Accountants’ Handbook Special Industries and Special Topics 10th Edition_14

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37.6 APPLICATION OF FASB STATEMENT NO. 123 37 41 • COMPARISON OF COMPENSATION COST RECOGNIZED UNDER FASB STATEMENT NO. 123 AND APB OPINION NO. 25 Assume the following for stock compensation awards made by Company A, a public company: Stock price at date of grant (January 1, 2000) $40 Expected life of options 6 years Risk-free interest rate 7.0% Expected volatility in stock price 30% Expected dividend yield 1.5% Vesting schedule for options 100% at end of third year Options expected to vest (5,000 forfeited each year) 285,000 Estimated fair value of each option* $15 Stock price at December 31, 2002 $60 *Fair value calculated using an acceptable pricing model. Fixed Stock Option Award On January 1, 2000, Company A grants 300,000 stock options to ofﬁcers and other employees with a maximum term of 10 years and an exercise price equal to the market price of the stock at date of grant. APB Opinion 25 FASB Statement No. 123 Compensation cost recognized: Year 2000 $0,000,000 $1,425,000 Year 2001 0 1,425,000 Year 2002 $0,000,000 $1,425,000 Total $0,000,000 $4,275,000 Performance Stock Award On January 1, 2000, Company A also grants 30,000 restricted shares to certain employees. The restrictions lapse at the end of three years if certain annual earnings per share targets are met during the three-year period. For purposes of this example, assume the earnings per share targets were met during the three-year period and the restrictions lapsed on December 31, 2002. APB Opinion 25 FASB Statement No. 123 Compensation cost recognized $1,800,000 $1,200,000 Exhibit 37.7 Comparison of compensation cost recognized under FASB Statement No. 123 and APB Opinion No. 25. feited because of failure to meet vesting requirements are excluded from determination of com- pensation cost. In certain circumstances, due to the terms of a stock option or other equity instrument, it may not be feasible to reasonably estimate the fair value of a stock-based award at the grant date. For example, the fair value of a stock option whose exercise price adjusts by a speciﬁed amount with each change in the underlying price of the stock cannot be reasonably estimated using an option pricing model. If the fair value cannot be estimated at the grant date, fair value at the ﬁrst date at which it is possible to reasonably estimate that value should be used as the ﬁnal measure of compensation cost. For interim periods during which it is not possible to de- termine fair value, companies should estimate compensation cost based on the current intrinsic value of the award.
37 42 STOCK-BASED COMPENSATION • (d) OPTION PRICING MODELS. In addressing the issue of estimating fair value of equity instruments, the FASB noted that it was not aware of any quoted market prices that would be appropriate for employee stock options. Accordingly, FASB Statement No. 123 requires that the fair value of a stock option (or its equivalent) be estimated using an option-pricing model, such as the Black-Scholes or a binomial pricing model, that considers the following assump- tions or variables: • Exercise price of the option. • Expected life of the option—Considers the outcome of service-related conditions (i.e., vesting requirements and forfeitures) and performance-related conditions. Expected life is typically less than the contractual term. • Current price of the underlying stock—Stock price at date of grant. • Expected volatility of the underlying stock—An estimate of the future price ﬂuctuation of the underlying stock for a term commensurate with the expected life of the option. Volatility is not required for nonpublic companies. • Expected dividend yield on the underlying stock—Should reﬂect a reasonable expectation of dividend yield commensurate with the expected life of the option. • Risk-free interest rate during the expected term of the option—The rate currently available for zero-coupon U. S. government issues with a remaining term equal to the expected life of the options. FASB Statement No. 123 requires that the option pricing model utilized consider manage- ment’s expectations relative to the life of the option, future dividends, and stock price volatility. Both the volatility and dividend yield components should reﬂect reasonable expectations com- mensurate with the expected life of the option. As there is likely to be a range of reasonable ex- pectations about factors such as expected volatility, dividend yield, and lives of options, a company may use the low end of the range for expected volatility and expected option lives and the high end of the range for dividend yield (assuming that one point within the ranges is no better estimate than another). These estimates introduce signiﬁcant judgments in determining the value of stock-based compensation awards. During the FASB’s discussions prior to issuance of FASB Statement No. 123, those favoring re- tention of the basic requirements of APB Opinion No. 25 emphasized the imprecision of measuring fair value through option pricing models, particularly in light of the fact that most stock options is- sued to employees are not transferable and are forfeitable. The Board believes that it has addressed these issues by valuing at zero options that are expected to be forfeited, and by valuing options that vest based on the length of time they are expected to remain outstanding rather than on the stated term of the options. During the last 20 years, a number of mathematical models for estimating the fair value of traded options have been developed. The most commonly used methodologies for valuing options include the Black-Scholes model, binomial pricing models, and the minimum value method. The minimum value of a stock option can be determined by a simple present value calculation which ignores the ef- fect of expected volatility. (See Exhibit 37.8 for an illustration of the minimum value method.) The fair value of an option exceeds the minimum value because of the volatility component of an option’s value, which represents the beneﬁt of the option holder’s right to participate in stock price increases without having to bear the risk of stock price decreases. The Black–Scholes and binomial pricing models were originally developed for valuing traded options with relatively short lives and are based on complex mathematical formulas. Option values derived under these models are sensitive to both the expected stock volatility and the expected dividend yield. Exhibit 37.8 illustrates the relative effect of changes in ex- pected volatility and dividend rates using a generalized Black-Scholes option-pricing model. Software packages that include option pricing models are readily available from numerous software vendors.
37.6 APPLICATION OF FASB STATEMENT NO. 123 37 43 • ESTIMATED OPTION VALUES Assumptions: Exercise price—$40 (equals current price of underlying stock) Expected dividends—0%, 2%, and 4% Expected risk-free rate of return—7% Expected volatility—0%, 20%, 30%, and 40% Expected term—six years Fair values calculated using a Black-Scholes option pricing model Volatility Dividend Rate 0% 20% 30% 40% 0% $13.35 $15.14 $17.56 $20.16 2% 8.87 11.42 13.98 16.57 4% 4.96 8.45 11.05 13.58 Exhibit 37.8 Estimated option values. As demonstrated in Exhibit 37.8, option values increase as expected volatility increases, and op- tion values decrease as expected dividend yield increases. It is interesting to note that in instances where higher expected volatility is coupled with higher dividend yields, the binomial model gener- ally produces higher option values than the Black-Scholes model due primarily to increased sensi- tivity to compounded dividend yields in the binomial model. Nevertheless, FASB Statement No. 123 permits the use of either model. (i) Expected Volatility. Volatility is the measure of the amount that a stock’s price has ﬂuc- tuated (historical volatility) or is expected to ﬂuctuate (expected volatility) during a speciﬁed period. Volatility is expressed as a percentage; a stock with a volatility of 25% would be ex- pected to have its annual rate of return fall within a range of plus or minus 25 percentage points of its expected rate about two-thirds of the time. For example, if a stock currently trades at $100 with a volatility of 25% and an expected rate of return of 12%, after one year the stock price should fall within the range of $87 to $137 approximately two-thirds of the time (using simple interest for illustration). Stocks with high volatility provide option holders with greater economic “up-side” potential and, accordingly, result in higher option values under the Black– Scholes and binomial option pricing models. FASB Statement No. 123 suggests that estimating expected future volatility should begin with calculating historical volatility over the most recent period equal to the expected life of the op- tions. Thus, if the weighted-average expected life of the options is six years, historical volatility should be calculated for the six years immediately preceding the option grant. FASB Statement No. 123 provides an illustrative example for calculating historical volatility. Companies should modify historical stock volatility to the extent that recent experience indicates that the future is reasonably expected to differ from the past. Although historical averages may be the best available indicator of expected future volatility for some mature companies, there are legitimate exceptions including: (1) a company whose common stock has only recently become publicly traded with lit- tle, if any, historical data on its stock price volatility, (2) a company with only a few years of pub- lic trading history where recent experience indicates that the stock has generally become less volatile, and (3) a company that sells off a line of business with signiﬁcantly different volatility than the remaining line of business. In such cases, it is appropriate for companies to adjust histor- ical volatility for current circumstances or use the average volatilities of similar companies until a longer series of historical data is available.
