After reading through both schweser and CFAI, I cannot figure out the difference on the cash flow statement between the old method and the new method. Is the only change on cash from operations the tax advantage? Is there any other re-placement of cash flows? How do they determine the Cash from operations? Is it the number of shares the company purchased to replace the options employees exercised. For example: If employees exercised 100 options at $50, and the company repurchased 200 shares at $75, what would be the Cash from operations? Would it be (100 shares X $75) - tax benefits?
I think it depends on how those options were accounted for when they were issued. Not sure.
err…I believe tax benefits are included in Cash from Financing?
I meant expensing the options when they are issued!! Then they’ll flow through CFO. Otherwise CFF. Comments
You are correct, tax benefits from options are included in CFF. Also, the stock-compensation expense is adjusted from net income to derive CFO. In other words, it is added back under CFO on the CF statement. This expense is actually determined using the Black-Scholes option pricing model. Also, instead of buying back shares, companies will typically issue additional shares to meet option excercises. However, they will usually have a stock repurchase program where they periodically purchase shares. So, they do kind of indirectly fund option exercises by buying back shares. The shares issued through the options will be recorded on the statement of changes in shareholders equity as an increase to additional paid in capital and and incrase to common stock. They will also be recorded as a cash inflow from financing. The stock buybacks through the repurchase program will be recorded as a cash outflow from financing. These transactions will also be recorded on the statement of changes in shareholders equity as an increase in treasury shares (contra account), decrease in common stock and a decrease in retained earnings.
Wow TMurf, RIGHT ON! That seems to sum up the 8 or so pages schweser has on this topic. That is the need to know accounting stuff that I had to search different sources for. As an analyst (not GAAP): should we remove some cash from operating to represent the companies decision to buyback shares? This would be because, in a sense, this is a compensation expense. For example: Find the number of shares exercised and the strike price, find the number of shares repurchased and the price repurchased at; and then subtract the average strike price from the repurchased price. Multiply this number by the number of options exercised to get an actual cash outflow that can (in a sense) be attributed to compensation??
TMurf, just printed that and put it up in my cube, starting a wall of fame based on osmosis principles.