Standards
Global Options
The debate on the best method to account for employee stock options continues.
FROM: JUL-AUG 2003 ISSUE | BY STEPHEN SPECTOR
Acynic once observed that "If at first you don't succeed, give up." Obviously, the international accounting community never talked to that fellow since collectively, they are once again attempting to derive acceptable standards on accounting for stock options. Last issue, Derek Strocher's feature article, "Options to Expense," addressed some of the difficulties associated with accounting for stock options. Despite these problems, Canada, the United States and the International Accounting Standards Board (IASB) have all indicated that they will be re-examining the current standards that deal with this form of compensation.
IASB
First off the mark was the IASB. In November 2002, the Board released an exposure draft that will, subject to public comment and possible revision, require stock options to be expensed on issuers' income statements. There will be no exemptions from the requirements, and the recognition and measurement standards will apply to both public and private companies.
If approved, the resulting International Financial Reporting Standard (IFRS) would require the following:
- All share-based payment transactions must be recognized in the financial statements, using a fair value measurement basis. The expense would be recognized in the period when the goods or services are received or consumed. For example, an employee's provision of service would be the triggering event. Another example would be when a consultant provides services and is compensated with stock options rather than cash.
- Transactions in which goods or services are received as consideration for equity instruments of the entity should be measured at the fair value of the goods or services received, or the fair value of the equity instruments granted, whichever is easier to determine. For transactions measured at the fair value of the equity instruments granted (such as transactions with employees), fair value should be estimated at grant date. For transactions measured at the fair value of the goods or services received, fair value should be estimated at the date of receipt of those goods or services.
- To estimate the fair value of a share option, where an observable market price does not exist, an option pricing model should be used. The exposure draft does not specify which particular model to use. The entity should disclose the model it used, the inputs to that model and other information on how it measured fair value.
The proposed IFRS contains various proposals related to estimating the fair value of employee share options, to allow for differences between employee share options and traded options. For example, the valuation should take into account all types of vesting conditions, including service conditions and performance conditions. In other words, the grant date valuation should be reduced to allow for the possibility of forfeiture because of failure to satisfy vesting conditions.
Canada
As released in December 2001, Canadian GAAP requires fair value accounting and concomitant expense recognition for all stock-based payments to non-employees, and for employee awards that were stock or called for settlement in cash or other assets and for stock appreciation rights. For all other employee awards, enterprises were permitted to disclose pro-formanet income and pro-formaearnings per share as if the fair value-based accounting method had been used in place of expense recognition. This requirement is more or less the same as U.S. Financial Accounting Standards Board (FASB) Statement No. 123, Accounting for Stock-Based Compensation.
The Canadian Accounting Standards Board's (AcSB) original actions were consistent with its stated policy to harmonize with FASB requirements. In April 2002, the Board chair acknowledged that disclosure (as opposed to expensing) was not a satisfactory substitute; the disclosure option was meant to be a temporary measure. Nevertheless, despite the fact that the AcSB concluded that the fair value-based method was superior to other methods, it was deemed that unless and until the FASB changed its rules, there would be no significant changes to Canada's GAAP.
Shortly after the November 2002 release of the IASB exposure draft, the AcSB announced that it planned to revise Handbooksection 3870 to require the expensing of certain stock options. If approved, the CICA amendments would eliminate the current option allowing an enterprise to disclose for each period for which an income statement is provided, the pro-formanet income and pro-formaearnings per share as if the fair value-based method of accounting had been applied. Although this action would ostensibly require the recognition of stock-based compensation expenses for all stock-based compensation transactions, the CICA held off requiring it for most employee stock purchase plans. Consequently, the proposed amendment would leave section 3870 basically harmonized with U.S. GAAP.
However, the December 2002 CICA exposure draft did hold out a ray of hope for more radical action. The AcSB indicated that it was prepared to converge with the draft IASB IFRS (and away from FASB 123) if respondents could show that the result would be demonstrably superior to that produced by section 3870. At the time of writing, the outcome of this consultation was unknown.
United States
About the same time the IASB released its exposure draft, the FASB sought comments from its constituents relating to the accounting for stock-based compensation, including valuation of stock options, as part of an Invitation to Comment. The Invitation to Comment explained the similarities and differences between the proposed guidance on accounting for stock-based compensation included in the IASB's draft and the FASB's guidance under Statement 123.
Based on the responses to the Invitation to Comment, the FASB stated that it would assess whether it should undertake a more comprehensive reconsideration of its standard, and revisit its 1995 decision permitting companies to disclose the pro-formaeffects of the fair value-based method rather than requiring all companies to recognize the fair value of employee stock options as an expense in the income statement.
After analyzing the feedback it received, the Board added a project on stock-based compensation to its technical agenda in March 2003. In light of the actions taken by the IASB and Canada, the FASB recognized that it could wind up with U.S. GAAP diametrically opposed to that followed by Canada and the European Union. In adding the project, the FASB also acknowledged that a single, high-quality accounting standard on stock-based compensation with worldwide acceptance was needed for capital markets to efficiently assess the impact of stock options on companies' financial statements.
One Standard?
There is still no clear consensus on how to account for stock options and other share-based forms of compensation. The IASB approach, which will become GAAP for the European Union, Australia and New Zealand on January 1, 2005, permits no exceptions. All stock options must be expensed. The Canadian position is uncertain. We may adopt the IFRS approach or we may retain the U.S. approach — at least until the FASB changes its requirements. And what about the FASB? Political sensitivity and other post-Enron pressures suggest that, slowly but inexorably, U.S. GAAP will move toward adoption of the expense alternative. And if that happens, it is almost certain that Canada will follow the U.S. lead, with the end result being the single, high quality accounting standard already acknowledged as necessary.
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Stephen Spector, MA, FCGA, owns Spector and Associates and teaches Financial and Managerial Accounting at Simon Fraser University. He also serves on CGA-BC’s board of governors. E-mail shspector@shaw.ca.