Project Updates

Equity-Based Compensation

Last Updated: September 16, 2004 (Updated sections are indicated with an asterisk *)

The staff has prepared this summary of Board decisions for information purposes only. Those Board decisions are tentative and do not change current accounting. Official positions of the FASB are determined only after extensive due process and deliberations.

Objectives
Summary of the Exposure Draft
History and Background
Reasons for Issuing the Proposed Statement
Differences between the Proposed Statement and Current Practice
How the Proposed Statement Would Improve Financial Reporting
How the Conclusions in the Proposed Statement Relate to the FASB’s Conceptual Framework
Costs and Benefits
The Effective Dates of the Proposed Statement
Immediate Plans
*Recent Board Meetings
*Summary of Decisions Reached in Redeliberations
*Board Meeting and Public Meeting Dates
Related FASB Articles
Additional Information for Interested Constituents
Contact Information

Objectives

In March 2003, the Financial Accounting Standards Board (FASB) added a project to address issues related to equity-based compensation (EBC). The objective of this project is to cooperate with the International Accounting Standards Board (IASB) in order to achieve convergence to a single, high-quality global accounting standard on EBC. The Board added this project to its agenda because of user concerns, concerns about comparability, and the Board’s goal of convergence.

This project will address that lack of comparability by resolving the following main issues: (a) whether compensation paid in the form of equity instruments (and other EBC arrangements) should be recognized in the financial statements and (b) how should compensation in the form of equity instruments (and other EBC arrangements) be measured in the financial statements. The ultimate goal is the establishment of one method for the recognition and measurement of EBC transactions that would be followed by all companies applying U.S. GAAP and international accounting standards.

FASB Exposure Draft, Share-Based Payment—an amendment of Statements No. 123 and 95 (Proposed Statement of Financial Accounting Standards)

[Download Exposure Draft]

On March 31, 2004, the FASB issued an Exposure Draft, Share-Based Payment, that addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. The proposed Statement would eliminate the ability to account for share-based compensation transactions using APB Opinion No. 25, Accounting for Stock Issued to Employees, and generally would require instead that such transactions be accounted for using a fair-value-based method.

Summary of the Exposure Draft

The proposed Statement addresses the accounting for transactions in which an enterprise exchanges its valuable equity instruments for employee services. It also addresses transactions in which an enterprise incurs liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of those equity instruments in exchange for employee services. The proposed Statement does not change the accounting for similar transactions involving parties other than employees or the accounting for employee stock ownership plans, which are subject to AICPA Statement of Position 93-6, Employers’ Accounting for Employee Stock Ownership Plans; the Board intends to reconsider the accounting for those transactions and plans in a later phase of its project on EBC.

The objective of the accounting required by FASB Statement No. 123, Accounting for Stock-Based Compensation, as it would be amended by the proposed Statement, is to recognize in an entity’s financial statements the cost of employee services received in exchange for valuable equity instruments issued, and liabilities incurred, to employees in share-based payment transactions. Key provisions of the proposed Statement are as follows:

  1. For public entities, the cost of employee services received in exchange for equity instruments would be measured based on the grant-date fair value of those instruments (with limited exceptions). That cost would be recognized over the requisite service period (often the vesting period). Generally, no compensation cost would be recognized for equity instruments that do not vest.

  2. For public entities, the cost of employee services received in exchange for liabilities would be measured initially at the fair value of liabilities and would be remeasured subsequently at each reporting date through settlement date. The pro rata change in fair value during the requisite service period would be recognized over that period, and the change in fair value after the requisite service period is complete would be recognized in the financial statements in the period of change.

  3. The grant-date fair value of employee share options and similar instruments would be estimated using option-pricing models adjusted for the unique characteristics of those options and instruments (unless observable market prices for the same or similar options are available).

  4. If an equity award is modified subsequent to the grant date, incremental compensation cost would be recognized in an amount equal to the excess of the fair value of the modified award over the fair value of the original award immediately prior to the modification.

  5. Employee share purchase plans would not be considered compensatory if the terms of those plans were no more favorable than those available to all holders of the same class of shares and substantially all eligible employees could participate on an equitable basis.

  6. Excess tax benefits, as defined by the proposed Statement, would be recognized as an addition to paid-in capital. Cash retained as a result of those excess tax benefits would be presented in the statement of cash flows as financing cash inflows. The write-off of deferred tax assets relating to unrealized tax benefits associated with recognized compensation cost would be reported as income tax expense.

  7. The proposed Statement allows nonpublic entities to elect to measure compensation cost of awards of equity share options and similar instruments at intrinsic value through the date of settlement. That election also would apply to awards of liability instruments. The proposed Statement also requires that public entities measure compensation cost of awards of equity share options and similar instruments at intrinsic value through the date of settlement if it is not reasonably possible to estimate their grant-date fair value.

  8. The notes to financial statements of both public and nonpublic entities would disclose the information that users of financial information need to understand the nature of share-based payment transactions and the effects of those transactions on the financial statements.

History and Background

Opinion 25, issued in 1972, required that compensation cost for awards of share options be measured at their intrinsic value, which is the amount by which the fair value of an equity share exceeds the exercise price. Opinion 25 also established criteria for determining the date at which an award’s intrinsic value should be measured; that criteria distinguished between awards whose terms are known (or fixed) at the date of grant and awards whose terms are not known (or variable) at the date of grant. Measuring fixed awards’ intrinsic values at the date of grant generally resulted in little or no compensation cost being recognized for valuable equity instruments given to employees in exchange for their services. Additionally, distinguishing between fixed and variable awards was difficult in practice, and resulted in a large amount of specialized and complex accounting guidance.