37 44 STOCK-BASED COMPENSATION • FASB Statement No. 123 does not allow for a company with publicly traded stock to ignore volatility simply because its stock has little or no trading history. A company with only publicly traded debt is not considered a public company under FASB Statement No. 123. Subsidiaries of public companies are considered public companies for purposes of applying FASB Statement No. 123’s provisions. (ii) Expected Dividends. The assumption about expected dividends should be based on publicly available information. While standard option pricing models generally call for expected dividend yield, the model may be modiﬁed to use an expected dividend amount rather than a yield. If a com- pany uses expected payments, any history of regular increases in dividends should be considered. For example, if a company’s policy has been to increase dividends by approximately 3% per year, its estimated option value should not assume a ﬁxed dividend amount throughout the expected life of the option. Some companies with no history of paying dividends might reasonably expect to begin paying small dividends during the expected lives of their employee stock options. These companies may use an average of their past dividend yield (zero) and the mean dividend yield of an appropriately comparable peer group. (iii) Expected Option Lives. The expected life of an employee stock option award should be es- timated based on reasonable facts and assumptions on the grant date. The following factors should be considered: (1) the vesting period of the grant, (2) the average length of time similar grants have re- mained outstanding, and (3) historical and expected volatility of the underlying stock. The expected life must at least include the vesting period and, in most circumstances, will be less than the contrac- tual life of the option. Option value increases at a higher rate during the earlier part of an option term. For example, a two-year option is worth less than twice as much as a one-year option if all other assumptions are equal. As a result, calculating estimated option values based on a single weighted-average life that includes widely differing individual lives may overstate the value of the entire award. Companies are encouraged to group option recipients into relatively homogeneous groups and calculate the related option values based on appropriate weighted-average expectations for each group. For example, if top level executives tend to hold their options longer than middle management, and nonmanagement employees tend to exercise their options sooner than any other groups, it would be appropriate to stratify the employees into these three groups in calculating the weighted-average estimated life of the options. (iv) Minimum Value Method. FASB Statement No. 123 indicates that a nonpublic company may estimate the value of options issued to employees without consideration of the expected volatility of its stock. This method of estimating an option’s value is commonly referred to as the minimum value method. The underlying concept of the minimum value method is that an individual would be will- ing to pay at least an amount that represents the beneﬁt of the right to defer payment of the exercise price until a future date (time value beneﬁt). For a dividend-paying stock, that amount is reduced by the present value of dividends forgone due to deferring exercise of the option. Minimum value can be determined by a present value calculation of the difference between the current stock price and the present value of the exercise price, less the present value of expected divi- dends, if any. Minimum value also can be computed using an option-pricing model and an expected volatility of effectively zero. Although the amounts computed using present value techniques may produce slightly different results than option-pricing models for dividend-paying stocks, the Board decided to permit either method of computing minimum value. Exhibit 37.9 illustrates a minimum value computation for an option, assuming an expected ﬁve- year life with an exercise price equal to the current stock price of $40, an expected annual dividend yield of 1.25%, and a risk-free interest rate available for ﬁve-year investments of 6%. The FASB Statement No. 123 does not allow public companies to account for employee stock options based on the minimum value method because that approach was considered
37.6 APPLICATION OF FASB STATEMENT NO. 123 37 45 • MINIMUM VALUE METHOD Current stock price $40.00) Less: Present value of exercise price (29.89) Present value of expected dividends 0(2.11) Minimum value of option1 $08.00) 1 The $8.00 minimum value was determined by a present value calculation. By way of contrast, applica- tion of a Black–Scholes option-pricing model results in a minimum value of $7.70. Exhibit 37.9 Minimum value computation. inconsistent with the overall fair value concept. However, the FASB acknowledged that esti- mating expected volatility for the stock of nonpublic companies is not feasible. Accordingly, FASB Statement No. 123 permits nonpublic companies to ignore expected volatility in esti- mating the value of options granted. As a result, nonpublic entities are allowed to use the min- imum value method for stock options issued to employees. However, during the EITF’s discussion of EITF Issue No. 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services,” an FASB staff representative stated that when applying the consensuses in that Issue, the minimum value method is not an acceptable method for determining the fair value of nonemployee awards by nonpublic companies. (e) RECOGNITION OF COMPENSATION COST. As previously discussed, FASB Statement No. 123 requires either recognition of compensation cost in an employer’s ﬁnancial statements for those companies adopting the new standard or disclosure of pro forma net income and earnings per share for companies remaining under APB Opinion No. 25 for all awards of stock options and other stock-based instruments. FASB Statement No. 123 applies the same basic accounting principles to all stock-based plans, including those currently considered noncompensatory under APB Opinion No. 25. At the date of grant, compensation cost is measured as the fair value of the total number of awards expected to vest. Adjustments to the amount of compensation cost recognized should be made for ac- tual experience in performance and service-related factors (i.e., forfeitures, attainment of performance goals, etc.). Changes in the price of the underlying stock or its volatility, the life of the option, divi- dends on the stock, or the risk-free interest rate subsequent to the grant date do not adjust the fair value of options or the related compensation cost. A stock option for which vesting or exercisability is conditioned upon achievement of a targeted stock price or speciﬁed amount of intrinsic value does not constitute a performance award for which compensation expense would be subsequently adjusted. For awards that incorporate such features, compensation cost is recognized for employees who remain in service over the service period re- gardless of whether the target stock price or amount of intrinsic value is reached. FASB Statement No. 123 does indicate, however, that a target stock price condition generally affects the value of such options. Previously recognized compensation cost should not be reversed if a vested employee stock option expires unexercised. Awards for past services would be recognized as a cost in the period the award is granted. Compensation expense related to awards for future services would be recognized over the pe- riod the related services are rendered by a charge to compensation cost and a corresponding credit to equity (paid-in capital). Unless otherwise deﬁned, the service period would be con- sidered equivalent to the vesting period. Vesting occurs when the employee’s right to receive the award is not contingent upon performance of additional services or achievement of a spec- iﬁed target.
