Gartner Inc. (IT), the technology consulting firm, came clean with its 10-K application of SAB 108, and increased its retained earnings by a bit less than 2%. Even more striking: some of the adjustments also affected additional paid-in capital, and in total, the SAB 108 adjustment increased stockholders’ equity by 7%.
The biggest piece of the favorable increase to retained earnings - $7.4 million - came from a previously overstated income tax payable balance. According to the filing, “The adjustment was due to the carryover impact of an excess payable balance from prior years in the current taxes payable account which had accumulated over a period of years prior to 2000.” What made the current taxes payable too large is still unclear.
The most curious item in the SAB 108 stew had to do with stock option pricing:
Prior to October 1999, the exercise price of stock options granted to employees under the Company’s stock option plans was equal to the average of the closing price of the Company’s common stock for the five trading days immediately preceding the grant date. In 2006, the Company determined that for valuation purposes, the exercise price should have been the closing price on the date of grant (which is the formula used by the Company since October 1999). Accordingly, the Company revalued options granted prior to October 1999 using the closing price on the date of grant and determined that an additional $6.0 million of compensation expense should have been recorded. The cumulative effect of the adjustment resulted in a reduction in opening accumulated earnings of approximately $3.8 million, an increase to additional paid-in capital of $3.9 million, and a tax effect of less than $0.1 million.
Using SAB 108 to clear up stock option problems is probably not what the SEC had in mind when it published the bulletin. The Commission’s intent, I believe, in developing SAB 108 was to motivate companies to eliminate known old errors that had accumulated on balance sheets for years. If a company just figured out in 2006 that there were problems in its option practices, restatement might be a more appropriate route, or at least the disclosures discussed in the recent letter sent from the Division of Corporation Finance to companies with known option reporting issues.
IT 1-yr chart