|
In an
effort to ease the burden for companies bogged down with Sarbanes-Oxley, the
FASB has decided to delay implementation of Share-Based Payment, an Amendment of
FASB Statements No. 123 and 95, the exposure draft it issued in March.
Implementation will take effect for public companies on Jun. 15, 2005, while
private companies have been given until Dec. 15, 2005, to start expensing
options. Although companies have been given a stay of execution, the FASB has
completed redeliberation and plans to issue the final statement by the end of
the year. In its final redeliberation meeting, the Board made some significant
decisions that will impact nonpublic entities.
Intrinsic Value Method
Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for
Stock-Based Compensation, requires that all share-based payment be measured at
fair value. Statement 123 also provided an alternative to use Opinion 25's
intrinsic value method of accounting. Intrinsic value, as defined in the
exposure draft, exists if the market price of the share exceeds the exercise
price. Most employee stock option plans are structured so that the exercise
price equals the quoted market price on the grant date. As a result, the option
has no intrinsic value on the grant date and the compensation cost is equal to
zero.
During the redeliberation process, the FASB addressed concerns from respondents
to the proposed statement. More than half of the respondents were opposed to
nonpublic companies being allowed to use the intrinsic value method as an
alternative method for measuring share-based compensation.
Respondents held three main views against allowing the intrinsic value method:
1) A company's decision to use the intrinsic value method is inconsistent
because similar transactions should be accounted for using a similar accounting
method.
2) Application of the intrinsic value method is inconsistent with the grant-date
approach.
3) The intrinsic value method has operational difficulties because it would
require remeasurement each reporting period, compared to the fair value method
which would require a single valuation.
The Board decided that nonpublic companies would be required to use the fair
value method it proposed in the exposure draft unless one of the following
scenarios exists:
1) The nonpublic entity is unable to make a reasonable estimate of the expected
volatility of its own stock price. In this situation, a nonpublic entity would
use the historical volatility of an appropriate index, rather than using the
expected volatility of its own stock price, as an input in the valuation model.
A nonpublic entity that uses this approach would be required to disclose the
index selected and how it made this selection.
2) The nonpublic entity cannot reasonably estimate fair value because the
unusual features of a particular equity award prevent it from doing so. In this
case, a nonpublic entity would be required to apply the intrinsic value method
as described in the final statement.
Valuation Methods
In the absence of observable market prices, the FASB requires use of an
option-pricing model to value employee stock options. The Board maintained
during redeliberations that either a closed-form, (Black-Scholes) model, or a
lattice (binomial) model should be used to value employee stock options. The
Black-Scholes model, intended for publicly traded options, fails to accurately
value employee stock options since it does not take into account the option's
lack of marketability. To account for this lack of marketability, the FASB has
supported the use of an expected term for the option based on historical
exercise behavior in the employee population, rather than the application of an
appropriate discount for illiquidity based on the specifics of the option plan.
A lattice model considers an employee's expected exercise and post-vesting
employment termination behavior. This type of model can incorporate a term
structure of volatility, and can also accommodate differences in exercise
behavior across the employee population. The lattice model can be difficult to
implement if sufficient historical data on an employee's exercise behavior is
not available.
In its original proposal, the FASB had stated a preference for a lattice model.
Recognizing that one option-pricing model may not be appropriate for all
circumstances, the FASB has indicated that it would not be identifiying a
preferred model in the final statement. Additionally, the Board will not be
prescribing a single method for estimating volatility. The Board states that,
"an entity should make a reasonable and supportable estimate of expected
volatility that is consistent with the stated fair value objective." The final
statement will include guidance on the process a company might follow in
estimating volatility.
The FASB's ultimate goal is to align U.S. accounting standards for share-based
compensation with International Accounting Standards Board (IASB) standards. The
IASB's rule for expensing options, similar to the U.S. standard, will be
effective January 1. For more information regarding valuing stock options,
contact your Valuation Research representative or Larry Van Kirk at (513)
579-9100. VR
|
