Proper Accounting for Stock Based Compensation
The Financial Accounting Standards Board (FASB) is driving companies to properly expense equity based compensation using a fair value based method. On March 31, 2004 they issued a proposed Statement which included the factors which should be used for determining the fair value of options granted, to expense them properly. They clearly state that valuation techniques should take into consideration the following factors: the exercise price of the option, the expected term of the option, the current expected dividends on the underlying share, and the risk-free interest rate.
Brief History of Prior APB Opinions and FASB Statements
APB 25
The Accounting Principles Board, which later became the FASB, issued APB 25 in October 1972, providing a guideline for the expensing of options granted by a company to their employees. APB 25 allowed companies to expense options in a way that was very supportive of the issuance of stock options. If a fixed option was granted with a strike price that was equal to or more than the market price of the underlying stock, then it did not result in the recognition of any expense. However, performance stock options and stock appreciation rights (SARs), sometimes resulted in recognition of compensation cost because the number of shares, price, or eventual cash settlement were not known at the time of grant and had to be recognized later.FASB 123
FASB issued Statement No. 123 in October, 1995 after an eleven year project to improve the accounting treatment for stock-based compensation. During this project, FASB proposed that companies take a charge against earnings for all stock options granted to employees, however this produced much controversy so that when FAS 123 was issued, it allowed employers to continue to apply APB 25 and to only disclose what would have been the additional compensation expense for all stock options under the fair value method in a footnote to their financial statements. Companies could take a charge against earnings for all stock options, but they were not required to do so. Consequently, most companies continued to apply Opinion 25 with a disclosure in a footnote in their financial reports.br>FASB 148
FASB issued Statement No. 148 in December, 2002, to support a transition toward a voluntary change to the fair value based method of accounting for stock-based employee compensation. FASB was concerned that retroactive application would be excessively burdensome to financial statement preparers because the historical assumptions required to determine the fair market value of awards of stock-based compensation for periods prior to the issuance of Statement 123 were not readily available. It also stipulated prominent disclosures in the "Summary of Significant Accounting Policies" or its equivalent, in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. This prompted a number of companies to adopt the fair value based method of accounting for stock-based employee compensation.br>Analyze Your Company Options to Expense them Properly and Minimize Expenses
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