Extending the method of accounting for stock appreciation rights to employee stock options

In FASB Exposure Draft "Accounting for Stock-Based Compensation," the FASB advocates valuing employee stock options using the fair value at the grant date. A study discusses and illustrates the FASB approach, and presents an alternative method used to account for stock appreciation rights (SAR), which it shows are economically equivalent to stock options. Theoretically, the SAR approach: 1. reconciles the accounting for economically equivalent transactions, 2. produces accounting results that are objective and verifiable, 3. recognizes as expense an amount equal to the benefit to the employee and opportunity cost to the firm, and 4. matches expenses to the periods in which the benefits are received. Practically, when compared to the FASB proposal, compensation expense is easier to compute and understand if the SAR approach is extended to stock options. The FASB's Exposure Draft rejects this approach. The board concludes that stock-based compensation settled in cash differs from stock-based compensation settled in stock. It is argued that the FASB should look beyond definitions of liabilities and equities to the substance of the transaction.