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Tax Management Portfolio, Accounting for Share-Based Compensation, No. 341-3rd, provides a detailed analysis of the rules on share-based compensation contained in FASB Accounting Standards Codification (“ASC”) Topic 718, (former Statement of Financial Accounting Standards 123(R), Share-Based Payment). ASC 718 requires companies to recognize the compensation cost of options under the fair-value method. ASC 718 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. FAS 123(R), codified in ASC 718 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 ASC 718, 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. 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 distinguish awards classified as equity versus awards classified as liabilities.
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.
Section II of this Portfolio analyzes the detailed measurement and recognition requirements of ASC 718. Section III compares ASC 718 (former FAS 123(R)) with International Financial Reporting Standards 2 (IFRS 2), Share-Based Payment, issued by the International Accounting Standards Board. 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 Mande & Chavis, 341-3rd T.M., Accounting for Share-Based Compensation.
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.
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