FASB View Of “Grant Date” Causing Options Headaches

Public companies may face a major headache related to implementing the revised rules on accounting for stock options, according to executive compensation experts. The issue stems from the determination of the grant date used in accounting for employee stock options, which must be expensed under a Financial Accounting Standards Board rule issued last December.

Under language in FASB's expensing standard, the date the options are approved by a company's board of directors would not necessarily be the grant date. Under the Board’s definition in FAS 123(R), the grant date is the date at which an employer and an employee reach a mutual understanding of the key terms and conditions of a share-based payment award—in other words, the date the award is communicated to the employee (see FASB definition of grant date and its basis for conclusions in box, below left).

Brumberg

“It's now the communications date and not the board approval date that matters for fixing the value of the stock in the calculation of the ‘fair value’ of the stock options," says Bruce Brumberg, a compensation expert and editor-in-chief of myStockOptions.com.

In light of that view, some experts say companies will need to change the way they communicate the terms of stock option grants to their employees. “Companies’ communications efforts related to stock grants will become more important as changes in the price between ‘when approved by the board’ and ‘when [employee is] notified’ impact the earnings charge,” says Brumberg.

Dunn

“This will affect virtually all companies, in terms of historic practices,” said William Dunn, a partner in Pricewaterhouse-Coopers’ Human Resource Services practice.

That’s because companies typically were allowed some time between the date they approved stock option grants and the time employees received notice of their grants—companies could still use the date the awards were approved as the grant date. “There could have been days, or often weeks, between the grant approval and the date when the employee learned that they got options,” said Dunn. “Under APB Opinion No. 25 [Accounting for Stock Issued to Employees—the predecessor to FAS 123R], it was a much more casual world.”

To fix the expense as of the day the board approves the grant, companies would need to communicate the grant to employees on that same day, which is not the way most companies operate, said Brumberg.

Kesner

“The way rules have long been applied, whether it was correct or not, was when board approved the award, that date was the grant date,” said Mike Kesner, principal-in-charge of Deloitte Consulting’s executive compensation practice. The grant was considered made, even though employee found out a few days later.”

In addition, the revised definition states that, “The grant date for an award of equity instruments is the date that an employee begins to benefit from, or be adversely affected by, subsequent changes in the price of the employer’s equity shares.” The problem, say experts, is that the date of grant and the notification date are typically unique, which makes valuing options for the purpose of expensing a headache.

In the past, companies often notified employees within different divisions about their stock option grants on different days. Under FASB’s view of the date grant as the day there is both a mutual agreement and an economic interest, Kesner said the value of the options would be different for employees in each division depending on the date they were notified of their stock option grants.

“This view changes companies’ determination timing,” says Dunn at PwC. “They have to compute the option expense at the date when the employee learns about their stock options.” If the stock price changes between the time the board approves the options awards and the time when the employees are notified of their awards, the value of the options changes, and the expense changes.

“This is creating a whole lot of work, even for companies who think it’s [expensing] the right thing to do,” said Kesner. “Companies are struggling with compliance—the rules are more complicated to implement than anybody thought.”

DEFINITIONS

The excerpts below are from the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 123 (Revised 2004), Share-Based Payment

FASB Definition Of Grant Date

The date at which an employer and an employee reach a mutual understanding of the key terms and conditions of a share-based payment award. The employer becomes contingently obligated on the grant date to issue equity instruments or transfer assets to an employee who renders the requisite service. Awards made under an arrangement that is subject to shareholder approval are not deemed to be granted until that approval is obtained unless approval is essentially a formality (or perfunctory), for example, if management and the members of the board of directors control enough votes to approve the arrangement. Similarly, individual awards that are subject to approval by the board of directors, management, or both are not deemed to be granted until all such approvals are obtained. The grant date for an award of equity instruments is the date that an employee begins to benefit from, or be adversely affected by, subsequent changes in the price of the employer’s equity shares. (Refer to the definition of service inception date.)

Appendix B: Basis for Conclusions—Definition of Grant Date

Paragraph B49. The definition of grant date in this Statement is essentially the same as in Statement 123, which in turn was essentially the same as the notion of grant date used in practice under Opinion 25. Common to all those definitions is the notion of the grant date as the date an agreement or mutual understanding is reached. That is, the grant date is the date at which an employer and employee reach a mutual understanding of (agree to) the key terms and conditions of a share-based payment award. In reconsidering the definition of grant date, however, the Board noted that entities will need to apply that definition to a wide variety of share-based payment awards and that it sometimes may be difficult to determine when a mutual understanding of the key terms and conditions has been reached. The Board therefore decided to clarify the concepts underlying the definition of grant date by adding the following sentence to the definition in Appendix E:

The grant date for an award of equity instruments is the date that an employee begins to benefit from, or be adversely affected by, subsequent changes in the price of the employer’s equity shares.

Some respondents to the Exposure Draft objected to the addition of that sentence. They said that a grant date has been reached when the parties to a share-based payment award have a mutual understanding of how its key terms, for example, the exercise price, will be established, even though the exact terms may not yet be known because they depend solely on a future market price. To illustrate, an award of equity share options may specify that the exercise price will be the market price of the underlying shares on a specified future date.

Source

Excerpts Of FASB Statement Of Financial Accounting Standards No. 123 (Revised 2004), Share-Based PaymentCopyright Financial Accounting Standards Board, Norwalk, CT 06856. Reproduced By Permission. Complete Copies Available From The FASB.

When asked about the issue, FASB spokesman Gerard Carney said, “123(R) acknowledges that the grant date is when there is a mutual understanding of the grant. As matter of course we commonly get questions with respect to implementation issues and we answer them.”

As far as determining what constitutes a “mutual understanding,” Kesner said Deloitte’s position is that “if the company communicates the terms of the award to its employees, it’s a mutual understanding.”

Creating Needless Problems

To avoid having to calculate several different values for employee stock options, executive compensation consultants are advising companies to notify all employees of their option awards at the same time, and to do it as quickly as possible after the awards are approved. “Companies need to have a coordinated process for notifying employees,” advised Dunn. “They should establish a consistent approach within the organization so that all of their options are granted the same day and have the same stock price.”

In addition, Dunn and others said companies should notify employees as soon as possible after the board takes action on options. “The more delay they have between the approval and the employee notification, the higher the chance that the stock price will move,” said Dunn. “Companies probably need to have an automated process to notify their employees as soon as possible.”

Kesner at Deloitte suggested that companies post a generic copy of their award agreement on their Web site in advance, and send a blast e-mail on the date of approval or on a given date to all plan participants specifying their number of options or restricted shares.

“In my opinion, this is creating needless problems for administrating these grants,” says Kesner. “I have clients with 3,500 participants in their plan—to get all of that information communicated in one afternoon is not practical.”

“This creates a huge frustration,” Kesner added. “It’s yet another surprise that’s causing more work and nobody’s seeing how shareholders and the investing public are benefiting from this.”

Kesner also cautioned that while a mass communication approach solves the issue of having multiple stock option values, it can create serious employee relations problems. “These awards are often very sensitive,” said Kesner. For instance, if an employee received a significantly smaller number of shares than they were expecting, he said supervisors might want to take a one-on-one approach and “tell the employee the ‘why’ behind the decision.”

“This isn’t cookie cutter stuff—it’s about people’s careers,” said Kesner. A mass e-mail communication “makes this very impersonal.”

Kesner said he would like to see a change that could make implementing easier. “There ought to be a safe harbor for companies if they communicate the awards to their employees within a set time after board approval—maybe three days,” he said.