Fair value era.

• Author: Hardesty, David E.

FASB Statement No. 123(R), Share-Based Payment, has a single goal: to report the fair value of employee compensation paid in the form of stock options and other share-based payments in financial statements.

Some 800 public companies already use fair value. However, for years beginning after June 15, 2005, all public companies--other than small businesses--must do so. And all other public and private companies will use fair value for years beginning after Dec. 15, 2005.

While share-based payment arrangements include stock options, restricted and unrestricted stock, share appreciation rights and employee stock purchase plans, this article focuses on accounting for stock options.

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WHAT, AND WHEN, TO RECOGNIZE

The fair value method requires an issuer to recognize compensation for employee stock options as employees perform services to earn those options. The value of that compensation is determined on the option grant date. No further compensation is recognized once employees have earned the options, unless the options are modified.

For example, Entity X awards Jones 1,000 options Jan. 1, 2006, to acquire Entity X common stock. On that date, each option has a fair value of $10. Jones must remain an employee of Entity X for three years to exercise the options. Under FAS 123(R), Entity X recognizes $10,000 of compensation cost ratably over the three-year service period--if Jones remains with the company. If Jones leaves before vesting in the shares, and loses all of the options, Entity X recognizes no compensation cost. If Entity X has recognized a portion of the compensation cost prior to Jones' departure, then it must reverse that cost.

An issuer treats compensation cost recognized under the fair value method the same as cash compensation. That is, compensation cost arising from the issuance of stock options may be expensed or capitalized in the same way as cash compensation. Compensation cost is offset by an entry to paid-in capital. When a holder exercises options the issuer transfers a portion of paid-in capital to its outstanding stock account, but does not recognize any additional compensation cost.

The issuer ordinarily will receive a tax benefit from the issuance and exercise of stock options, and must estimate and account for that benefit in the same period that it recognizes compensation cost for financial reporting purposes. Until the actual tax benefit is known, the amount of accrued benefit (deferred tax asset)...