FASB invites comment on options accounting

by Glenn Cheney

Norwalk, Conn. -- The Financial Accounting Standards Board has issued an invitation to comment on a report that compares its Statement 123, on employee stock option compensation, and a proposed statement on a similar topic that has been issued by the International Accounting Standards Board.

The purpose of the invitation, which includes a detailed comparison of the FASB and IASB documents, is three-fold, according to FASB practice fellow Michael W. Tovey. The document and its elicited comments will serve as a tool that the board’s constituents can use in writing comment letters on the IASB proposal.

"We’re hoping this invitation to comment will be a useful tool for constituents who want to analyze the IASB exposure draft on share-based payments and comment on it," Tovey said. "We also want constituents to be aware that there are similarities between the ED and FASB Statement 123. We also want to get feedback on our constituents’ view of the similarities and differences between the two."

Tovey said that the comments would also give FASB a good basis for discussion if it re-opens the issue of stock option compensation with the intent of converging the U.S. standard with whatever standard is adopted by the IASB and perhaps amending Statement 123 in response to the financial controversies of the past year. The board expects to consider adding the project to its agenda early next year.

The stock option issue became a political battle in the mid-1990s as the board hammered out Statement 123. The board originally proposed expensing such compensation on income statements. Corporations protested and enlisted the aid of the U.S. Senate, which passed a non-binding resolution asking FASB to drop the project altogether. The board eventually backed down, issuing a statement that required the disclosure of the value of stock option compensation issued but left the expensing of it optional.

In November of this year, the IASB issued a proposal for a standard on share-based payment that requires expensing. The proposal is meeting resistance from the corporate sector. The ad hoc International Employee Stock Compensation Coalition is the principal organization opposing the project.

In October, FASB issued an exposure draft of an amendment to Statement 123 that was intended to clarify and facilitate the transition to the expensing of stock option compensation for companies that choose to do so. The proposal would enable companies to immediately adopt the fair-value-based method to report the full effect of employee stock options in their financial statements. It would also give investors better and more frequent disclosure about the cost of employee stock options. It provides three methods of transition. The board has already decided to begin writing a final statement.

Grace Hinchman, senior vice president of public affairs at the Financial Executives International, a trade group of financial executives, said the FEI supports FASB’s efforts to converge its standards with international financial reporting standards. The FEI has advocated a more accurate and reliable measurement formula for valuing stock option compensation.

"I know of FEI member companies that have made the decision to expense stock option compensation. They are finding themselves in the conundrum of how to value the options appropriately," Hinchman said. "That issue is what’s driving the FEI to look at the valuation and come up with something that a majority of people are comfortable with and feel is predictable and reliable. Then we can start looking at the other aspects of the various proposals."

The FASB document highlights four main similarities between Statement 123 and the IASB proposal. Both standards hold that stock options granted to employees are valuable, and both establish fair value as the measurement objective. Both require that the fair value of equity instruments that are granted to employees be measured at the grant date. And both require that equity instruments granted to employees as compensation be recognized in the income statement over the period in which the employees provide services to earn the related benefits.

But the documents differ on several crucial issues. They put completely different emphases on the notion of issuance.

The standards prescribe different dates to measure the fair value of equity instruments granted for transactions with non-employees, and they use different methods to attribute compensation expense over the period in which benefits are earned, resulting in a difference in the total amount of cumulative compensation expense being recognized over the life of the award. The standards also differ on income tax benefits, employee stock ownership plans and application to nonpublic companies.

Both standards are principles-based, but their principles are different. Statement 123’s main objective is to account for stock-based compensation by measuring and recognizing the fair value of goods or services acquired in exchange for equity instruments. With respect to transactions with employees, the objective is achieved by using a modified grant-date fair-value measurement method, which is a hybrid of grant-date and vesting-date measurement methods.

The IASB proposal measures and recognizes the fair value of goods or services received in exchange for equity instruments. For transactions with employees, a form of the grant-date fair-value measurement method is employed as a practical expedient. That measurement method does not have characteristics of a vesting-date measurement method. The philosophical focus of the measurement method is on the services received.

The FASB document pointedly notes that the board will not be commenting on the IASB proposal and that responses to its invitation to comment will not substitute for comments on the IASB proposal. FASB requests comment by Feb. 1, 2003, and the IASB requests comments by March 7, 2003.