Alphabet to recognise stock compensation as an expense – only a decade late!

It’s good to see Alphabet (Google) take the accounting high ground and finally concede what should be obvious; that stock compensation is a “real cost of running our business” and henceforth will be expensed as such within its ‘adjusted’ earnings analysis. As such, the group is bringing its ‘adjusted’ earnings in line with those already produced in the GrowthRater and the approach recommended by the IASB since 2004 and adopted by most professional investors and analysts, at least this side of the Atlantic.$File/Applying-SBP-April2015.pdf


While there are many grey areas in pricing the fair value of a deferred and non-transferrable share option, the principal ought to be well established by now. If a company pays for a service with cash, it is an expense. If a company raises the cash by first issuing and selling new equity and then pays you the cash, it is also still an expense, as it would be if it issued the shares directly to you and you sold them on for cash. In these circumstances, when there is a transfer of intrinsic value from shareholders (the dilution and transfer of ownership) to the provider of a service, this transfer of value is clearly an expense. Where it can get a little obscure, is when the value of the item transferred in exchange for the goods and services has limited current intrinsic value, but a substantial time or opportunity value, such as options (or warrants) issued at the prevailing share price. The opportunity awarded to the recipient has a value which can be assessed however, and which becomes a future potential liability to the party making the award. Just as if I wrote a call option on a stock, this represents an exchange of value which could have very real cash implications. When a company issues options it is forgoing real cash that could have been raised today from selling these instruments. To claim otherwise smacks of sophistry.


Fortunately, equity markets seem to be fairly efficient in looking through these gimmicks, although it does mean that for most US tech companies one needs at least three version of earnings; statutory (GAAP), the company ‘adjusted’ numbers and a real adjusted figure to strip out the non-operating items (but not stock comp).


So, well done Alphabet, for making such obscenely large profits that it feels it can now dispense with the funny-money earnings.
“Before I move to my conclusion, I’ll quickly cover some specific changes to our past practices. First, we are making changes to our non­GAAP reporting. SBC has always been an important part of how we reward our employees in a way that aligns their interests with those of all shareholders. Although it’s not a cash expense, we consider it to be a real cost of running our business because SBC is critical to our ability to attract and retain the best talent in the world. Starting with our first quarter results for 2017, we will no longer regularly exclude stock­based compensation expense from non­GAAP results.


As a payments company, one might have hoped that Paypal would be more appreciative of the value transfer occurring and perhaps ought to be encouraged to take Alphabet’s lead here, although without parking the >+40% increase in stock-comp costs outside of its ‘adjusted ‘ scope, its Q4 FY16 EPS would have been approx -23% below the level reported!

“We exclude stock-based compensation expense from our non-GAAP measures primarily because they are non-cash expenses that management does not believe are reflective of ongoing operating results.”