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Ethics in Stock Option Reporting Essay

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Updated: Nov 26th, 2021

Financial reporting reveals the data about the company’s performance. These data are often falsified in order to conceal certain profits, especially when reporting the stock options. Footnote disclosure in accounting for stock options and reporting stock directly in the financial statements differ in the truthfulness of the reported data; however, different processes for preventing financial frauds may easily detect the falsified information.

To begin with, footnote disclosure in accounting for stock options is a rather unclear and indefinite form of financial reporting. The information disclosed in the footnotes can often be misleading; some of the statements in footnotes may be too general because the “managers have rather broad freedom of choice regarding how frank to be and how to express what they put in footnotes” (Tracy, 2004, p. 106). Thus, for instance, eBay uses footnote disclosure for its financial reporting this is why “the extensive use of stock options at eBay is reflected in the footnote disclosures as large pro forma losses rather than the large profits reported by eBay” (Bradshow, 2004, p. 3). This has a considerable impact on the reported earnings, which is beneficial for the company but not for the investors. This is the main reason why the companies choose namely this method of financial reporting.

In contrast, reporting stock directly in the financial statements gives more accurate information of the current state of the company’s stock. This type of financial reporting “precludes directly including non-financial information in the financial statements of an organization” (Holsapple, 2003, p. 256). In other words, the body of the financial statement of a company which reports its stock directly contains the description of the activities which led to changing the value of the stock. This results in transparency of the company’s stock options; this trend has been initiated by Winn Dixie and Boeing in 2002 and then supported by AMB Property Corp. Within several years, “a growing number of companies joined AMB in its switch to expensing employee stock options, including Coca-Cola, Washington Post Co., Procter & Gamble, Wachovia, General Electric, Marathon Oil, and General Motors” (Bradshow, 2004, p. 3). Unlike footnote disclosure, reporting stock directly affects the financial ratio of profitability because the firm exhibits its full control of expenses, which shows that its rate of return is acceptable. In case with footnote disclosure, the expenses are concealed and no ratios are affected. Therefore, reporting stock directly is fairer than footnote disclosure but, despite this, some companies still choose it as an appropriate one.

When the company chooses to report about its performance unfairly, fraudulent financial reporting often takes place. Some processes used for preventing fraudulent reporting in accounting for stock options are maintaining ethical values within the company (this is the task of the manager who is expected to ensure ethical business conduct of each employee), carrying out internal audit (analysis of business processes and procedures, working out solutions for improvement, checking reliability of financial reports), external audit (performing evaluation of financial statements and tracing misstatements in them), and providing motivations for honest business practices (either material or non-material incentives). From these, external audit seems to be the best way of preventing fraudulent financial reporting because it is an unbiased and independent evaluation of financial statements. Using this process could help to avoid the situation which took place at eBay after the introduction of a new accounting disclosure, according to which the company, instead of reporting $48 million of net profit “would have reported a loss of almost $91 million if fair values of options had been expensed” (Bradshaw, 2004, p. 1). If external audit was carried out in the company, the misstatements in the financial report would have been detected by an independent auditor and the company would have failed to falsify this information.

Therefore, choosing a way of financial reporting depends on the decision of the company’s management. Choosing footnote disclosure in accounting for stock changes the information about the reported profits, while reporting directly in financial statement reveals only truthful information about the company’s performance. The former way of reporting may work if no fraudulent reporting preventing processes, such as external audit, are carried out in the company.

Reference

Bradshow, M.T. (2004). eBay, Inc.: Stock Option Plans. New York: The McGraw Hill Companies.

Holsapple, C.W. (2003). Handbook on Knowledge management: Knowledge Matters. London: Springer.

Tracy, J.A. (2004). How to read a financial report: wringing vital signs out of the numbers. New York: John Wiley and Sons.

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IvyPanda. 2021. "Ethics in Stock Option Reporting." November 26, 2021. https://ivypanda.com/essays/ethics-in-stock-option-reporting/.

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IvyPanda. (2021) 'Ethics in Stock Option Reporting'. 26 November.

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