37 46 STOCK-BASED COMPENSATION • Compensation cost for an award with a graded vesting schedule should be recognized in accor- dance with the method described in FASB Interpretation 28, “Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans,” if the fair value of the award is determined based on different expected lives for the options that vest each year, as it would be if the award is viewed as several separate awards, each with a different vesting date. However, if the value of the award is determined based on a composite expected life, or if the award vests at the end of a period (i.e., cliff vesting), the related compensation cost may be recognized on a straight-line basis over the service period, presumed to be the vesting period. FASB Statement No. 123 does require that the amount of compensation cost recognized at any date must at least equal the value of the vested por- tion of the award at that date. FASB Statement No. 123 requires that dividends or dividend equivalents paid to employees on the portion of restricted stock or other equity award that is not expected to vest be recognized as ad- ditional compensation cost during the vesting period. Also, certain awards provide for reductions in the exercise or purchase price for dividends paid on the underlying stock. In these circumstances, FASB Statement No. 123 requires use of a dividend yield of zero in estimating the fair value of the related award. This provision would have the effect of increasing the fair value of a stock option on a dividend-paying stock. (f) ADJUSTMENTS OF INITIAL ESTIMATES. Measurement of the value of stock options at grant date requires estimates relative to the outcome of service- and performance-related conditions. FASB Statement No. 123 adopts a grant date approach for stock-based awards with service require- ments or performance conditions and speciﬁes that resulting compensation cost should be adjusted for subsequent changes in the expected or actual outcome of these factors. Subsequent adjustments would not be made to the original volatility, dividend yield, expected life, and interest rate assump- tions or for changes in the price of the underlying stock. Exhibit 37.10 illustrates the impact on com- pensation cost when actual forfeitures resulting from terminations deviate from the rate anticipated at grant date. A performance requirement adds another condition that must be met in order for employees to vest in certain awards, in addition to rendering services over a period of years. Compensa- tion cost for these awards should be recognized each period based on an assessment of the probability that the performance-related conditions will be met. Those estimates should be subsequently adjusted to reﬂect differences between expectations and actual outcomes. The cu- mulative effect of such changes in estimates on current and prior periods should be recognized in the period of change. ADJUSTMENT OF FORFEITURE RATE UNDER FASB STATEMENT NO. 123 Assumptions: Options granted 10,000) Vesting schedule 100% at end of third year (cliff vesting) Estimated forfeiture rate 6% per year (upon termination) Actual forfeiture rate 6% in years 1 and 2; 3% in year 3 Option value at grant date $10) Estimated fair value of award at grant date: (10,000 .94 .94 .94) $10 $83,100) Compensation cost recognized in years 1 and 2: $83,100 3 $27,700) Compensation cost recognized in year 3 (3% forfeiture rate): Total compensation cost to be recognized: (10,000 .94 .94 .97) $10 $85,700) Cost recognized in year 1 (27,700) Cost recognized in year 2 (27,700) Cost recognized in year 3 $30,300) Exhibit 37.10 Adjustment of forfeiture rate under FASB Statement No. 123.
37.6 APPLICATION OF FASB STATEMENT NO. 123 37 47 • (g) MODIFICATIONS TO GRANTS. FASB Statement No. 123 requires that a modiﬁcation to the terms of an award that increases the award’s fair value at the modiﬁcation date be treated, in sub- stance, as the repurchase of the original award in exchange for a new award of greater value. Addi- tional compensation cost arising from a modiﬁcation of a vested award should be recognized for the difference between the fair value of the new award at the modiﬁcation date and the fair value of the original award immediately before its terms are modiﬁed, determined based on the shorter of (a) its remaining expected life or (b) the expected life of the modiﬁed option. For modiﬁcations of non- vested options, compensation cost related to the original award not yet recognized must be added to the incremental compensation cost of the new award and recognized over the remainder of the em- ployee’s service period. As an example of a modiﬁcation of a vested option, assume that, on January 1, 2000, Com- pany A granted its employees 300,000 stock options with an exercise price of $50 per share and a contractual term of 10 years. The options vested at the end of three years and 15,000 of the original 300,000 options were forfeited prior to vesting. On January 1, 2004, the market price of Company A stock has declined to $40 per share, and Company A decides to reduce the exercise price of the options. Under FASB Statement No. 123, Company A has effectively issued new options and would recognize additional compensation cost as a result of the reduc- tion in exercise price. The estimated fair value of the original award at the modiﬁcation date would be determined using the assumptions for dividend yield, volatility, and risk-free interest rate at the modiﬁcation date. Exhibit 37.11 illustrates the measurement of additional compen- sation cost upon modiﬁcation of the terms of this award. In certain cases, modiﬁcations may be made to options that were granted before FASB State- ment No. 123 was effective. Under APB Opinion No. 25, compensation cost would not have been MODIFICATIONS TO GRANTS UNDER STATEMENT FASB NO. 123 Assume the following for stock options granted and subsequently modiﬁed by Company A, a public company: Fair Value of Fair Value of Fair Value of Original Award New Award Original Award January 1, 2000 January 1, 2004 January 1, 2004 Exercise price $50 $40 $50 Stock price $50 $40 $40 Expected volatility 30% 35% 35% Expected dividend yield 1.5% 2.0% 2.0% 2 years1 Expected option life 6 years 5 years Risk-free interest rate 6.5% 5.75% 5.75% Estimated fair value of each option2 $18 $13 $05 1 Lesser of remaining expected life of original award or expected life of new award. 2 Fair value calculated using an acceptable pricing model. The computation of additional compensation cost resulting from this modiﬁcation would be as follows: Estimated fair value of new award ($13/option 285,000) $(3,705,000) Estimated fair value of original award at modiﬁcation date ($5/option 285,000) (1,425,000) Incremental compensation cost of new award $(2,280,000) Because the award is fully vested at the modiﬁcation date, the additional compensation cost of $2,280,000 would be expensed in the period of modiﬁcation. Exhibit 37.11 Modiﬁcations to grants under FASB Statement No. 123.
