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FAS 123R Stock Option
Reporting Now Mandatory
A recently
issued, revised Financial Accounting Standards Board (FASB)
statement will require financial institutions, public institutions,
and private companies to recognize in the income statement the
grant-date fair value of stock options and other equity-based
compensation issued to employees. This is effective in 2006.
HOW DOES fas 123r WORK AND
WHO MUST COMPLY?
FAS 123R
applies to all share-based payment transactions for acquiring goods
or services, including:
-
Issuance of shares
-
Issuance of share options (stock options)
-
Incurring liabilities whose settlements are based, at least in
part, on the price of the entity’s shares or other equity
instruments
-
Settling obligations by issuing the entity’s equity shares or
other equity instruments
The only
exception: Shares held in an ESOP that are still accounted for in
accordance with the AICPA Statement of Position No. 93-6, Employers’
Accounting for Employee Stock Ownership Plans, (SOP 93-6).
HISTORY|
The Original 123
The original
FAS 123 encouraged the use of grant-date fair value method of
accounting for equity-based compensation. However, it provided
financial institutions the opportunity to continue using the
intrinsic-value method provided by APB No. 25. APB No. 25 was
applicable as long as the footnotes to the financial statements
disclosed what the pre-forma impact on net income would have been
had the preferable fair value method been utilized. Most
institutions used this approach, as no compensation costs were
recognized in the income statement. FAS 123R supercedes both FAS 123
and APB No. 25. Compensation costs related to equity-based
compensation will now be required to be recognized in the income
statement.
What Does 123R Require?
FAS 123R
does not require a specific valuation technique to determine the
grant-date fair value of employee stock options and other
equity-based compensation issued to employees. Estimate the
value using option pricing models adjusted for the unique
characteristics of the instruments. Valuation models that meet
the FAS 123R criteria include:
- Lattice
models, such as a binomial model
-
Closed-form models, such as the Black-Scholes model. The
compensation cost recognized in the income statement for
equity-based awards will generally be recognized over the
vesting period based on the grant-date fair value of the award
FAS 123
allowed forfeitures to be accounted for, either by estimating the
number of forfeitures at the grant date or accounting for the
effects of the forfeitures when they occurred. FAS 123R
removes this option and requires estimation of forfeitures at the
date of grant with the possibility of subsequent revisions. In
addition, FAS 123R will generally require expensing of employee
stock purchase plans (ESPP).
Historically,
ESPP permitted participants to purchase an employer institution
stock at a discount up to 15% and the institution did not recognize
compensation cost on the income statement. An employee would
be permitted to purchase employer shares at a price of 85% of the
lower of the stock price either at the end of the purchase period or
at the beginning of the look-back period, which is generally six
months. FAS 123R will require institutions to record
compensation cost equal to the sum of any discount and the fair
value of the look-back. If the institution’s plan limits the
discount to 5% or less and meets certain other criteria, the ESPP
will not be considered compensatory under FAS 123R,
and compensation cost will not be required to be recorded on the
income statement.
FAS 123R is a complex statement
that contains many new requirements and issues not fully addressed
in this summary. Because this revised statement may have a
significant impact on your bank’s financial statements, you may want
to contact Wright/Kirby to further discuss.
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