FASB stock comp rule ends decade-old debate - for now

Last month, the Financial Accounting Standards Board issued its long-awaited final statement on share-based compensation or "stock comp." But many wonder if that's the last that we'll hear of it.

Not likely.

Statement 123R (R as in "revised") marked the culmination of a 10-year struggle to establish accurate and equitable rules that would require, among other things, the fair-value expensing of stock option compensation on companies' income statements.

"We believe that recognizing the cost of these compensation arrangements in the financial statement improves the relevance, reliability and comparability of financial information and will help the users of financial information to better understand the economic transactions affecting companies and to better assess the absolute and relative profitability of companies," said FASB Chairman Robert Herz.

Herz said that the board had decided to review the original Statement 123 two years ago, after investors, creditors, analysts and others complained that the failure to include employee compensation costs in the income statement impaired the transparency, comparability and credibility of financial statements.

Statement 123R, which the board approved unanimously, brings the U.S. treatment of stock option compensation into line with those of Canada and the International Accounting Standards Board.

The statement calls for public companies to start expensing options beginning with their first annual reporting period after June 15, 2005.

The move was lauded by shareholder advocates, but criticized, perhaps understandably, by many larger companies - especially those in the technology sector - that offer stock options as part of employee compensation packages.

Stock options allow both executives and rank-and-file employees to buy shares of their company's stock in the future at a set price. If the company's share price rises prior to an employee exercising their options, the employee can buy the stock at the predetermined lower price, then subsequently sell it at the higher price.

After Statement 123 went into effect in the late 1990s, U.S. companies were allowed, but not required, to keep stock option compensation off their balance sheets. They have had the option to merely disclose in footnotes the hypothetical effect on the balance sheets if such compensation were expensed. Herz said that about 750 public companies have been voluntarily expensing stock option compensation.

Herz pointed out that the statement covers a very wide range of share-based compensation arrangements, including many forms of stock options, restricted stock plans, performance-based awards, share appreciation rights, and employee stock purchase plans.

Trouble on the Hill

Though the statement brings to an end the seemingly endless deliberations at FASB, the U.S. Congress is now debating the issue.

Several months ago, Congress, led by Rep. Richard Baker, R-La., passed H.R. 3574, a bill that would effectively override FASB, requiring companies to expense only the estimated value of the stock options issued to their five largest recipients. The Senate is considering a similar bill.

Jeffrey Peck, lead consultant for the International Employee Stock Options Coalition and a partner with lobbying firm Griffin, Johnson, Madigan & Peck, said that the issue is far from settled.

"I would think about this as the end of a chapter in the middle of a long book," Peck said. "There's a lot of work yet to be done by the Securities and Exchange Commission and the Congress and by others. FASB has finished its work, and that phase of the process is over, but there's plenty left to go."

Peck said that the SEC has indicated interest in promulgating additional guidance, and that members of Congress believe that more consideration should be given to the economic impact of the change in accounting.

"This part of the process was certainly a surprise to no one," Peck said. "Everybody knew FASB was going to end up in this place. This is where they started, and this is where their commitment was in the beginning, and they were not going to be deterred regardless of how many comment letters suggested that they not go down this path."

At a press conference, Herz declined to discuss the political struggle that has accompanied the project since its inception.

"Those who oppose the mandatory expensing of stock options have lobbied quite vigorously, and they say they intend to continue to do so," he said. "That is their right, but we need to fulfill our role, and that is what we have done in issuing this standard."

Herz said that an independent organization had estimated that if Statement 123R had been in effect two years ago, it might have impacted the profits of the S&P 500 by about 19 percent in 2002 and 8 percent in 2003. He added that now that the standard has been established, many companies will "change their business arrangements" to minimize the impact of the accounting change.

Board member Michael Crooch said that the SEC had expressed an interest in issuing implementation guidance to help companies adopt and properly use the most appropriate measurement model. He said that the commission was waiting to see the final statement before moving ahead with any additional guidance.