37 48 STOCK-BASED COMPENSATION • recognized upon initial issuance of an option if the exercise price was equal to the market price on the grant date. Because no compensation cost was recognized for the original options, the modiﬁed options are treated as a new grant. For modiﬁcations of vested options, compensation cost is recog- nized immediately for the fair value of the new option on the modiﬁcation date. However, if the op- tions had intrinsic value on the modiﬁcation date (i.e., the options were in the money), the intrinsic value would be excluded from the amount of compensation cost recognized because an employee could have exercised the options immediately before the modiﬁcation and received the intrinsic value without affecting the amount of compensation cost recognized by the company. For modiﬁ- cations to nonvested options, previously unrecognized compensation cost, if any, is added to incre- mental compensation cost from the new award and recognized over the employee’s service period. Exchanges of options or changes in their terms in conjunction with business combinations, spin-offs, or other equity restructurings are considered modiﬁcations under FASB Statement No. 123, with the exception of those changes made to reﬂect the terms of the exchange of shares in a business combination accounted for as a pooling of interests. This represents a change in practice, as such modiﬁcations do not typically result in a new measurement date under APB Opinion No. 25, and, therefore, additional compensation expense is not recorded. However, changing the terms of an award in accordance with antidilution provisions that are designed, for example, to equalize an option’s value before and after a stock split or a stock dividend is not considered a modiﬁcation. (h) OPTIONS WITH RELOAD FEATURES. Reload stock options are granted to employees upon exercise of previously granted options whose original terms provide for the use of “mature” shares of stock that the employee has owned for a speciﬁed period of time (generally six months) rather than cash to satisfy the exercise price. When an employee exercises the original options using mature shares (a stock for stock exercise), the employee is automatically granted a reload option for the same number of shares used to exercise the original option. The exercise price of the reload option is the market price of the stock at the date the reload option is granted, and the term is equal to the remain- der of the term of the original option. Compensation cost related to options with reload features should be calculated separately for the initial option grant and each subsequent grant of a reload option. In the Basis for Conclusions (Appendix A to FASB Statement No. 123), the FASB states its belief that, ideally, the value of an option with a reload feature should be estimated at the grant date, taking into account all of its features. However, the Board concluded that it is not feasible to do so because no reasonable method currently exists to estimate the value added by a reload feature. Accordingly, the Board decided that compensation cost for an option with a reload feature should be calculated separately for the initial option grant and for each subsequent grant of a reload option as if it were a new grant. (i) SETTLEMENT OF AWARDS. Employers occasionally repurchase vested equity instruments issued to employees for cash or other assets. Under FASB Statement No. 123, amounts paid up to the fair value of the instrument at the date of repurchase should be charged to equity, and amounts paid in excess of fair value should be recognized as additional compensation cost. For example, a com- pany that repurchases a vested share of stock for its market price does not incur additional compen- sation cost. A company that settles a nonvested award for cash has, in effect, vested the award, and the amount of compensation cost measured at the grant date and not yet recognized should be recog- nized at the repurchase date. A repurchase of vested stock options would be treated in a manner similar to a modiﬁcation of an option grant. Incremental compensation cost, if any, to be recognized upon cash settlement should be determined as the excess of cash paid over the fair value of the option on the date the employee ac- cepts the repurchase offer, determined based on the remainder of its original expected life at that date. Additionally, if unvested stock options are repurchased, the amount of previously unrecognized compensation cost should be recognized at the repurchase date because the repurchase of the option effectively vests the award. Exhibit 37.12 illustrates the accounting for the repurchase of an award by the employer.
37.6 APPLICATION OF FASB STATEMENT NO. 123 37 49 • REPURCHASE OF AWARD UNDER FASB STATEMENT NO. 123 On January 1, 2000, Company A grants a total of 10,000 “at-the-money” options to employees. The options vest after three years and are exercisable through December 31, 2009. The market price of Company A stock is $50 at grant date. It is expected that a total of 8,500 options will vest, based on projected forfeitures. The fair value of an option at grant date is $18, using an acceptable option pricing model. At grant date, Company A would compute compensation cost of $153,000 (8,500 $18 per option) to be recognized ratably over the service period. On January 1, 2005, Company A repurchases 2,000 of the vested options for $30 per option. On that date, the market price of Company A’s stock is $60 and the option’s fair value is $24. Additional compensation cost would be recognized for the difference between the cash paid and the fair value of the option at the date of repurchase. Calculations: Repurchase price of options $30 Fair value of options at repurchase date 24 Additional compensation cost $06 2,000 options $12,000 Journal entry: Compensation expense $12,000 Additional paid in capital1 48,000 Cash $60,000 1 Fair value of options repurchased (2,000 $24) Exhibit 37.12 Repurchase of award under FASB Statement No. 123. In certain circumstances, awards granted prior to adoption of FASB Statement No. 123 may be set- tled in cash subsequent to adoption of FASB Statement No. 123. Compensation cost would not have been recognized for the original award under APB Opinion No. 25 if the exercise price equaled the market price on the grant date. Because no cost was previously recognized for the original award, the cash settlement of the vested options is treated as a new grant and recognized as compensation cost on the repurchase date. However, if the original options had been in-the-money and thus had intrinsic value immediately before the settlement, the intrinsic value is excluded from compensation cost, sim- ilar to the accounting for a grant modiﬁcation. (j) TANDEM PLANS AND COMBINATION PLANS. Employers may have compensation plans that offer employees a choice of receiving either cash or shares of stock in settlement of their stock- based awards. Such plans are considered tandem plans. For example, an employee may be given an award consisting of a cash stock appreciation right and an SAR with the same terms except that it calls for settlement in shares of stock with an equivalent value. The employee may demand settle- ment in either cash or in shares of stock and the election of one component of the plan (cash or stock) cancels the other. Because the employee has the choice of receiving cash, this plan results in the company incurring a liability. The amount of the liability will be adjusted each period to reﬂect the current stock price. If employees subsequently choose to receive shares of stock rather than receive cash, the liability is settled by issuing stock. If the terms of a stock-based compensation plan provide that settlement of awards to employees will be made in a combination of stock and cash, the plan is considered a combination plan. In a combination plan, each part of the award is treated as a separate grant and accounted for separately. The portion to be settled in stock is accounted for as an equity instrument and the cash portion is ac- crued as a liability and adjusted each period based on ﬂuctuations in the underlying stock price. Exhibit 37.13 illustrates the accounting for an award expected to be settled in a combination of cash and stock.
37 50 STOCK-BASED COMPENSATION • COMBINATION PLAN UNDER FASB STATEMENT NO. 123 Company A has a performance-based plan that provides for a maximum of 900,000 performance awards to be earned by participants if certain ﬁnancial goals are met over a three-year period. Each performance award is equivalent to one share of Company A stock. The terms of the plan call for the awards to be settled two-thirds in stock and one-third in cash at the date the performance goals are attained (the settlement date). This plan may be viewed as a combination plan consisting of 600,000 shares of restricted stock and 300,000 cash SARs. The market price of Company A stock is $30 at grant date. The Company estimates that 750,000 performance awards will ultimately be earned based on the Company’s expectations of meeting benchmark goals and estimated forfeitures. Company A intends to settle the award by issuing 500,000 shares of stock and settling the remaining 250,000 units in cash based on the market price of Company A stock at the settlement date. The stock portion of the award is accounted for as a grant of an equity instrument. Company A would recognize compensation cost of $15 million (500,000 $30 per unit) over the three-year service period for the portion of the award expected to be settled in stock. The cash portion of the award would result in initial compensation cost of $7.5 million (250,000 $30) to be accrued as a liability over the participants’ service period. The amount of the liability will be adjusted each period based on ﬂuctuations in the market price of the stock. If the market price of Company A stock is $36 at the end of the service period, additional compensation cost of $1.5 million would be recognized (250,000 $6). Exhibit 37.13 Combination plan under FASB Statement No. 123. (k) EMPLOYEE STOCK PURCHASE PLANS. Some companies offer employees the opportunity to purchase company stock, typically at a discount from market price. If certain conditions are met, the plan may qualify under Section 423 of the Internal Revenue Code, which allows employees to defer taxation on the difference between the market price and the discounted purchase price. APB Opinion No. 25 generally treats employee stock purchase plans that qualify under Section 423 as noncompensatory. Under FASB Statement No. 123, broad-based employee stock purchase plans are compensatory unless the discount from market price is relatively small. Plans that provide a discount of no more than 5% would be considered noncompensatory; discounts in excess of this amount would be con- sidered compensatory under FASB Statement No. 123 unless the company could justify a higher dis- count. A company may justify a discount in excess of 5% if the discount from market price does not exceed the greater of (a) the per-share discount that would be reasonable in a recurring offer of stock to stockholders or (b) the per-share amount of stock issuance costs avoided by not having to raise a signiﬁcant amount of capital by a public offering. If a company cannot provide adequate support for a discount in excess of 5%, the entire amount of the discount should be treated as compensation cost. For example, if an employee stock purchase plan provides that employees can purchase the em- ployer’s common stock at a price equal to 85% of its market price as of the date of purchase, com- pensation cost would be based on the entire discount of 15% unless the discount in excess of 5% can be justiﬁed. If an employee stock purchase plan meets the following three criteria, the discount from market price is not considered stock-based compensation: 1. The plan incorporates no option features other than the following, which may be incorporated: (a) employees are permitted a short period of time (not exceeding 31 days) after the purchase price has been ﬁxed in which to enroll in the plan, and (b) the purchase price is based solely on the stock’s market price at the date of purchase and employees are permitted to cancel par- ticipation before the purchase date.
