Using the same example, a company choosing the accelerated-recognition method would be required to book the first tranche of the grant during the first year, which would comprise the one-quarter portion ($250) plus a fraction of each of the other three tranches not yet recognized. Mathematically, the company would be recognizing about 52% of the grant in the first year versus 25% under the straight-line method.
In year two, the company would recognize roughly 27%of the grant, then about 15% in year three, and the remaining percentage in year four under the accelerated method. Ultimately, a company would recognize the same amount over four years regardless of the accounting method, with the difference being when it attributes the expense.
By contrast, IFRS 2 does not allow a choice, but rather requires companies to use the accelerated-recognition method for graded-vesting options. “While the difference [between the standards] is a simple concept on the surface, how you implement the rule as a company could be a pretty daunting task in terms of the systems side of things,” asserts Gannon, noting that most corporate accounting systems today are based on the straight-line method. “So having to retool the system for each grant will be a challenge for many companies,” he adds.
Indeed, if a company’s systems are operating on a straight-line accounting basis, processing and tracking the option expense under the accelerated method involves making adjustments that could include reworking everything from the enterprise resource planning system right down to the bookkeeping system. The adjustment “has to be made on a grant-by-grant basis, and it’s not necessarily something that is going to be done on a spreadsheet if you issue a lot of grants,” emphasizes Gannon.
The Business of Stock Options
Further, there could be a business repercussion for companies that issue graded-vesting options and make the switch from U.S. GAAP to IFRS. If those companies are keen on using the straight-line method, they will likely consider changing vesting terms and issuing cliff-vesting options, says Gannon, which are recognized on more of a straight-line basis under both IFRS 2 and Topic 718. But switching to a cliff-vesting scheme creates a different economic scenario for the employee, who must stick with a company until the end of the vesting period to collect the award. In the end, that’s a less-desirable carrot for attracting and retaining talent.
A more subtle, but still tangible, difference between the two standards relates to the valuation of the stock options. To value the option under the accelerated-recognition model, a company must look into the future to estimate the potential fair value of the tranche. Depending on the volatility of a company’s stock price, there could be a material difference between the estimated value at the time of recognition and the actual valuation. That difference must eventually be reconciled.
Companies certainly perform such forward-looking valuations today. But the accelerated methodology required under IFRS 2 adds complexity and cost to the process of tracking the fair value of the estimated expense, something that is avoidable under Topic 718, says Gannon.