Statement 123, issued in 1995, was effective for share-based compensation transactions occurring in fiscal periods beginning after December 15, 1995. As originally issued, Statement 123 established a fair-value-based method of accounting for share-based compensation awarded to employees. The fair-value-based method of accounting requires that compensation cost for awards of share options be measured at their fair value on the date of grant. As opposed to the accounting under Opinion 25, the application of the fair-value-based method to fixed awards results in compensation cost being recognized when services are received in exchange for valuable equity instruments of the employer. Statement 123 established as preferable the fair-value-based method and encouraged, but did not require, entities to adopt it. The Board’s decision at that time to permit entities to continue accounting for share-based compensation transactions using Opinion 25 was based on practical rather than conceptual considerations.

In November 2002, the FASB issued an Invitation to Comment, Accounting for Stock-Based Compensation: A Comparison of FASB Statement No. 123, Accounting for Stock-Based Compensation, and Its Related Interpretations, and IASB Proposed IFRS, Share-based Payment, that compares the fair-value-based method of accounting for EBC in Statement 123 with the fair–value- based method of accounting for EBC in the proposed IFRS. (Note: The IASB issued IFRS 2, Share-based Payment, in February 2004. IFRS 2 is available from the IASB at www.iasb.org.) The Board issued the Invitation to Comment to achieve two objectives: (a) to provide information that would be useful to constituents that wished to comment on the IASB’s IFRS 2 (the comment letter deadline for the proposed IFRS was March 7, 2003), and (b) to solicit views from constituents on the key differences between IFRS 2 and Statement 123 and on certain other issues associated with accounting for EBC at fair value. The comment letter deadline for the Invitation to Comment was February 1, 2003. The FASB received 302 comment letters responding to the Invitation to Comment, which were reviewed and discussed at various Board meetings.

At the March 12, 2003 Board meeting the Board reviewed and discussed the comment letters received in response to the Invitation to Comment (See below). The Board also discussed issues relating to whether a project on EBC should be added to its agenda. At that meeting, the Board decided to add an EBC project to the agenda. The Board also decided that the project should be undertaken in cooperation with the IASB in order to achieve a single, high-quality accounting standard on EBC.

Reasons for Issuing the Proposed Statement

There are four principal reasons for issuing the proposed Statement:

  1. Addressing concerns of users and others. Users of financial statements, including institutional and individual investors, as well as many other parties expressed to the FASB their concerns that using Opinion 25’s intrinsic value method results in financial statements that do not faithfully represent the economic transactions affecting the issuer, namely, the receipt and consumption of employee services in exchange for valuable equity instruments. Financial statements that do not faithfully represent the economic transactions affecting an issuer can distort the reported financial condition and operations of that issuer and can lead to the inappropriate allocation of resources. Part of the FASB’s mission is to improve standards of financial accounting for the benefit of users of financial information.

  2. Improving the comparability of reported financial information through the elimination of alternative accounting methods. During the summer of 2002, a number of public companies announced their intention of voluntarily adopting Statement 123’s fair-value-based method of accounting for share-based compensation transactions with employees. Since then, approximately 500 public companies have voluntarily adopted or announced their intention to adopt the fair-value-based method. Despite the many public companies that have voluntarily adopted the fair-value-based method of accounting, there remains a large number of companies that continue to use Opinion 25’s intrinsic value method. The Board believes that similar economic transactions should be accounted for similarly (that is, share-based compensation transactions with employees should be accounted for using one method). Consistent with the conclusion in Statement 123, the Board believes such transactions should be accounted for using the fair-value-based method.

  3. Simplifying U.S. GAAP. The proposed Statement would simplify the accounting for share-based payments. The Board believes that U.S. GAAP should be simplified whenever possible. Requiring the use of a single method of accounting for share-based payment would result in the elimination of Opinion 25’s intrinsic value method and the many related detailed and form-driven rules.

  4. International convergence. The proposed Statement would result in greater international comparability in the accounting for share-based payment. In February 2004, the IASB, whose standards are followed by enterprises in many countries throughout the world, issued IFRS 2. IFRS 2 requires that all enterprises recognize an expense for all employee services received (and consumed) in exchange for the enterprise’s equity instruments. The IASB concluded that share-based compensation transactions should be accounted for using a fair-value-based method that is similar in most respects to the fair-value-based method established in the proposed Statement. Converging to a common set of high-quality financial accounting standards on an international basis for share-based payment transactions with employees improves the comparability of financial information around the world and simplifies the accounting for enterprises that report financial statements under both U.S. GAAP and international accounting standards.

The Board believes that the proposed Statement addresses users’ and other parties’ concerns by requiring enterprises to recognize an expense in the income statement for employee services received (and consumed) in exchange for the enterprises’ equity instruments, thereby reflecting the consequences of the economic transaction in the financial statements. By requiring the fair-value-based method for all public companies, the proposed Statement would eliminate an alternative accounting method and the accounting guidance associated with that method; consequently, similar economic transactions would be accounted for similarly. Finally, requiring the use of Statement 123’s fair-value-based method is convergent with IFRS 2.

Differences between the Proposed Statement and Current Practice

The proposed Statement would affect current practice in a number of ways, but chief among them is that it would eliminate the alternative to use Opinion 25’s intrinsic value method of accounting that was provided in Statement 123 as originally issued. Under Opinion 25, issuing stock options to employees generally resulted in recognition of no compensation cost. The proposed Statement would require public companies to recognize the cost of employee services received in exchange for equity instruments, based on the grant-date fair value of those instruments (with limited exceptions).

The proposed Statement would affect current practice in other ways, including the measurement attribute for nonpublic entities, the pattern in which compensation cost would be recognized, the accounting for employee share purchase plans, and the accounting for income tax effects of share-based payment transactions. Paragraphs 6–15 of the proposed Statement summarize those as well as other differences.

