Backdating of stock options is one of the latest hot topics in the accounting world. There are around 100 companies which have declared that they have backdated their options, there have been restatements on the account of backdating and a dozen or so lawsuits on this issue. So what exactly is backdating?

Backdating involves assigning a stock option contract an earlier date than its actual grant date. The date assigned is an earlier date when the underlying stock traded at a lower price than it did on the day of the grant. By doing this the stock option holder gets an “in the money” options grant. In the money in literal terms means that the option has some value, this happens when the strike price is less than the market price. Such grants need to be expensed. Some companies, however, accounted for them as at-the-money grants, which under old accounting rules, did not need to be expensed. (Under FAS 123R, all options need to be expensed.)
Backdating of employee stock options is not necessarily illegal provided no documents have been forged, backdating is clearly communicated to company’s shareholders, it is properly reflected in the earnings, and backdating is properly reflected in the taxes.
The new FAS 123R maybe blamed for this change in the stock option backdating landscape. Under the old accounting rule for stock options, firms did not have to expense options at all unless they were in-the-money. However, under the new FAS 123R, the expense is based on the fair market value on the grant date, such that even at-the-money options have to be expensed.
Once again the companies will have to take a look at their internal controls and strengthen their option accounting and record keeping.