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Accounting for Share-Based Compensation

PORTFOLIO DESCRIPTION

Portfolio 5109, Accounting for Share-Based Compensation (Accounting Policy and Practice Series), provides a detailed analysis of Statement of Financial Accounting Standards 123R, Share-Based Payment, which requires companies to recognize the compensation cost of options under the fair-value method. SFAS 123R eliminates the use of the intrinsic value method under which the compensation cost for an employee stock option was determined as the difference between the firm's stock price on the option's grant date and the option's exercise price. SFAS 123R became effective for all annual periods beginning after June 15, 2005 for public firms and December 15, 2005 for non-public and small business issuers.

Under SFAS 123R, the cost of employee services (or compensation cost) that a granting firm initially must recognize is the fair value on the grant date of the share-based instruments the firm is required to issue to employees in consideration for their services. Share-based instruments given to employees constitute either awards of equity (e.g., employee stock options) or liabilities incurred by the firm (e.g., stock appreciation rights that must be settled in cash). The cost of share-based instruments classified as equity is measured and fixed on the date on which the share-based instruments are granted. This cost is not re-measured in subsequent reporting periods. For share-based awards that are liabilities of the firm, the value of the award must be re-measured each reporting period until the liability is settled. Thus, recognized compensation costs tend to be more volatile for awards classified as liabilities. The authors explain how to distinguish awards classified as equity versus awards classified as liabilities and how to measure the cost of instruments in each of these two categories.

The Portfolio also discusses valuation techniques for estimating the fair value of an employee stock option (e.g., the Black-Scholes-Merton (BSM) and lattice option pricing models), the special considerations for non-public companies, and recognizing employee compensation costs over the period that employee services are provided.

Section II of this Portfolio analyzes the detailed measurement and recognition requirements of SFAS 123R. Section III compares SFAS 123R with International Financial Reporting Standards 2 (IFRS 2), Share-Based Payment, issued by the International Accounting Standards Board. Effective January 1, 2005, all firms belonging to countries of the European Union must comply with IFRS 2. Section IV of this Portfolio primarily will interest readers wishing to learn more about the mathematical foundations and theory behind the BSM and lattice models.

This Portfolio may be cited as BNA Tax and Accounting Portfolio 5109, Mande & Chavis, Accounting for Share-Based Compensation (Accounting Policy and Practice Series). Within the Accounting Policy and Practice Portfolio Series, however, references to the Portfolios will include only the Portfolio numbers and titles.

A portion of FASB Statement No. 123 (revised 2004), Share-Based Payment, copyright by the Financial Accounting Standards Board, 401 Merritt 7, PO Box 5116, Norwalk, CT 06856-5116, U.S.A., is reprinted with permission. Complete copies of this document are available from the FASB.

Vivek Mande, Ph.D, is a Professor of Accounting and the Director for the Center for Corporate Reporting and Governance at California State University, Fullerton. Dr. Mande teaches and researches in the areas of corporate governance, financial accounting, and auditing. He was the Academic Accounting Fellow at the Securities and Exchange Commission's Office of Economic Analysis in Washington, D.C. from 2001-2002. Professor Mande holds a Ph.D. in Accounting from the Anderson Graduate School of Management, U.C.L.A. Dr. Mande is an Associate Member of Institute of Chartered Accountants. His research findings have been published in Contemporary Accounting Research, Auditing: A Journal of Practice and Theory, Journal of Accounting and Public Policy, International Journal of Accounting, ABACUS, Accounting and Business Research, and a number of other journals.