How the Proposed Statement Would Improve Financial Reporting

The proposed Statement would require the recognition of compensation cost incurred as a result of receiving employee services in exchange for valuable equity instruments issued by the employer. Recognizing compensation cost in the financial statements improves the relevance and reliability of that financial information, helping users of financial information to understand better the economic transactions affecting an enterprise and to make better resource allocation decisions. Such information specifically will help users of financial statements understand the impact that share-based compensation arrangements have on an enterprise’s financial condition and operations. The proposed Statement also would improve comparability by eliminating one of two different methods of accounting for share-based compensation transactions and would also thereby simplify existing U.S. GAAP. Eliminating different methods of accounting for the same transactions leads to improved comparability of financial statements because similar economic transactions are accounted for similarly.

How the Conclusions in the Proposed Statement Relate to the FASB’s Conceptual Framework

FASB Concepts Statement No. 1, Objectives of Financial Reporting by Business Enterprises, states that financial reporting should provide information that is useful in making business and economic decisions. Recognizing compensation cost incurred as a result of receiving employee services in exchange for valuable equity instruments issued by the employer will help achieve that objective by providing information about the costs incurred by the employer to obtain employee services in the marketplace.

With respect to the notion of comparability, FASB Concepts Statement No. 2, Qualitative Characteristics of Accounting Information, states that information about an enterprise gains greatly in usefulness if it can be compared with similar information about other enterprises. Establishing the fair-value-based method of accounting as the required method will increase comparability because similar economic transactions will be accounted for similarly. That will improve the usefulness of financial information. Neutrality is another important characteristic of accounting information. Establishing that method also eliminates the accounting bias toward using employee share options for compensation, which results in accounting that is neutral for different forms of compensation.

Completeness is identified in Concepts Statement 2 as an essential element of representational faithfulness and relevance. Thus, to faithfully represent the total cost of employee services to the enterprise, compensation cost relating to valuable equity instruments issued by the employer to its employees in exchange for their services should be recognized in the employer’s financial statements.

FASB Concepts Statement No. 6, Elements of Financial Statements, defines assets as probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events. Employee services cannot be stored and are received and used simultaneously. Those employee services are assets of an enterprise only momentarily—as the entity receives and uses them—although their use may create or add value to other assets of the enterprise. When an employer exchanges its valuable equity instruments for employee services, the receipt of those employee services creates an asset that should be either capitalized as part of another asset of the enterprise (as permitted by U.S. GAAP) or expensed when consumed.

Costs and Benefits

The mission of the FASB is to establish and improve standards of financial accounting and reporting for the guidance and education of the public, including preparers, auditors, and users of financial information. In fulfilling that mission, the Board endeavors to determine that a proposed standard will fill a significant need and that the costs imposed to meet that standard, as compared with other alternatives, are justified in relation to the overall benefits of the resulting information. The Board’s consideration of each issue in a project includes the subjective weighing of the incremental improvement in financial reporting against the incremental cost of implementing the identified alternatives. At the end of that process, the Board considers the accounting provisions in the aggregate and assesses the related perceived costs on a qualitative basis.

Several procedures were conducted before the issuance of the proposed Statement to aid the Board in its assessment of the expected costs associated with implementing the required use of the fair-value-based accounting method. Those procedures included a field visit program, a survey of commercial software providers, and discussions with Option Valuation Group members, valuation experts, compensation consultants, and numerous other constituents. Based on the findings of those cost-benefit procedures, the Board concluded that the proposed Statement will sufficiently improve financial reporting to justify the costs it will impose. Paragraphs C40–C47 of the proposed Statement provide a discussion of the Board’s cost-benefit assessment with respect to the proposed Statement.

[Download Cost-Benefit Survey]

The Effective Dates of the Proposed Statement

The proposed Statement would be applied to public entities prospectively for fiscal years beginning after December 15, 2004, as if all share-based compensation awards granted, modified, or settled after December 15, 1994, had been accounted for using the fair-value-based method of accounting. Nonpublic entities that had adopted the fair-value-based method of accounting for recognition or pro forma disclosures would use the same transition and effective date as public entities. All other nonpublic entities would apply the proposed Statement prospectively for fiscal years beginning after December 15, 2005.

Immediate Plans

The Exposure Draft was issued on March 31, 2004, with a 90-day public comment period that ended on June 30, 2004. The Board also held four public roundtable meetings; two on June 24, 2004, in Palo Alto, California, and two on June 29, 2004, in Norwalk, Connecticut. An audio file of the four roundtable meetings is available to listeners for free via the internet.  Click on the links below to access the audio file, a list of the organizations that participated in the roundtables, and additional information:

  • Additional details
  • Agenda
  • Participant affiliation
  • Discussion questions
  • Audio file

    • The staff has analyzed the comment letters received and has provided the Board with a summary of those comment letters. The comment letter analysis summary can be accessed below.

  • Comment Letter Analysis Summary
  • Form Comment Letter Information

    • Now that the FASB has analyzed those comment letters as well as considered the input received at the public roundtable meetings, the Board has resumed deliberations in public meetings to consider and discuss all the accounting issues raised during the public comment period. The Board will reach tentative decisions on each of those issues as they are addressed in the deliberative process. Recent decisions reached during redeliberations can be found below. After the Board has deliberated all of the issues, the final Statement drafting process will be completed and a final Statement will be issued. A final Statement is expected to be issued in the fourth quarter of 2004.