37.6 APPLICATION OF FASB STATEMENT NO. 123 37 51 • 2. The discount from the market price is 5% or less (or the company is able to justify a higher discount). 3. Substantially all full-time employees meeting limited employment qualiﬁcations may partici- pate on an equitable basis. (l) LOOK-BACK OPTIONS. Some companies offer options to employees under Section 423 of the Internal Revenue Code, which allows employees to defer taxation on the difference between the market price of the stock and a discounted purchase price if certain requirements are met. One requirement is that the option price may not be less than the smaller of (a) 85% of the market price when the option is granted or (b) 85% of the market price at exercise date. Op- tions that provide for the more favorable of several exercise prices are referred to as “look- back” options. Under APB Opinion No. 25, Section 423 look-back plans generally are considered noncompensatory. Under the FASB Statement No. 123, the effect of a look-back feature would be recorded at fair value at the grant date similar to other stock-based compensation. Accordingly, the fair value of a look-back option should be estimated based on the stock price and terms of the option at the grant date by breaking it into its components and valuing the option as a combina- tion position. For example, on January 1, 2004, a company offers its employees the opportunity to sign up for payroll deductions to purchase its stock at either 85% of the stock’s current $50 price or 85% of the stock price at the end of the year when the options expire, whichever is lower. Assume that the divi- dend yield is zero, expected volatility is 35%, and the risk-free interest rate available for the next 12 months is 7%. The look-back option consists of 15% of a share of nonvested stock and 85% of a one-year call option. The underlying logic is that the holder of the look-back option will always receive 15% of a share of stock upon exercise, regardless of the stock price at that date. For example, if the stock price fell to $40, the exercise price will be $34 ($40 .85), and the holder will beneﬁt by $6 ($40 $34), or 15% of the exercise price. If the stock price exceeds the $50 exercise price, the holder of the look-back option receives a beneﬁt that is more than equivalent to 15% of a share of stock. A standard option-pricing model can be used to value the one-year call option on 85% of a share of stock represented by the second component. Total compensation cost at the grant date is computed in Exhibit 37.14. FASB Technical Bulletin No. 97-1, “Accounting under Statement 123 for Certain Employee Stock Purchase Plans with a Look-Back Option,” discusses various types of look-back options and provides illustrations of the related fair value calculations. (m) AWARDS REQUIRING SETTLEMENT IN CASH. In most cases, an employer settles stock options by issuing stock rather than paying cash. However, under certain stock-based plans, an em- ployer may elect or may be required to settle the award in cash. For example, a cash stock apprecia- COMPUTATION OF COMPENSATION COSTS OF A LOOK-BACK OPTION UNDER FASB STATEMENT NO. 123 .15 of a share of nonvested stock ($50 .15) $07.50 Call option on .85 of a share of stock, exercise price of $50 ($8.48* .85) $07.21 Total compensation cost at grant date $14.71 * Fair value calculated using an acceptable pricing model. Exhibit 37.14 Computation of compensation costs of a look-back option under FASB Statement No. 123.
37 52 STOCK-BASED COMPENSATION • tion right derives its value from increases in the price of the employer’s stock but is ultimately settled in cash. Such plans include phantom stock plans, cash stock appreciation rights, and cash perfor- mance unit awards. In other instances, an employee may have the option of requesting settlement in cash or stock. Under APB Opinion No. 25, cash paid to settle a stock-based award is the ﬁnal measure of compensation cost. The repurchase of stock shortly after exercise of an option is also considered cash paid to settle an earlier award and ultimately determines compensation cost. FASB Statement No. 123 indicates that awards calling for settlement in stock are considered equity instruments when issued, and their subsequent repurchase for cash would not necessarily require an adjustment to compensation cost if the amount paid does not exceed the fair value of the instruments repur- chased. Awards calling for settlement in cash (or other assets of the employer) are considered lia- bilities when issued, and their settlement would require an adjustment to previously recognized compensation cost if the settlement amount differs from the carrying amount of the liability. Also, if the choice of settlement (cash or stock) is the employee’s, FASB Statement No. 123 speciﬁes that the employer would be settling a liability rather than issuing an equity security; accordingly, compensation cost should be adjusted if the settlement amount differs from the carrying amount of the liability. FASB Statement No. 123 indicates that the accounting for stock compensation plans as equity or liability instruments should reﬂect the terms as understood by the employer and the employee. While the written plan generally provides the best evidence of its terms, an employer’s past practices may indicate substantive terms that differ from written terms. For ex- ample, an employer that is not legally obligated to settle an award in cash but that generally does so upon exercise of stock options whenever an employee asks for cash settlement is probably set- tling a substantive liability rather than repurchasing an equity instrument. In that instance, the Statement requires accounting for the substantive terms of the plan. FASB Statement No. 123 does not change current accounting practice for nonpublic companies with stock repurchase agreements, provided that the repurchase price is the fair value of the stock at the date of repurchase. Alternatively, many nonpublic companies sponsor stock purchase plans that provide for employees to acquire shares in the company at book value or a formula price based on book value or earnings. In addition, these arrangements frequently require the company to repur- chase the shares when the employee terminates at a price determined in the same manner as the pur- chase price. Under current practice, a nonpublic company is not required to recognize compensation cost for share repurchases under book value or formula plans if the employee has made a substantive investment that will be at risk for a reasonable period of time. FASB Statement No. 123, how- ever, requires fair value as the basic method of measuring compensation cost for all stock-based plans, including those of private companies. FASB Statement No. 123 indicates that each plan will need to be assessed on a case-by-case basis to determine whether the book value or formula price is a reasonable estimate of fair value and whether the plan is subject to additional compen- sation cost. (n) TRANSACTIONS WITH NONEMPLOYEES. Except for stock-based awards to employ- ees that are currently within the scope of APB Opinion No. 25, FASB Statement No. 123 pro- vides that all transactions in which goods or services are the consideration received for the issuance of equity instruments should be accounted for based on the fair value of the considera- tion received or the fair value of the equity instruments issued, whichever is more reliably mea- surable. In some cases, the fair value of goods or services received from suppliers, consultants, attorneys, or other nonemployees is more reliably measurable and indicates the fair value of the equity instrument issued. If the fair value of goods or services received is not reliably measurable, the measure of the cost of goods or services acquired in a transaction with nonemployees should be based on the fair value of the equity instruments issued. However, FASB Statement No. 123 does not specify the date that should be used to value the equity instruments or the methodology that should be used
