Staggered Start for Options Expensing

Although at least 26 companies will be required to expense stock options beginning next month, there is no consensus as to whether, or when, analysts should begin including the expense figure in earnings projections.

Most public companies must begin expensing options as of their first fiscal year that begins after June 15. For companies with a calendar year-end, that won’t be until March 31, 2006.

Cisco Systems Inc., which has proposed a widely discussed plan to market a derivative that could reduce the impact of stock-option expensing on its earnings, kicks off its fiscal year on August 1.

However, at least 26 companies — which have a fiscal year ending June 30 — will be required to expense stock options next month, according to corporate communications firm Financial Dynamics. These options-expensing trailblazers include Microsoft, Procter & Gamble, and Newscorp.

Altogether, at least 76 companies will begin expensing options before the end of the calendar year, including investment banks Morgan Stanley and Lehman Brothers Holdings and cruise line Carnival Corp.

The staggered start for options expensing is upsetting many investment professionals because there is no consensus as to whether, or when, analysts should begin including the expense figure in earnings projections, which are widely used by investors. This variable could play a major role in whether a company meets, beats, or misses consensus earnings estimates, which in turn affect its stock’s performance.

“Not only is there the issue of comparability of analysts’ estimates between those that include the expense versus those that do not, there is the potential for unduly negative comparisons when a company reports GAAP EPS, and the First Call mean estimate excludes the expense,” noted Financial Dynamics in a recent report. “We can envision media headlines that cite an earnings miss when, in reality, the First Call estimate overstates actual earnings.”

Financial Dynamics added its recommendation that companies consider following FAS 123R — the Financial Accounting Standards Board’s revised rule on options expensing — as soon as possible; break out the amount of the expense in the text of the earnings release, and consider adding a supplemental table showing the impact of the expense on earnings; and include the expense in analysts’ First Call estimates.

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