The Daily Technical #104: What is the primary purpose of US GAAP?

Good morning. Welcome to the 104th edition of The Daily Technical. You’re here for one reason so let’s dive in.

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OVERVIEW OF YESTERDAY’S QUESTION
How would you handle stock options when calculating a company’s share count?

Under standard accounting practices, companies calculate potential share dilution by including vested (exercisable) stock options that are "in-the-money" (i.e., where the strike price is below the current share price).

Using the treasury stock method, it is assumed that the proceeds from employees exercising these options are used to repurchase shares at the current market price, thereby reducing the net dilutive effect.

However, some analysts adopt a more conservative approach by including all outstanding in-the-money options—both vested and unvested—in their calculations.

Their rationale is that unvested options are likely to vest in the near future, and since they are already in-the-money, excluding them could understate potential dilution.

This method prioritizes caution, ensuring dilution estimates account for all probable increases in shares outstanding.

Common Mistakes

1. Overlooking the distinction between vested and unvested options, inadvertently skewing the share count. Ensure you identify and only include options eligible for conversion—that is, vested in-the-money options—unless you are explicitly utilizing an alternative method.

2. Ignoring the repurchase of shares with option proceeds when calculating the dilutive impact. Always factor in the treasury stock method, using the proceeds from option exercises to buy back shares, as this accurately captures dilution.

TL;DR

• Include vested in-the-money stock options in dilutive share count.

• Use proceeds from options to repurchase shares at current price (treasury stock method).

• Some professionals include all in-the-money options, vested or unvested.

• Including unvested options offers a conservative estimate of potential dilution.

• Choose method based on analysis needs: precision vs. conservatism.

TODAY’S QUESTION
What is the primary purpose of US GAAP?

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