37.6 APPLICATION OF FASB STATEMENT NO. 123 37 53 • to determine the total cost to be recognized when the number or terms of the equity instruments are variable. These issues are addressed in EITF Issue No. 96-18, “Accounting for Equity Instru- ments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services.” Further, some such transactions are more complex: the exchange may span several periods, the issuance of the equity instruments is contingent on service or delivery of goods that must be completed by the provider of the goods or services in order to vest in the equity instrument, or fully vested, nonforfeitable equity instruments issued to a grantee may contain terms that may vary based on the achievement of a performance condition or certain market conditions. In cer- tain cases, the fair value of the equity instruments to be received may be more reliably measur- able than the fair value of the goods or services to be given as consideration. In EITF Issue No. 00-8, the Task Force agreed that for transactions in which an entity pro- vides goods or services in exchange for equity instruments, the grantee should measure the fair value of the equity instruments using the stock price and other measurement assumptions as of the earlier of either of these dates: • The date the parties come to a mutual understanding of the terms of the equity-based compensation arrangement and commitment for performance by the grantee to earn the equity instruments (a “performance commitment” in the sense used in EITF Issue No. 96- 18) is reached • The date at which the grantee’s performance necessary to earn the equity instruments is com- plete, which is the vesting date The Task Force agreed that if on the measurement date the quantity or any of the terms of the equity instrument depend on the achievement of a market condition, the grantee should measure revenue based on the fair value of the equity instruments inclusive of the adjustment provisions, calculated as the fair value of the equity instruments without regard to the market condition plus the fair value of the commitment to change the quantity or terms of the equity instruments if the market condition is met. Footnote 10 to FASB Statement No. 123 indicates that pricing models have been adapted to value many of those path-dependent instruments. The Task Force agreed that if on the measurement date the quantity or any of the terms of the equity instrument depend on the achievement of grantee performance conditions beyond those for which a performance commitment exists, changes in the fair value of the equity instrument that result from an adjustment to the instrument on the achievement of a performance condition should be measured as additional revenue from the transaction using a methodology consistent with “modiﬁcation accounting” described in paragraph 35 of FASB Statement No. 123. The ad- justment should thus be measured at the date of the revision of the quantity or terms of the in- strument as the difference between (a) the then-current fair value of the revised instruments using the then-known quantity and terms and (b) the then-current fair value of the old equity in- struments immediately before the adjustment. EITF Issue Nos. 96-18 and 00-8 do not address the periods or manner in which the fair value of the transactions should be recognized other than to observe that a transaction should be rec- ognized in the same periods and in the same manner as if cash were being exchanged in the transaction instead of the equity instruments. EITF Issue No. 00-18 addresses those issues but does not readdress the issues addressed by EITF Issue Nos. 96-18 and 00-8. The Task Force agreed that if fully vested, exercisable, nonforfeitable equity instruments are issued at the date the grantor and grantee enter into an agreement, any obligation on the part of the counterparty to earn the equity instruments has been eliminated, and thus a measurement date has been reached. The grantor should therefore recognize the equity instruments when they are issued, usually when the agreement is entered into. Most of the Task Force generally agreed that the speciﬁc facts and circumstances determine whether the corresponding cost is an imme- diate expense, a prepaid asset, or an amount that should be classiﬁed as contra-equity.
37 54 STOCK-BASED COMPENSATION • The Task Force generally agreed that if fully vested, nonforfeitable equity instruments exercisable by the grantee only after a speciﬁed period of time, but the agreement provides for earlier exercisability if the grantee achieves speciﬁed performance conditions, the grantor should measure the fair value of the equity instruments at the date of grant and should recognize that measured cost as indicated in the pre- ceding paragraph. Footnote 5 in EITF Issue No. 96-18 should be amended to eliminate the reference to immediate exercisability. Most of the Task Force agreed that if, after the arrangement date, the grantee performs as speciﬁed in the agreement and exercisability is accelerated, the grantor should measure and report the resulting increase in the fair value of the equity instruments using “modiﬁcation accounting.” If a transaction includes a grantee performance commitment with the grantee having a contingent right to receive, on performing under the commitment, grantor equity instruments that are consider- ation for the grantee’s future performance, the grantee treats the arrangement as an executory con- tract, with no accounting before performance, the same as the grantee would have agreed to pay cash on vesting for the goods or services. (o) ACCOUNTING FOR INCOME TAXES UNDER FASB STATEMENT NO. 123. The cumu- lative amount of compensation cost recognized that ordinarily results in a future tax deduction under existing tax law is a deductible temporary difference under FASB Statement No. 109, “Accounting for Income Taxes.” Under current tax law, incentive stock options do not result in tax deductions for an employer (provided employees comply with requisite holding periods) and, accordingly, do not create a future deductible temporary difference. Tax beneﬁts arising because employees do not com- ply with requisite holding periods (i.e., disqualifying dispositions) are recognized in the ﬁnancial statements only when such events occur. Nonqualiﬁed stock options and grants of restricted stock do generate tax deductions for employ- ers. In general, the tax deduction equals the intrinsic value of the award at the date of exercise. Under FASB Statement No. 123, the cumulative amount of compensation cost recognized in a company’s income statement is considered to be a deductible temporary difference under FASB Statement No. 109. Deferred tax assets recognized for deductible temporary differences should be reduced by a valuation allowance if, based on available evidence, such an allowance is deemed necessary. The de- ferred tax beneﬁt or expense resulting from increases or decreases in that temporary difference (e.g., as additional compensation cost is recognized over the vesting period) is recognized in the income statement because those tax effects relate to continuing operations. Similar to the provisions of APB Opinion No. 25 on accounting for the income tax effects of stock compensation awards, the amount of tax beneﬁts recognized in the income statement is limited to the effects of deductions based on re- ported compensation cost. If the deduction for income tax purposes exceeds the amount of compen- sation cost recognized for ﬁnancial reporting purposes, the beneﬁt of the excess tax deduction is credited to additional paid-in capital. (p) EFFECTIVE DATE AND TRANSITION. The disclosure provisions of FASB Statement No. 123, as discussed below, are effective for ﬁscal years beginning after December 15, 1995. However, disclosure of pro forma net income and earnings per share, as if the fair value method had been used to account for stock-based compensation, is required for all awards granted in ﬁscal years beginning after December 5, 1994. During the initial phase-in period, the effects of applying FASB Statement No. 123 for either rec- ognizing compensation cost or providing pro forma disclosures may not be representative of the ef- fects on reported net income for future years. Financial statements should include a disclosure to this effect if applicable. 37.7 EARNINGS PER SHARE UNDER FASB STATEMENT NO. 123 Computation of the impact of stock-based compensation awards on earnings per share is addressed in FASB Statement No. 128, and the same concepts apply to the earnings per share computations regard- less of the method of accounting for stock-based compensation. Accordingly, much of the discussion of earnings per share computations for stock-based awards under APB Opinion No. 25 in Section 37.4 is