    Since a final Statement is expected to be issued in the fourth quarter of 2004, the Board has received several questions about the effective date of the final Statement. When the Board makes decisions related to a final Statement’s effective date, it must assess a variety of factors, including the need to have the final Statement in place to provide useful information to users of financial statements, the relative level of complexity of the accounting required by a final Statement, and the ability of enterprises to prepare for and implement the requirements of the final Statement. Generally, that assessment cannot be completed until all the critical accounting issues have been addressed by the Board during its deliberative process. Because the Board has neither completed its analysis of the comment letters received during the public comment period nor addressed all the critical accounting issues at this time, the Board is not in a position to complete that assessment. Nevertheless, the Board is cognizant of the needs of its constituents to have adequate time to consider and prepare for any new accounting pronouncement; as the Board moves through its final deliberations and begins to address critical accounting issues, which may affect the proposed effective date, it will carefully assess the factors noted above in deciding upon the appropriate effective date(s) and complete that assessment as quickly as possible.

    *Recent Board Meetings

    On September 8, 2004, the Board continued its redeliberations of the Exposure Draft.

    Employee Share Purchase Plans (ESPPs)

    The Board tentatively decided that an ESPP is not compensatory and does not give rise to recognizable compensation cost if all of the following conditions are met:

    1. The ESPP satisfies one of the following criteria:

      1. The terms of the ESPP are no more favorable than those available to all holders of the same class of shares.

      2. Any discount for the purchase of shares provided under the plan results in proceeds to the employer that are not less than the proceeds it would receive in an offering of shares if the shares had been issued to third parties by other means, for example, through an underwriter. A discount of 5 percent or less from the market price shall be considered to comply with this criterion without further justification.

    2. Substantially all eligible employees that meet limited employment qualifications may participate on an equitable basis.

    3. The ESPP does not incorporate option features. For example, a plan in which the purchase price is based on the share price at date of grant and that permits a participating employee to cancel participation before the purchase date and obtain a refund of amounts previously paid is a compensatory plan.

    The Board also made the following tentative decisions on implementation issues regarding ESPPs:

    1. If an entity justifies a purchase discount in excess of 5 percent, it would be required to reassess that discount at least annually and no later than the first share purchase during that fiscal year. If upon reassessment that discount is not deemed justifiable, subsequent grants using that discount would be compensatory.

    2. If an ESPP provides for a discount in excess of that specified in criterion 1(b) above, the entire discount associated with the grant, not just the portion in excess of that specified in criterion 1(b), is considered compensatory.

    3. Compensation cost related to grants made under ESPPs should be recognized over the requisite service period. The Board agreed that the requisite service period generally would be the period over which cash is accumulated for the purchase of shares or the purchase date if there is no required cash accumulation period.

    Disclosures

    The Board reaffirmed its support for the disclosure objectives in paragraph 46 of the Exposure Draft. Those objectives are as follows:

    An entity with one or more share-based payment arrangements with employees shall disclose information that enables users of the financial statements to understand:

    1. The nature and general terms of such arrangements that existed during the period and the potential effects of those arrangements on shareholders (for example, the transfer of value from existing shareholders to option holders upon exercise)

    2. The effect of compensation cost arising from share-based employee payment arrangements on the income statement

    3. The method of estimating the fair value of the goods or services received, or the fair value of the equity instruments granted, during the period

    4. The cash flow effects resulting from share-based payment arrangements.

    Minimum Disclosure Requirements

    With one exception, the Board reaffirmed its support for the minimum disclosure requirements described in paragraph B191 of the proposed Statement. The Board decided to modify the disclosure in paragraph B191(i) of the proposed Statement to require disclosure of the actual tax benefits realized from stock options exercised during the annual period. The Board also decided that the proposed Statement’s basis for conclusions should explain that disclosures are subject to its general materiality provision, which states that the provisions of that the Statement need not be applied to immaterial items. The Board considered whether to add any additional required disclosures beyond those described in paragraph B191 of the proposed Statement and decided against adding any such disclosures.

    Sensitivity Analysis

    The Board considered whether sensitivity analysis relating to certain parameters used for pricing stock options should be a required minimum disclosure and decided not to require it. The Board reemphasized the guidance provided on this matter in paragraph B193 of the proposed Statement, which states that an entity may provide such analysis in the form of a supplemental disclosure if the entity believes that the analysis would be useful to investors and creditors.

    Interim Disclosures

    The Board agreed that the minimum disclosure requirements relate to annual periods and decided not to amend APB Opinion No. 28, Interim Financial Reporting, to require any interim disclosure for share-based payment awards. The Board agreed that the basis for conclusions of the proposed Statement should explain that entities should refer to Opinion 28 in assessing whether any quarterly disclosures would be necessary for users of financial information to understand the impact of share-based payment transactions during a quarterly period.

    Other Disclosures

    The Board considered a variety of additional proposed disclosures and decided that none of them should be required.

    *Summary of Decisions Reached in Redeliberations

    On August 4, 2004, the Board began its redeliberations of the Exposure Draft. The Board discussed and affirmed its tentative conclusions on the following issues:

    Recognition of Compensation Cost

    1. Goods or services received (from any party) in exchange for share-based payment results in a cost that is recognizable in the financial statements; that cost should be recognized in the income statement as an expense when the goods or services are consumed by the enterprise. In making that decision, the Board noted that employee services received in exchange for share-based payment meet the definition of an asset (at least momentarily) in Concepts Statement 6. The consumption of that employee-service asset in an enterprise’s operations is the event that gives rise to a recognizable expense in the income statement. [8/4/2004 Board Meeting]

    Measurement Attribute and Measurement Date

    1. The cost of employee services received in exchange for equity instruments issued by public enterprises should be measured based on the grant-date fair value of those instruments. [8/4/2004 Board Meeting]

    Modified Grant-Date Method and Deep Out-of-the-Money Options

    1. The Board considered whether a notion of substantive vesting based on subsequent fluctuations in the value of equity instruments is theoretically consistent with the modified grant-date method and decided that such a notion is not theoretically consistent. Therefore, the Board decided not to propose any changes to the modified grant-date method for stock options that become deep out-of-the-money during the requisite service period. [9/1/2004 Board Meeting]

