FASB Modifies Option Expensing Proposal

August 27, 2004 (PLANSPONSOR.com) - A split Financial Accounting Standards Board (FASB) has retreated a bit on its planned stock option expensing plan by deciding to stick with existing rules on accounting for income taxes of option awards.

FASB voted to keep the approach in nine-year old rules on employee stock compensation (FASB Statement No. 123), which the board’s March 31  draft expensing plan  would replace or amend. The tentative 4 to 3 decision by the national accounting rulemaker would effectively lessen the option awards’ impact on the company’s bottom line and represent a pullback from FASB’s original stance.

While the original proposal included a method for the reporting of options’ tax effects by tax deductions from option amounts recorded in financial statements having to be recognized in the income statement, the Statement 123 procedure is different. The approach embraced by the divided board relies on a “portfolio approach” to viewing option awards instead of focusing the unit of accounting on specific, individual options.

By relying on FASB No. 123, a company can avoid or lessen the income statement impact of writing off an options-related deferred tax asset if there is a remaining pool of paid-in capital from excess tax deductions from previous stock compensation awards. The advantage: the write-off gets charged to the pool of capital – an equity item – rather than dragging down earnings.

On the other hand, the FASB minority instead backed a procedure that is less popular with US companies than the one in the March FASB proposal, which mirrors eight-month-old rules issued by the International Accounting Standards Board (IASB).

Separately, a still-split FASB tentatively opted to modify its approach employee stock purchase plans (ESPP).   FASB decided to keep the principle in the March proposal that provides that discounts to ESPP participants not available to all holders of that class of securities are deemed compensation, according to a  staff summary . The FASB move would permit a discount to not be considered compensation if what the worker gets is equal to or greater than the proceeds he or she would get via a share offering from an underwriter, the FASB documents said.

FASB has said it plans to issue the final options expensing rule in the fourth quarter of 2004 so most companies can implement it by January 1, 2005.

Under the March plan, all forms of share-based payments to employees would be treated the same as other forms of compensation by recognizing the related cost in the income statement. The expense of the award generally would be measured at fair value at the grant date (See  The Bottom Line: Expensing Proposition ).  To arrive at this cost, FASB provided several valuation techniques in the Exposure Draft, including a lattice model (an example of which is a binomial model) and a closed-form model (an example of which is the Black-Scholes-Merton formula) that would meet the criteria for estimating the fair values of employee share options.