FASB On Equity Accounting; EU On Liability

The Financial Accounting Standards Board has finished a technical correction to guidance issued last summer related to stock option expensing rules.

Staff Position No. 123(R)-5 addresses whether changes to equity compensation grants made in connection with an equity restructuring or a business combination, such as a merger or acquisition, should be regarded as a change to the award for purposes of applying the stock option expensing rules in Financial Accounting Statement No. 123(R) and in guidance issued in August 2005 in Staff Position No. 123(R)-1.

Welk

Thomas Welk, a partner with Cooley Godward, says the newest staff position—FASB’s fifth piece of guidance on implementing stock option expensing rules finalized in late 2004—is simply a “technical correction” of the first staff position, FSP 123(R)-1. Welk said the latest position focuses on the tricky question of when certain awards change from being an equity on the books to a liability, and therefore how they should be treated under accounting rules.

When FASB issued the first staff position, it heard questions about how an equity restructuring or a business combination would affect the recognition and measurement of financial instruments or share-based equity awards when the holder is no longer an employee. The new staff position spells out the conditions when no change in the measurement or recognition of the instrument is necessary.

FASB said when it issued the initial guidance that it would prefer to see consistent treatment regardless of the holder’s employment status or how the instruments ultimately would be purchased, but it would take a pass on the issue for now pending its more comprehensive project to draw a clearer line between liabilities and equity, “which could significant[ly] change other applicable GAAP.”

European Study Argues For Auditors’ Liability Protections

Consultants at London Economics have studied the auditing profession in Europe and concluded that the market for audit services rests on such rickety ground that limiting auditors’ exposure to liability may be a good idea.

Commissioned by the European Union, the study came to four key conclusions. Foremost, it said the Big 4 accounting firms dominate the international market for audits, allowing little opportunity for other firms to achieve a strong market position and fill the breach should a Big 4 firm ever fold. It also said auditors are having a tougher time getting liability insurance with higher levels of protection—which puts their personal income at risk, and subsequently undermines the firm and the profession as a whole if partners bail out rather than continue practicing with their own assets on the line.

The study said the failure of a Big 4 firm would pose difficult economic consequences, because it would create a serious lack of audit resources for large companies that must be audited. Finally, the study concluded that limitations on auditor liability would reduce the risk of an audit-firm failure, although it admitted that a one-size-fits-all approach won’t do.

McCreevy

“There are important issues at stake,” Charlie McCreevy, commissioner of EU’s Internal Market and Services, said in a statement. ”I recognize opinions are divided about how we should address these. I hope the discussion that this report will engender will allow us to reach a clearer understanding of how best to address the real problems that are there and will not go away.”

McCreevy said his group will present its views on the study and recommend some possible solutions for further discussion. The study represents the first large-scale study of audit concerns in Europe. EU officials promise a more detailed report on the problem by the end of the year.

FEI Issues Corporate Advice On Stock Option Accounting

Financial Executives International has issued professional guidance to companies assessing their historical accounting for stock options, in light of the recent regulatory dive into whether companies have illegally backdated or otherwise accounted for stock options.

The FEI “Issue Alert” summarizes guidance recently issued by Securities and Exchange Commission Chief Accountant Conrad Hewitt, where he reviewed the various circumstances the SEC is finding as it investigates companies for possible options backdating. The alert notes Hewitt’s distinction between awards where administrative delays reflected no fraudulent intent or any material change in accounting for the grants, versus changes in individual awards that call into question the finality of the grant date for all other option awards.

FEI encourages companies to work with their legal advisers, auditors, management, and board of directors to review and discuss the SEC guidance, as well as related audit guidance issued in July by the Public Company Accounting Oversight Board. “A determination should be made as to what, if any, changes to previously report information or additional disclosures are required to provide adequate information to shareholders and the public,” the alert says.