Accounting treatment of option plans.

• Author: Lowe, Donna

Many companies, particularly start-ups, consider stock options the best form of compensation. Stock options are popular with employers because it is not necessary to part with cash to keep key employees well-compensated. These companies are also willing to accept some amount of shareholder dilution in exchange for the "incentive" that stock options can instill in employees.

The recent volatility of the stock market, however, has caused many to question if stock options are still the best form of incentive compensation. Besides that, the Financial Accounting Standards Board (FASB) is revising the accounting rules, so that companies with stock-based compensation arrangements need to determine if the revisions will negatively affect their financial statements.

History of Accounting Rules

The accounting rules associated with stock-based compensation plans are complex. The current generally accepted accounting principles (GAAP) for stock-based compensation plans are laid out in Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation (October 1995).

SFAS 123 encourages employers to adopt its fair value methodology to determine compensation expenses associated with stock-based compensation. Companies can elect to continue following Accounting Principles Board (APB) Opinion No. 25, for stock-based compensation, but only if a footnote disclosure showing the pro forma effect of using the fair value method is included. The rules of SFAS 123 and APB 25 apply to all forms of stock-based compensation, but the greatest impact is on stock options.

Recently, a series of technical bulletins and pronouncements clarifying SFAS 123 was released. However, these clarifications pertain primarily to footnote disclosures, because most companies continue to follow APB 25 for employee awards. However, now that the FASB is "cleaning up" APB 25, companies may have to change the way they account for their stock option plans. While the FASB's project is intended to clarify (not alter) the provisions of APB 25, several items will have different interpretations as a result.

The most recent information from the FASB indicates that the new interpretation will be effective prospectively for all awards made after Dec. 15, 1998; the exposure draft will be released in the first quarter of 1999 and the final pronouncement will be released in the fall of 1999. The discussion that follows is based on the FASB meetings to date. The rules will continue to evolve during the year as the exposure draft is released and the final pronouncement is developed.

The changes have not been released and an effective date has not been announced, but companies may want to begin evaluating the possible impact...