    Fair Value Measurement

    1. The Board tentatively affirmed its conclusion that the grant-date fair value of EBC instruments issued by public entities is measurable with sufficient reliability for purposes of financial statement recognition. [9/1/2004 Board Meeting]

    2. The Board affirmed its conclusion not to require the use of a specific model for estimating the grant-date fair value of employee stock options. The Board also discussed and decided to eliminate an explicit preference for the lattice model. In considering that issue, the Board agreed that the general measurement objectives and related principles in the proposed Statement provide sufficient guidance for evaluating and selecting an appropriate valuation method. The Board also directed the staff to make necessary changes to paragraphs B10–B12 to reflect those decisions in the proposed Statement. [9/1/2004 Board Meeting]

    3. The Board affirmed the guidance in the proposed Statement relating to estimating the expected volatility of the price of the underlying share and its decision not to prescribe a single method of estimating volatility. That is, the Board affirmed that an entity should make a reasonable and supportable estimate of expected volatility that is consistent with the stated fair value objective. The Board also considered requests to provide additional guidance on estimating volatility and agreed to include additional guidance on the process an entity might follow in estimating volatility, including explicit guidance that an entity may consider the implied volatility of outstanding convertible debt instruments, if any. [9/1/2004 Board Meeting]

    4. The Board decided to include in Appendix B of the proposed Statement a discussion of additional factors that may affect an employee's early exercise decision, such as an employee's age, length of service at the entity, the evolution of the stock price during the option term, and an employee's home jurisdiction (that is, domestic or foreign). The Board also agreed to note that entities should calibrate early exercise algorithms used in estimating a stock option's expected term based on actual exercise experience. [9/1/2004 Board Meeting]

    5. The Board considered a number of alternatives for accounting for the effect of an employee stock option's nontransferability suggested by constituents and affirmed its support for the notion of expected term as described in the proposed Statement. The Board affirmed that using the expected term provides an objective and theoretically sound methodology for estimating the effect of nontransferability on the value of an employee stock option. The Board also directed the staff to include an explicit section related to nontransferability in Appendix B of the proposed Statement. [9/1/2004 Board Meeting]

    6. The Board affirmed the proposed treatment of awards with reload features. That treatment requires that each reload grant be accounted for as a new award, if and when granted; consequently, the effect of a reload feature would not be considered when measuring the grant-date fair value of an award. [9/1/2004 Board Meeting]

    7. The Board agreed and tentatively affirmed that the guidance in the proposed Statement would not preclude an entity from considering the effect of clauses that accelerate vesting of an award upon death and disability in estimating the expected term of an employee stock option. The Board decided it is not necessary to include explicit guidance on that point in the proposed Statement. [9/1/2004 Board Meeting]

    8. The Board affirmed the proposed accounting for certain contingent features (often referred to as clawback provisions) related to "noncompete," nonsolicitation, or fraudulent behavior. Contingent features that require an employee to transfer equity shares earned or realized gains from the sale of equity instruments earned as a result of share-based payment arrangements to the issuing entity for consideration that is less than fair value on the date of transfer (including no consideration), such as a clawback feature, should not be considered in estimating the fair value of an equity instrument on the date it is granted. Those features are to be accounted for if and when the contingent event occurs. [9/1/2004 Board Meeting]

    9. The Board also considered, but decided not to provide, additional guidance on the following matters relating to measurement: (a) the meaning of statistical significance, (b) guidance in those situations in which historical information is not available, and (c) the number of steps needed to construct a binomial lattice. [9/1/2004 Board Meeting]

    10. The Board agreed that the guidance in Appendix B of the proposed Statement implies that an entity must have evidence supporting the fair value estimate. That guidance explicitly states in many instances that assumptions must be reasonable and supportable. The Board agreed that the guidance is sufficient. [9/1/2004 Board Meeting]

    11. The Board decided that changes in valuation techniques should be accounted for as changes in estimate; consequently, the Board directed the staff to combine paragraphs B17 and B18 of the proposed Statement and further modify them as necessary to reflect the decisions made during this meeting. [9/1/2004 Board Meeting]

    12. The Board decided to retain the alternative measurement method for situations in which it is not possible to reasonably estimate fair value. That method requires that compensation cost be measured at the award's intrinsic value through the date of exercise, forfeiture, or other settlement. [9/1/2004 Board Meeting]

    Recognition and Measurement of Equity-Based Compensation Liabilities

    1. The Board reaffirmed the recognition and measurement approach for share-based payment liabilities of public companies and also reaffirmed that fair value is the appropriate measurement attribute for such liabilities. [8/18/2004 Board Meeting]

    Attribution of Compensation Cost

    1. The cost of employee services received in exchange for equity instruments should be recognized over the requisite service period. [8/4/2004 Board Meeting]

    2. The key concepts underlying the definition of grant date in the Exposure Draft should be retained. [8/4/2004 Board Meeting]

    3. The Board discussed and decided to modify the requirements for recognition of compensation cost when the service inception date, as defined in the Exposure Draft, precedes the grant date. If the service inception date precedes the grant date because non-perfunctory shareholder approval has not been obtained, no compensation cost would be recognized in periods before such approvals are obtained. If the service inception date precedes the grant date because key terms and conditions of the award are not mutually understood, compensation cost would be recognized over the requisite service period beginning as of the service inception date. [8/4/2004 Board Meeting]

    4. The Board decided to retain the concepts of explicit, implicit, and derived service periods for determining the requisite service period of an award, to include their definitions in the glossary of the proposed Statement, and to include the example of a fully vested, deep out-of-the-money stock option in the definition of derived service period. [8/18/2004 Board Meeting]