37.7 EARNINGS PER SHARE UNDER FASB STATEMENT NO. 123 37 55 • relevant to earnings per share computations for stock-based awards under FASB Statement No. 123. However, the impact of stock-based compensation awards accounted for under FASB Statement No. 123 usually differs from the impact of awards accounted for under APB Opinion No. 25. Net income available to common stockholders (the numerator) frequently differs because of the differences in the methods of determining compensation cost under each of these standards. Furthermore, the weighted- average number of common shares outstanding (the denominator) in computations of diluted earnings per share may differ due to the differences in the determination of assumed proceeds in application of the Treasury stock method. For example, the amount of compensation cost attributed to future services and not yet recognized and the amount of tax beneﬁts that would be credited to stockholders’ equity assum- ing exercise of the options generally would differ depending on whether a company is accounting for stock-based compensation under FASB Statement No. 123 or APB Opinion No. 25. Discussed below are a few other points to consider in computing the impact of stock-based awards on earnings per share. Under FASB Statement No. 128, forfeitures of stock-based awards do not affect the computation of assumed proceeds in application of the treasury stock method until the forfeitures actually occur. This practice may be inconsistent with the method that a company uses for determining compensa- tion expense since, under FASB Statement No. 123, a company can determine compensation ex- pense based on actual forfeitures as they occur or based on an estimate of forfeitures with adjustments to actual forfeitures. There also is an inconsistency in when compensation cost for performance awards is included in the numerator of the diluted earnings per share computation pursuant to FASB Statement No. 123 and when the related contingent shares are included in the denominator of the same computation pursuant to FASB Statement No. 128. Interim accruals of compensation cost for performance awards are based on the best estimate of the outcome of the performance condition. In other words, for each reporting period, compensation cost is estimated for the awards that are expected to vest based on performance- related conditions. However, pursuant to FASB Statement No. 128, diluted earnings per share reﬂects only those awards that would be issued if the end of the reporting period were the end of the contin- gency period. In most cases, performance awards will not be reﬂected in diluted earnings per share until the performance condition has been satisﬁed. In applying the Treasury stock method to awards accounted for pursuant to FASB Statement No. 123, the awards may be antidilutive even when the market price of the underlying stock exceeds the related exercise price. This result is possible because compensation cost attributed to future services and not yet recognized is included as a component of assumed proceeds upon exercise in applying the Treasury stock method. Since this component represents an amount over and above the intrinsic value of the award at the grant date, it is possible that stock options with a positive intrinsic value would be considered antidilutive and thereby excluded from diluted earnings per share computations under to FASB Statement No. 128. Exhibit 37.15 illustrates basic and diluted earnings per share computations under APB Opinion No. 25 and FASB Statement No. 123. EARNINGS PER SHARE UNDER FASB STATEMENT NO. 123 AND APB OPINION NO. 25 For purposes of this example, assume that 2006 is the ﬁrst year that Company A had a stock option plan. On January 1, 2001, Company A granted 100,000 options with an exercise price equal to the market price of the stock at that date ($30). The fair value of each option granted was $9, and the options vest at the end of three years. Company A expects that 85,000 options granted in 2001 will vest. Assume a 40% tax rate. On January 1, 2001, Company A computed compensation cost of $765,000 (85,000 × $9) to be recognized ratably at $255,000 per year pursuant to FASB Statement No. 123. (For this example, compensation cost under FASB Statement No. 123 has been computed based on the number of options expected to vest. Alternatively, the company may have elected to recognize forfeitures as they occur.) During 2001, 5,000 options were forfeited. (Continued) Exhibit 37.15 Earnings per share under FASB Statement No. 123 and APB Opinion No. 25.
37 56 STOCK-BASED COMPENSATION • The market price of Company A stock at December 31, 2001, is $42, and the average stock price during 2001 was $36. Net income for 2001 (before recognition of compensation expense related to the option grant) was $2,700,000. Weighted average common shares outstanding are 1,500,000 at December 31, 2001. Calculation of basic earnings per share for the year ended December 31, 2001: FASB STATEMENT APB OPINION No. 123 No. 25 Net income before stock compensation expense $2,700,000 $2,700,000 Stock-based compensation, net of income taxes1 153,000 0 Net income $2,547,000 $2,700,000 Weighted average shares outstanding 1,500,000 1,500,000 Basic earnings per share $1.70 $1.80 FASB STATEMENT APB OPINION No. 123 No. 25 Assumed proceeds from exercise of options2 $2,925,000)* $2,925,000 Average unrecognized compensation cost related to future services3 735,000)1 0 Tax beneﬁts credited to equity on assumed exercise based on average market price less weighted average exercise price4 $0,000,000)* $0,234,000 Total assumed proceeds $3,660,500)* $3,159,000 Shares assumed issued upon exercise of options 97,500)* 97,500 Shares repurchased at average market price $0,0101,667)* $0,087,750 Incremental shares $0,0(4,167)* $0,009,750 Net income before stock compensation expense $2,700,000* $2,700,000 Stock-based compensation, net of income taxes5 153,000 $0,000,000 Net income $2,547,000)* $2,700,000 Weighted average shares outstanding 1,500,000)* 1,500,000 Incremental shares $0,000,000) $0,009,750 Total weighted average shares outstanding $1,500,000)* $1,509,750 Diluted earnings per share $0,0001.70)* $0,0001.79 * Impact on earnings per share is antidilutive; therefore, options are excluded from weighted average shares outstanding. ($765,000 ÷ 3) × .60 = $153,000. 1 97,500 (average options outstanding) × $30. 2 ($900,000 + $570,000) ÷ 2 = $735,000. 3 4 Under FASB Statement No. 123, the tax deduction based upon average market price ($6 per option) is less than the cost recognized for ﬁnancial statement purposes ($9 per option); therefore, there is no tax beneﬁt upon assumed exercise that would be credited to paid-in capital. Under APB Opinion No. 25, the tax deduction of $6 for each of the 97,500 average outstanding options at a tax rate of 40% would result in a tax beneﬁt of $234,000. ($765,000 ÷ 3) × .60 = $153,000. 5 Exhibit 37.15 Continued.
