When accounting rulemakers recently gave corporate finance executives an alternative method of calculating the tax impact of stock option expensing, they may also have created an escape hatch from a weakness or deficiency finding on their internal control over financial reporting.
As Compliance Week covered last week (see box at right), the Financial Accounting Standards Board recently proposed a new method for calculating how companies could report the tax effects of expensing stock options. They created the method in response to corporate calls for help, after many companies realized they didn’t have the historical data necessary to track the tax effect as required in the Board's stock option expensing rule.
Neuhausen
“There may be a SOX [Sarbanes-Oxley] overlay to this issue,” said Ben Neuhausen, national director of accounting for BDO Seidman. “Some accountants who specialize in SOX issues are saying if you don’t have the historical data, that could amount to a material weakness or a reportable deficiency in your internal controls.”
When companies grant options and set a value using their chosen valuation method, they also must calculate the tax benefit they can expect to earn when the option is eventually exercised. They book that projected deduction for accounting purposes as a tax asset, or a future tax benefit.
When the option is eventually exercised, the actual tax impact likely will differ from the original booked asset since it was based on a projection. Companies don’t directly add or subtract such variances on the income statement; instead, they account for them in a separate fund called the additional paid-in capital pool, or APIC pool.
As experts have uncovered implementation issues associated with stock option expensing, problems surfaced in calculating the APIC pool. For a variety of reasons—such as mergers, acquisitions, divestitures, changes in accounting systems, and others—scores of companies found they didn’t have the historical data to create their opening APIC pool for option expensing purposes. FASB issued a proposed staff position recently that described a "shortcut" approach (instead of requiring an accounting for actual tax effects of every option exercised over the past decade, the shortcut utilizes gross figures).
Howell
Jay Howell, associate director of assurance for BDO, said the plight of missing historical data might have created an “interesting theoretical debate” for companies; namely, whether the lack of data would constitute a material weakness or significant deficiency under Section 404 of Sarbanes-Oxley. “But the need for that debate has been eliminated now,” Howell said, because FASB’s alternative method gives companies a solution that is compliant with Generally Accepted Accounting Principles.
FASB says the prospective Sarbanes-Oxley implications did not figure into the equation as the staff developed and deployed the alternative method, according to spokesman Gerard Carney.
“I haven’t perceived that compliance with Section 404 was a primary consideration,” in FASB’s development of the alternative method, Howell said. “My reaction is that this was a practical solution to a problem; it’s one of many complexities in implementing 123R.”
“I’m not even remotely surprised companies were not tracking this data," says Joseph Carcello, director of research for the University of Tennessee’s Corporate Governance Center. "If you look at the data, it has absolutely nothing to do with how a company runs its business—it’s strictly compliance driven.”
Whether companies could face a weakness or deficiency by adopting the alternative method “is in the eye of the beholder, as all this stuff is,” Carcello adds. “I would have been very surprised if there were any weakness findings, but companies are essentially bulletproof now. Any issue that would have been out there is gone.”
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