    5. The Board decided to change the guidance for determining a derived service period. The derived service period would be the median (as opposed to the mode, which was proposed in the Exposure Draft) of the distribution of paths of a path-dependent option-pricing model on which the market condition is satisfied. In addition, the Board decided to clarify the meaning of certain statistical concepts used in the proposed Statement. [8/18/2004 Board Meeting]

    6. The Board decided that a change in the initial estimate of the requisite service period based on a performance or service condition would not result in the grant-date fair value of the award being revised using its grant-date inputs. Rather, such a change would affect the period over which compensation cost is attributed. Additionally, any unrecognized compensation cost would be attributed prospectively from the date of change based on the revised estimate of the requisite service period; that is, no cumulative-effect type adjustments affecting the recognized compensation cost would be permitted. [8/18/2004 Board Meeting]

    7. The Board agreed to retain the definition of market condition in the Exposure Draft as well as the Exposure Draft’s attribution method for awards with market conditions. [8/18/2004 Board Meeting]

    8. The Board directed the staff to add an example in the implementation guidance that addresses the accounting for an exchange in which the award’s contractual term is unaffected by an employee’s termination of service. [8/18/2004 Board Meeting]

    9. The Board decided that no portion of compensation cost would be immediately attributable at the date of shareholder approval to a period prior to such approval even if vesting begins during that prior period. [8/18/2004 Board Meeting]

    10. The Board decided to provide additional guidance in the proposed Statement to identify situations in which the service inception date occurs before the grant date. Normally, the service inception date is the grant date; however, if either of the following conditions applies, the service inception date precedes the grant date: (a) the award’s terms do not include a substantive future requisite service condition that becomes effective at the grant date or (b) the award contains a market or performance condition that if not satisfied during the service period preceding the grant date and following the arrangement’s inception results in a forfeiture of the award. [8/18/2004 Board Meeting]

    Awards with Graded Vesting

    1. With respect to awards with graded vesting, the Board decided to change the Exposure Draft’s requirements and instead use Statement 123’s original requirements. That is, if the fair value of the award is determined based on different expected lives for the options that vest each year, then compensation cost for an award with a graded vesting schedule should be recognized in accordance with the method described in FASB Interpretation No. 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans. If the expected life or lives of the award are determined in another manner, the related compensation cost would be recognized on a straight-line basis or in accordance with the method described in Interpretation 28. However, the amount of compensation cost recognized at any date should at least equal the value of the vested portion of the award at that date. [8/18/2004 Board Meeting]

    Minimum Equity Withholdings, Clawback Features, Etc.

    1. The Board addressed the accounting for certain share-based payment awards that contain a class of condition, including certain clawback provisions relating to noncompete requirements and illegal behavior as well as minimum equity holding requirements, that requires an employee to transfer cash or shares earned as a result of a share-based payment award to the issuing enterprise. The Board concluded that such conditions would not cause an equity award to be classified as a liability. Those conditions would be accounted for by the issuing enterprise if and when the specified event occurs by recognizing a credit equal to the lesser of the recognized compensation cost or the fair value of the consideration transferred on the date it is received by the enterprise. Those conditions would not be considered in estimating the grant-date fair value of an award. [8/18/2004 Board Meeting]

    Modifications and Settlements

    1. The Board decided to retain the guidance in paragraph 35(b) of the proposed Statement on the accounting for Type III modifications. That guidance specifies that total recognized compensation cost for an award rarely will be less than the fair value of the award at the grant date unless at the date of the modification the performance or service conditions of the original award are not expected to be satisfied. Thus, the total compensation cost measured at the date of a modification would be (a) the portion of the grant-date fair value of the original award for which the requisite service is expected to be rendered (or has already been rendered) at that date plus (b) the incremental cost resulting from the modification. Compensation cost would be subsequently adjusted, if necessary, in accordance with paragraph 26 of the proposed Statement. [9/1/2004 Board Meeting]

    2. The Board agreed to change paragraph 36 of the proposed Statement regarding equity restructurings to add the following clarifications:

      1. A a change to the terms of an award in accordance with antidilution provisions that are designed to equalize an option's value before and after an equity restructuring is a modification of an award (however, such modifications generally would not result in additional compensation cost if the antidilution provisions were properly structured).

      2. A change to the terms of an award in contemplation of an equity restructuring, or addingantidilution provisions in contemplation of an equity restructuring is a modification. However, a change to the terms of an award to add antidilution provisions in the absence of a contemplated equity restructuring is a modification that should not result in incremental compensation cost. [9/1/2004 Board Meeting]

    3. The Board decided to change the guidance for a modification from a liability award to an equity award in a manner that is similar to the guidance in IFRS 2, Share-based Payment. That is, an entity would compare the fair value of the instrument immediately before the modification with the fair value of the modified award and recognize any incremental compensation cost in accordance with the guidance in the proposed Statement. The modified award would be accounted for as an equity award from the date of modification. [9/1/2004 Board Meeting]

    Spinoffs

    1. The Board reconsidered the modification guidance for equity restructurings and decided there would be no exceptions to that guidance for spinoff transactions. In connection with a spinoff transaction and as a result of the related modification, employees of the former parent may receive unvested equity instruments of the former subsidiary, or employees of the former subsidiary may retain unvested equity instruments of the former parent. The Board decided that, based on the current accounting model for spinoff transactions, the former parent and former subsidiary should recognize compensation cost related to the unvested modified awards for those employees that provide service to each respective entity. For example, if an employee of the former subsidiary retains unvested equity instruments of the former parent, the former subsidiary would recognize in its financial statements the remaining unrecognized compensation cost pertaining to those instruments. In those cases, the former parent would recognize no compensation cost related to its unvested equity instruments held by those former employees that subsequent to the spinoff provide services solely to the former subsidiary. The Board directed the staff to include an example in the proposed Statement that illustrates the accounting described above. [9/1/2004 Board Meeting]

