FASB Issues Final Stock Option Rule

The mandate for expensing equity-based compensation has arrived, but what will the SEC have to say about it?

The Financial Accounting Standards Board has finally published Statement 123R, a revised standard that requires most companies to recognize the cost of stock options on their books by the middle of next year.

Under FASB’s original standard, published in 1995, companies were allowed to keep the cost of broad-based stock options off their income statement as long as they made footnote disclosures of what net income would have been if options were expensed. Particularly after recent accounting scandals, however, the standards board received complaints from auditors, academics, and investors that not treating stock options as an expense impaired the transparency, comparability, and credibility of financial statements.

FASB board member Michael Crooch believes that Statement 123R will improve financial reporting for companies. “This is something I’m proud of,” he said in a follow-up interview with CFO.com, noting that 123R includes significant examples for application and provides a thorough explanation of “how we got there.”

Public companies, other than those filing as small-business issuers, will be required to apply Statement 123R as of the first interim or annual reporting period that begins after June 15, 2005; the effective date for small-business issuers and private companies is December 15, 2005.

Issuing 123R also brings FASB up to speed with the International Accounting Standards Board, which also requires companies to recognize the cost of options. Despite some differences in the handling of income taxes, 123R and the IASB standard are “real close,” says Crooch. “Given all the guidance that’s in there, to have it as close as this is good.”

The Securities and Exchange Commission, which oversees FASB, still has some work to do. It’s Crooch’s understanding that the SEC may consider some safe harbors for measurement inputs. Companies have also reportedly asked the commission to allow non-GAAP disclosures and to permit earnings to be computed after companies “back out” the cost of stock-based compensation.

One widely reported loophole in 123R, which the SEC will undoubtedly scrutinize, concerns how companies have reportedly been accelerating the vesting of underwater options, which under current guidance requires income to be expensed immediately. The likely intent, suggest some observers, is to reduce the impact on reported income, since the expense would not need to be amortized after the revised standard takes effect.

Addressing reports of accelerated vesting, Chad Kokenge, a professional accounting fellow in the SEC’s office of the chief accountant, told attendees at a recent conference to “be prepared to explain your actions in your SEC filings.” That includes “the reasons” for accelerated vesting, he emphasized.

According to Crooch, FASB considered the issue but decided not to address it in the revised standard.

Crooch is hardly on a vacation now that the standard has been published. After a press briefing Thursday afternoon, he went back to his office where the next memo, on revenue recognition, was waiting for FASB’s December 20 meeting. “This is not a time to put down your pencil,” he said.

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