Taking stock of Statement 123.

• Author: Pacter, Paul
• Position: Accounting for stock-based compensation - Includes related articles - Corporate Reporting

It's here, finally: the FASB's stock-compensation regulation, vintage 1995. Find out what emerged from all the hoopla.

At long last, the Financial Accounting Standards Board has issued Statement 123, "Accounting for Stock-Based Compensation." Starting with calendar-year 1996 financial statements, the standard requires expanded disclosures, rather than recognition of compensation cost, for fixed stock options whose exercise price is at least equal to the stock price at the option grant date (in-the-money options). Companies will still recognize compensation for most performance-based options and other equity securities they issue to employees.

Although the statement doesn't require expense recognition for fixed options, it does encourage companies to use that method. Compensation cost for stock options and other equity instruments awarded to employees would be based on the estimated fair value at the grant date.

If you decide not to recognize compensation cost by adopting that method, you'll need to continue applying the provisions of Accounting Principles Board Opinion 25, "Accounting for Stock Issued to Employees." Opinion 25 requires expense recognition only if an option's exercise price is less than the underlying stock's market price on the grant date or other measurement date. That's normally true only for performance-based stock options, which are exercisable only if certain conditions are met. For garden-variety fixed stock options, Opinion 25 recognizes zero-compensation cost. If you follow Opinion 25, you must disclose in notes to the financial statements the pro forma effects on your net income and earnings per share as if you'd followed the new accounting method for all options. Statement 123 also introduces a new expense-recognition measurement approach for most variable or performance options, awards of restricted stock and other forms of stock-based compensation, for those who choose to move away from Opinion 25.

One caution: You must choose to follow either the recognition provisions of Statement 123 or Opinion 25 for all your stock-based compensation plans. You can't selectively apply the new standard to some plans and the old one to others. And once you've adopted the provisions of Statement 123, you can't switch back to Opinion 25, since the former's cost-accrual provisions are deemed preferable.

Statement 123 is effective for financial statements for fiscal years beginning after December 15, 1995, though the FASB permits earlier adoption. When you first start applying its provisions, you must include in your pro forma disclosures the effects of all awards granted in fiscal years beginning after December 15, 1994.

As guidance for companies applying these principles to optional recognition and to disclosure, the FASB has decided the following:

1. You must measure compensation cost using a valuation method similar to the one proposed in the exposure draft that preceded Statement 123. For options, that means using a pricing model that considers certain factors, such as the expected life of the option, volatility, dividends, the risk-free interest rate, the stock price at grant date and the exercise price. Your judgment will determine the option-pricing model and the assumptions to use in applying it.

2. If you're a nonpublic company, you can exclude volatility in estimating the value of your options, even if your stock trades frequently enough for you to compute volatility.

3. The standard considers compensation cost an expense during the periods in which the employee works for you, with an off-setting increase to equity. The statement presumes the service period is the vesting period, unless the stock-option plan defines some shorter period, and it contains special provisions for options with graded vesting on attributing compensation cost over the vesting period.

4. In measuring compensation cost, the statement addresses the nontransferability of employee options after vesting by using the expected life of the option. But you don't have to go back and adjust the measure of compensation cost at grant date if the actual...