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Put options written on an enterprise's own stock: Accounting for a popular derivative
Author(s) -
Schneider Douglas K.,
Schneider Douglas K.,
McCarthy Mark G.
Publication year - 1995
Publication title -
journal of corporate accounting and finance
Language(s) - English
Resource type - Journals
eISSN - 1097-0053
pISSN - 1044-8136
DOI - 10.1002/jcaf.3970060304
Subject(s) - accounting , business , treasury , issuer , finance , accounting method , commission , popularity , financial accounting , equity (law) , economics , accounting information system , psychology , social psychology , archaeology , political science , law , history
In recent years, approximately two dozen U.S. firms have issued put options written on an enterprise's own stock (POWEOS). The motive for their issuance is to help subsidize stock buy backs or treasury stock. Traditionally, firms were precluded from issuing such a security. But a 1992 letter ruling by the Securities and Exchange Commission (SEC) opened the door for firms to begin issuing POWEOS. The appeal of this security is the tax‐free status of the premium and the limited risk to the issuing firm. There appears to be the potential for a large increase in the number of firms using POWEOS because the financial instrument has thus far provided positive benefits to issuers. Current tax rules favor the use of POWEOS even though current accounting rules impose a reporting penalty by removing total potential repurchase cost from equity. However, just as POWEOS are poised to increase in popularity, new accounting rules for POWEOS are being considered and suggested. Although one suggested accounting change would be beneficial from a reporting standpoint, it could raise uncertainties about the tax status of POWEOS' premiums. While the benefits of using POWEOS should continue to outweigh the costs, firms interested in using POWEOS should be alert to possible changes in accounting rules and possible tax implications.