposals but says the changes should be implemented internationally to have full effect.

According to figures compiled by Bear Stearns, the impact of the new proposals would have cut operating income in the S&P 500 companies in the US by 8 per cent. Hi-tech companies, which have showered their executives with share options, would see the worst effects. Bear Stearns calculates that the reduction in operating income in the communications equipment sector would be 56 per cent.

The IASB says US companies bought back $490m (£320m) worth of shares in 2001 in order to balance the earnings dilution of share options. But it points out that given share options would typically be exercised when the share price is high, companies are buying back shares at the wrong time. Some large UK companies already account for share options as a cost to the bottom line, including Unilever and Boots. But in the US only the Enron affair has forced companies to follow suit.

Coca-Cola is one high-profile example while luminaries such as Warren Buffett and Alan Greenspan have voiced their support. In April, Mr Buffett said: "If options aren't a form of compensation, what are they? If compensation isn't an expense, what is it? And if expenses shouldn't go into the calculation of earnings, where in the world should they go?"

As part of its consultation paper the IASB is proposing that the fair value of an employee's options should be taken as a cost in the accounts over the period during which they are granted.