    Equity and Liability Classification

    1. The Board reaffirmed that the classification scheme of the proposed Statement is based on Concepts Statement 6 and that, consequently, it also incorporates the classification provisions of FASB Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. [8/18/2004 Board Meeting]

    2. The Board acknowledged that EITF Issue No. 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock,” does not incorporate a substantive liability notion based on predominant cash settlement when an instrument permits the issuer a nominal choice of settlement alternatives (including net-cash settlement); therefore, Issue 00-19 and the proposed Statement provide different classification treatments for similar economic arrangements. The Board decided that that difference should be addressed in its project on liabilities and equity and the Board directed the staff to describe that difference in the proposed Statement’s basis for conclusions. [8/18/2004 Board Meeting]

    3. The Board reaffirmed that awards containing conditions or other features relevant in measuring fair value indexed to something other than a market, performance, or service condition should be accounted for as liabilities. The Board also acknowledged that relative market and performance conditions would cause similar economic arrangements to be classified differently under the proposed Statement and Issue 00-19, including its interpretation on EITF Issue No. 01-6, “The Meaning of ‘Indexed to a Company’s Own Stock.’” The Board decided that that difference should be addressed in its project on liabilities and equity, and the Board directed the staff to describe that difference in the proposed Statement’s basis for conclusions. The Board also decided that an issuer of share-based payment awards would need to consider the guidance provided in paragraphs 12–32 of Issue 00-19 in determining the appropriate classification for such awards. [8/18/2004 Board Meeting]

    4. The Board decided to provide guidance in the proposed Statement similar to that in Issue 31 of EITF Issue No. 00-23, “Issues Related to the Accounting for Stock Compensation under APB Opinion No. 25 and FASB Interpretation No. 44.” That guidance would create a narrow exception: awards of equity instruments with fixed exercise prices denominated in certain foreign currencies (for example, the functional currency of the employer or the currency in which the employee is paid) would not be classified as liabilities under the Board’s decision noted in Item 35 above. [8/18/2004 Board Meeting]

    5. The Board reaffirmed and further clarified its position on accounting for financial instruments originally issued under arrangements subject to the proposed Statement that cease to be compensatory in nature (and therefore cease to be subject to the proposed Statement). Such financial instruments should be accounted for in accordance with other applicable U.S. GAAP when they cease to be compensatory in nature; U.S. GAAP that may apply to such financial instruments includes FASB Statements No. 133, Accounting for Derivative Instruments and Hedging Activities, and No. 150, and Issue 00-19. The Board also requested the staff to clarify and modify paragraphs 40A–40B of the proposed Statement as a result of its decision. [8/18/2004 Board Meeting]

    6. The Board decided to eliminate footnote 11(c) of the proposed Statement and requested that the staff consider how the intent of footnote 11(c) might be better described in the basis for conclusions relating to the interaction of the proposed Statement and Statement 150. [8/18/2004 Board Meeting]

    7. The Board clarified that the guidance in paragraph 25C of the proposed Statement relating to a broker-assisted cashless exercise also could apply to a portion of an award and decided that (a) the definition of cashless exercise should be renamed to broker-assisted cashless exercise and (b) footnote 9(f) should be modified to state that the sale must occur in a normal settlement period. [8/18/2004 Board Meeting]

    8. The Board reaffirmed the guidance in paragraph 25C of the proposed Statement on minimum statutory withholding taxes and expanded it to include minimum statutory withholding taxes for all relevant tax authorities. The Board rejected the expansion of that guidance to include amounts in excess of the minimum statutory withholding taxes. [8/18/2004 Board Meeting]

    Accounting for Income Tax Effects of Share-Based Payment Awards

    1. The Board decided to change the method for equity awards from that specified in the Exposure Draft to the method originally promulgated in Statement 123. Those methods account differently for a tax benefit deficiency, which is the portion of a recognized deferred tax asset that will not be realized because the actual tax deduction for an award is less than the total recognized compensation cost pertaining to that award. Under the Exposure Draft, the write-off of the portion of the deferred tax asset related to that deficiency, net of the related valuation allowance, is always recognized in the income statement; whereas, under Statement 123, that write-off, net of the related valuation allowance, is recognized in the income statement except to the extent that there is remaining additional paid-in capital from excess tax benefits from previous share-based payment awards accounted for in accordance with the fair-value based method in Statement 123. [8/25/04 Board Meeting]

    2. The Board reaffirmed its support for the amendment made to FASB Statement No. 95, Statement of Cash Flows, that would require excess tax benefits, as defined in the proposed Statement, to be reported as a financing cash inflow. The Board also directed the staff to consider whether any revisions to that amendment are necessary in light of the Board’s decision to change the method of accounting for income tax effects. [8/25/04 Board Meeting]

    Transition Alternatives for Public Entities

    1. The Board affirmed its support for the modified prospective transition method in the proposed Statement. Under that transition method, an entity would recognize share-based employee compensation cost from the beginning of the fiscal year in which the recognition provisions are first applied as if the fair-value-based accounting method in the proposed Statement had been used to account for all employee awards granted, modified, or settled in fiscal years beginning after the effective date of the final Statement. The Board will discuss effective date at a future Board meeting. As of the effective date, compensation cost related to the nonvested portion of awards outstanding as of that date would be based on the grant-date fair value of those awards as calculated under the original provisions of Statement 123; that is, an entity would not remeasure the grant-date fair value estimate of the unvested portion of awards granted prior to the effective date of the final Statement. [9/1/2004 Board Meeting]

