Quieting another ripple of panic around the implementation of stock option expensing, the Financial Accounting Standards Board proposed new guidance last week that relaxes language on how to account for options that are granted with a cash-settlement feature attached.
Companies had worried that FASB’s Statement No. 123R, the controversial stock-option expensing rule that went into effect this month, would saddle their balance sheets with new liabilities for option plans that included a cash-settlement provision. Many plans do have such clauses, to pay cash for employees’ options during mergers or other change-in-control events.
Dyckman
Statement 123R says such options should be recorded on the balance sheet as a liability. But that detail went largely unnoticed as attention focused mostly on the expensing requirement associated with share-based payment awards, says Matthew Dyckman, a partner at law firm Thacher Proffit. Only late in 2005 did accountants apparently ask regulators about the cash-settlement language and begin alerting clients.
“There was a lot of panic among a lot of our clients,” says Thomas Welk, a partner with law firm Cooley Godward. “I thought FASB would come out with some kind of reconsideration. I assumed (the original language) was an inadvertent oversight.”
To answer the uncertainty, FASB issued proposed staff position No. 123(R)-d. The position is an effort to restore historical practice, saying companies would only record such options as a liability when it seems probable that the event triggering the cash settlement will occur.
Earlier literature on share-based payments—FAS 123 and APB Opinion No. 25 that preceded the current expensing rule—generally did not require companies to record options with a cash settlement provision as a liability. Welk said it’s not clear why the new statement contained the liability requirement. FASB itself declined to comment beyond its new staff position.
At the same time, however, FASB is fishing for reaction to another approach that would grandfather existing options, but apply the more strict liability classification currently contained in 123R to all future grants. “Do you believe the grandfathering approach more appropriately addresses this issue?” FASB asks in the staff position. FASB is open to comments through Jan. 31.
Welk
Welk said FASB’s new language makes more sense because it is illogical for an option to be classified as a liability unless it becomes likely that the company will be required to settle it in cash. “This is where FASB would originally have come out had it been focused on this issue all along,” he says.
The sequence of events is reminiscent of the uncertainty and subsequent guidance surrounding how companies should establish the grant date for stock options, he adds.
In that episode, companies raised concerns about the logistics of adhering to the strict language of the statement. FASB resisted the demand for guidance, imploring issuers and auditors to exercise more judgment, but ultimately issued guidance last fall that relaxed a strict interpretation and made the grant date easier to determine.
“I wouldn’t be surprised if there are other similar lurking issues out there that someone will raise,” Welk says.
While FASB’s newly proposed guidance might seem at first pass to provide companies with some relief on expensing options, Dyckman suspects the entire notion of classifying some options as a liability will come as a surprise to many companies.
“If they want to sign an agreement to a merger or file registration papers to initiate a public offering, this adverse accounting treatment might be triggered,” he says. “Companies are still not going to be happy with that. Overall companies will not see this as a positive development.”
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