37.8 FINANCIAL STATEMENT DISCLOSURES 37 57 • 37.8 FINANCIAL STATEMENT DISCLOSURES (a) DISCLOSURE REQUIREMENTS FOR ALL COMPANIES. FASB Statement No. 123 super- seded the disclosure requirements under APB Opinion No. 25 and requires disclosure of the follow- ing information by employers with one or more stock-based compensation plans regardless of whether a company has elected the recognition provisions or retained accounting under APB Opin- ion No. 25: 1. A description of the method used to account for all stock-based employee compensation arrangements should be included in the company’s summary of signiﬁcant accounting poli- cies. 2. A description of the plans, including the general terms of the awards under the plans such as vesting requirements, the maximum term of options granted, and the number of shares autho- rized for grants of options or other equity instruments. 3. The following information should be disclosed for each year for which an income statement is presented: a. The number and weighted-average exercise prices of options for each of the following groups of options: (1) those outstanding at the beginning and end of the year, (2) those exercisable at the end of the year, and (3) the number of options granted, exer- cised, forfeited, or expired during the year. b. The weighted-average grant-date fair values of options granted during the year. If the ex- ercise prices of some options differ from the market price of the stock on the grant date, weighted-average exercise prices and fair values of options would be disclosed separately for options whose exercise price (1) equals, (2) exceeds, or (3) is less than the market price of the stock on the date of grant. c. The number and weighted-average grant-date fair value of equity instruments other than options (e.g., shares of nonvested stock) granted during the year. d. A description of the method and signiﬁcant assumptions used to estimate the fair values of options, including the weighted-average (1) risk-free interest rate, (2) expected life, (3) ex- pected volatility, and (4) expected dividend yield. e. Total compensation cost recognized in income for stock-based compensation awards. f. The terms of signiﬁcant modiﬁcations to outstanding awards. A company that has both ﬁxed and indexed or performance-based plans should provide cer- tain of the foregoing information separately for different types of plans. For example, the weighted-average exercise price at the end of the year would be shown separately for plans with a ﬁxed exercise price and those with an indexed exercise price. 4. For options outstanding at the date of the latest balance sheet presented, disclosure of the range of exercise prices, the weighted-average exercise price, and the weighted-average re- maining contractual life. If the range of exercise prices is wide (e.g., the highest exercise price exceeds 150% of the lowest exercise price), the exercise prices should be segregated into meaningful ranges. The following information should be disclosed for each range: a. The number, weighted-average exercise price, and weighted-average remaining contrac- tual life of options outstanding, and b. The number and weighted-average exercise price of options currently exercisable. FASB Statement No. 123 provides an extensive example disclosure. (b) DISCLOSURES BY COMPANIES THAT CONTINUE TO APPLY THE PROVISIONS OF APB OPINION NO. 25. In addition to the disclosures described above, companies that
37 58 STOCK-BASED COMPENSATION • continue to apply the provisions of APB Opinion No. 25 must disclose the following for each year an income statement is presented: • The pro forma net income and, for public entities, the pro forma earnings per share, as if the fair value-based accounting method prescribed by FASB Statement No. 123 had been used to account for stock-based compensation cost • Those pro forma amounts should reﬂect the difference between compensation cost, if any, in- cluded in net income in accordance with APB Opinion No. 25 and the related cost measured by the fair value-based method, as well as additional tax effects, if any, that would have been rec- ognized in the income statement if the fair value-based method had been used • The required pro forma amounts should reﬂect no other adjustments to reported net income or earnings per share FASB Statement No. 123 provides an extensive example disclosure. 37.9 SOURCES AND SUGGESTED REFERENCES Accounting Principles Board, “Accounting for Stock Issued to Employees,” APB Opinion No. 25. AICPA, New York, 1972. , “Stock Plans Established by a Principle Stockholder,” Accounting for Stock Issued to Employees: In- terpretation of APB Opinion No. 25. AICPA, New York, 1973. Financial Accounting Standards Board, “Purchase of Stock Options and Stock Appreciation Rights in a Lever- aged Buyout,” EITF Issue No. 84-13. FASB, Stamford, CT, 1984. , “Stock Option Pyramiding,” EITF Issue No. 84-18. FASB, Stamford, CT, 1984. , “Permanent Discount Restricted Stock Purchase Plans,” EITF Issue No. 84-34. FASB, Stamford, CT, 1984. , “Business Combinations: Settlement of Stock Options and Awards,” EITF Issue No. 85-45. FASB, Stamford, CT, 1985. , “Adjustments Relating to Stock Compensation Plans,” EITF Issue No. 87-6. FASB, Stamford, CT, 1987. , “Book Value Stock Purchase Plans,” EITF Issue No. 87-23. FASB, Stamford, CT, 1987. , “Stock Compensation Issues Related to Market Decline,” EITF Issue No. 87-33. FASB, Stamford, CT, 1987. , “Book Value Stock Plans in an Initial Public Offering,” EITF Issue No. 88-6. FASB, Norwalk, CT, 1988. , “Accounting for a Reload Stock Option,” EITF Issue No. 90-7. FASB, Norwalk, CT, 1990. , “Changes to Fixed Employee Stock Option Plans as a Result of Equity Restructuring,” EITF Issue No. 90-9. FASB, Norwalk, CT, 1990. , “Accounting for the Buyout of Compensatory Stock Options,” EITF Issue No. 94-6. FASB, Norwalk, CT, 1994. , “Accounting for Stock Compensation Arrangements with Employer Loan Features under APB Opinion No. 25,” EITF Issue No. 95-16. FASB, Norwalk, CT, 1995. , “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Con- junction with Selling, Goods or Services,” EITF Issue No. 96-18. FASB, Norwalk, CT, 1997. , “Accounting for the Delayed Receipt of Option Shares upon Exercise under APB Opinion No. 25,” EITF Issue No. 97-5. FASB, Norwalk, CT, 1997. , “Accounting for Increased Share Authorizations in an IRS Section 423 Employee Stock Purchase Plan under APB Opinion No. 25,” EITF Issue No. 97-12. FASB, Norwalk, CT, 1997. , “Accounting by a Grantee for an Equity Instrument to Be Received in Conjunction with Providing Goods or Services,” EITF Issue No. 00-8, FASB, Norwalk, CT, 2000.
37.9 SOURCES AND SUGGESTED REFERENCES 37 59 • , “Accounting Recognition for Certain Transactions Involving Equity Instruments Granted to Other Than Employees,” EITF Issue No. 00-18, FASB, Norwalk, CT, 2000. , “Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans,” FASB In- terpretation No. 28. FASB, Stamford, CT, 1978. , “Determining the Measurement Date for Stock Option, Purchase, and Award Plans Involving Junior Stock,” FASB Interpretation No. 38. FASB, Stamford, CT, 1984. , “Accounting for Certain Transactions Involving Stock Compensation,” FASB Interpretation No. 44, FASB, Norwalk, CT, 2000. , “Accounting for the Conversion of Stock Options into Incentive Stock Options as a Result of the Eco- nomic Recovery Tax Act of 1981,” FASB Technical Bulletin No. 82-2. FASB, Stamford, CT, 1982. , “Accounting under Statement 123 for Certain Employee Stock Purchase Plans with a Look-Back Op- tion,” FASB Technical Bulletin 97-1. FASB, Norwalk, CT, 1997. , “Accounting for Income Taxes,” Statement of Financial Accounting Standards No. 109. FASB, Nor- walk, CT, 1992. , “Accounting for Stock-Based Compensation,” Statement of Financial Accounting Standards No. 123. FASB, Norwalk, CT, 1995. , “Earnings Per Share,” Statement of Financial Accounting Standards No. 128. FASB, Norwalk, CT, 1997. Securities and Exchange Commission, “Codiﬁcation of Financial Reporting Policies,” Financial Reporting Re- lease No. 1, § 211 (ASR No. 268). SEC, Washington, DC, 1982