    2. The Board decided to permit the use of a modified restrospective method of transition. Under that transition method, an entity would recognize employee compensation cost for prior periods presented in accordance with the original provisions of Statement 123; that is, an entity would recognize employee compensation cost in the amounts reported in the pro forma disclosures provided in accordance with Statement 123. [9/1/2004 Board Meeting]

    3. The Board affirmed that an alternative transition method would not be permitted for those entities that previously adopted Statement 123 under the prospective transition method permitted by FASB Statement No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure. [9/1/2004 Board Meeting]

    Employee Share Purchase Plans

    1. The Board tentatively decided to modify the guidance for determining the compensatory status of ESPPs in the Exposure Draft. An ESPP does not give rise to recognizable compensation cost (that is, the plan is not compensatory) if the ESPP meets all of the following conditions: (a) it satisfies one of the following criteria: (1) the terms of the ESPP are no more favorable than those available to all holders of the same class of shares or (2) any discount for the purchase of shares provided under the plan results in proceeds to the employer that are not less than the proceeds it would receive in an offering of shares if the shares had been issued to third parties by other means, for example, through an underwriter; (b) substantially all eligible employees that meet limited employment qualifications may participate on an equitable basis; and (c) the ESPP incorporates no option features. For example, a plan in which the purchase price is based on the stock’s market price at date of grant and that permits a participating employee to cancel participation before the purchase date and obtain a refund of amounts previously paid is a compensatory plan. The Board will consider implementation issues relating to this tentative decision at a future Board meeting. [8/25/04 Board Meeting]

    *Board Meeting and Public Meeting Dates

    The following are links to the minutes for each meeting.

    September 15, 2004 Informational Board Meeting—Meeting with constituents to discuss measurement of employee stock options. The meeting was informational and no Board decisions were made.
    September 8, 2004 Board Meeting—Redeliberations regarding Employee Share Purchase Plans and Disclosures
    September 1, 2004 Board Meeting—Redeliberations regarding Modified Grant-Date Method and Deep Out-of-the-Money Stock Options, Fair Value Measurement, Modifications and Settlements, Spinoffs, and Transition Alternatives for Public Entities
    August 25, 2004 Board Meeting—Redeliberations regarding Income Tax Effects of Share-Based Payment Awards and Employee Share Purchase Plans
    August 18, 2004 Board Meeting—Redeliberations regarding Requisite Service Period, Service Inception Date, Awards with Graded Vesting and Equity and Liability Classification
    August 4, 2004 Board Meeting—Comment Letter Summary, Redeliberations regarding Recognition, Measurement Attribute and Date, and Requisite Service Period
    June 24 & 29, 2004 Roundtable Meetings—Discussion with constituents regarding the Exposure Draft
    June 9, 2004 Board Meeting—Discussion of EBC awards exchanged in a business combination
    April 7, 2004 Board Meeting—Discussion of EBC awards exchanged in a business combination
    March 16, 2004 Board Meeting—Discussion of Transition Issues
    March 3, 2004 Board Meeting—Discussion of Certain Transition Issues
    February 18, 2004 Board Meeting—Discussion of External Review Issues
    February 11, 2004 Board Meeting—Discussion of Cost-Benefit Procedures, Fair Value Measurement, and PreBallot Draft Authorization
    January 14, 2004 Board Meeting—Discussion of Certain Drafting and Other Issues
    November 26, 2003 Board Meeting—Discussion of Disclosures and Transition and Effective Date for Nonpublic Enterprises
    November 19, 2003 Board Meeting—Discussion of Income Taxes, Related Party Transactions, and Other Issues
    November 11, 2003 Board Meeting—Discussion of Interaction of Statements 123 and 150 and Other Issues
    October 29, 2003 Board Meeting—Discussion of Disclosures, Transition and Effective Date, and Certain Definitions
    October 22, 2003 Board Meeting—Discussion of Convergence Issues
    October 15, 2003 Board Meeting—Discussion of Other Valuation Issues and Income Taxes
    October 8, 2003 Board Meeting—Discussion of Certain Definitions and Other Issues
    October 1, 2003 Board Meeting—Discussion of Attribution and Valuation Issues
    September 17, 2003 Board Meeting—Discussion of Modifications and Related Issues
    September 10, 2003 Board Meeting—Discussion of Valuation Issues
    August 27, 2003 Board Meeting—Discussion of Modifications and Settlements
    August 13, 2003 Board Meeting—Discussion of the Definition of Grant Date, Cash-Settled EBC Arrangements, and Statement 150 Issues
    July 23, 2003 Board Meeting—Discussion of Income Tax Effects
    July 8, 2003 Public Meeting with Option Valuation Group
    June 18, 2003 Board Meeting—Measurement Date for Nonemployee Transactions
    May 7, 2003 Board Meeting—Discussion of Measurement and Attribution Issues
    April 22, 2003 Board Meeting—Discussion of Measurement and Recognition Issues
    March 12, 2003 Board Meeting—Addition of project to technical agenda

    Related FASB Articles

    None.

    Additional Information for Interested Constituents

    The FASB has received requests from constituents for information on (a) arguments for and against recognizing EBC as an expense in the income statement, (b) historical background on the deliberations and issuance of Statement 123, and (c) other issues related to EBC. That information is contained in Statement 123’s basis for conclusions. The proposed IFRS’s basis for conclusions also addresses arguments for and against recognizing EBC as an expense in the income statement. Both bases for conclusions are contained in appendixes to the Invitation to Comment. Those appendixes can be downloaded from this website at no cost.

    Contact Information

    Michael Tovey
    Project Manager
    mwtovey@fasb.org

    Danielle T. Zeyher
    Project Manager
    dtzeyher@fasb.org