Company Valuation Under IFRS : Interpreting and Forecasting ...

Company valuation under IFRS
These points do not seem as odd if the form of valuation model chosen is an
economic profit model, since we are accustomed to non-cash items appearing in
profit and loss accounts. But it is crucial to understand that the same issues apply
even within the format of a DCF model.
2. Stock options
2.1 Why is it important?
In many sectors, such as technology and telecommunications, the remuneration
of executives contains a significant component of stock options. These options
provide management and other employees the opportunity to participate in the
capital growth of the business. At the same time they achieve a level of goal
congruence, i.e. harmonising the objectives of management and shareholders. In
order to understand corporate performance fully, analysts must appreciate the
cost of this significant component of remuneration. If it bypasses the income
statement then this may have significant implications for comparable company
analysis as well as accurate profitability assessment. Furthermore, if a PE
approach to valuation is to be employed then the analyst needs to be aware of
how the potential dilution resulting from stock option compensation is reflected
in EPS numbers. And the same point applies to intrinsic value models; there is a
cost associated with the dilution.
2.2 What is current GAAP under IFRS for stock
options?
Accounting for employee compensation would not typically be construed as an
area of controversy or complexity. Yet recent debates have shown that achieving
a broad consensus is a significant challenge.
Essentially, there are two key accounting issues relating to stock options that
must be resolved. First, what is the compensation charge to be recognised in the
income statement? Second, what is the impact, if any, on diluted EPS?
2.2.1 The Compensation Charge
Until recently, there was no guidance on this issue under International Financial
Reporting Standards (IFRS) and very little in most national GAAPs. Therefore,
US GAAP, in the form of SFAS 123 and APB 25 Accounting for Stock Issued to
Employees, were the appropriate reference points. There are two broad
approaches to calculating the compensation cost:
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