In this paper, we propose a method of accounting for stock options that tracks the effect of the options on shareholder value. The accounting approach we outline can be applied not only to employee stock options but to all claims that are effectively convertible into common shares, including convertible preferred stock, warrants, and call and put options on the firm's own stock. Our proposal also aims to make accounting consistent with stock prices, since the market surely takes account of the (potential) valuation effects of these claims when setting stock prices. Accordingly, the accounting we propose is that which a sophisticated equity analyst might use to correct the deficiencies in GAAP when valuing common shares. Most important, the accounting satisfies the objective of faithfully reporting to shareholders.
Ohlson, James, and Stephen Penman. "Accounting for Employee Stock Options and Other Contingent Equity Claims: Taking a Shareholder's View." Journal of Applied Corporate Finance 19, no. 2 (Spring 2007): 105-110.
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