October 13, 2004 Board Meeting, FASB

Equity-based compensation. The Board continued its redeliberations of the March 2004 FASB Exposure Draft, Share-Based Payment. The Board discussed certain issues related to fair value measurement, equity and liability classification, cost-benefit procedures, and the effective date for public companies. The Board made the following decisions regarding those issues.

Certain Fair Value Measurement Issues

The Board unanimously affirmed its previous decisions regarding volatility and the concept of expected term in estimating the grant-date fair value of instruments granted in a share-based payment transaction. However, the Board decided to add guidance similar to that of IFRS 2, Share-based Payment (paragraphs B38B41), relating to the consideration of certain capital structure effects when estimating the grant-date fair value of share-based awards. The Board noted, however, that it would be rare for a public company to adjust the grant-date fair value of an instrument for those effects because those effects generally are reflected in the underlying stock price.

Effect of Dividends or Dividend Equivalents on Recognition and Measurement of Equity Awards

The Board decided to incorporate into the final Statement a measurement principle stating that the estimate of an awards grant-date fair value should take account of dividend (or dividend-equivalent) rights or the absence thereof. The Board also agreed to provide some examples illustrating the application of that principle.

The Meaning of Requisite Service Period and Certain Noncompete Agreements

The Board decided that if the terms of a noncompete agreement, represent, in substance, a service condition, the compensation cost of the related equity-based award would be recognized over the substantive service period. The Board also decided to provide an illustration in the final Statements implementation guidance of such a case.

Awards with Graded Vesting

The Board decided that the choice of attribution method for awards with graded vesting schedules would be a policy decision that is not dependent on an enterprises choice of valuation technique. The Board also clarified that the choice of attribution method pertains solely to awards with service conditions.

Equity and Liability Classification

The Board decided to:

  1. Clarify the guidance in paragraph 39A of the Exposure Draft concerning the classification of awards with repurchase features.

  2. Clarify the guidance in the final Statement concerning the classification of puttable shares by incorporating certain aspects of guidance based on APB Opinion No. 25, Accounting for Stock Issued to Employees.

  3. Require all options on shares with repurchase features to be classified consistently with the underlying shares, and provide an illustration in the final Statement.

The above decisions would result in the following:

  1. Mandatorily redeemable shares and options on mandatorily redeemable shares would be classified as liabilities unless the shares or underlying shares were subject to the deferral provisions of FSP FAS 150-3, Effective Date, Disclosures, and Transition for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests under FASB Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.E

  2. Puttable shares would be classified as equity (or temporary equity) if certain APB Opinion 25-based criteria relating to the redemption feature and redemption price are met.

  3. Options on puttable shares would be classified as equity (or temporary equity) if the underlying shares would be classified in the same manner.

  4. Puttable options would be classified as liabilities.

Cost-Benefit Procedures

The Board considered this issue solely as it pertains to public entities and concluded that based on the findings of the cost-benefit procedures performed related to this project, the final Statement will sufficiently improve the financial reporting to justify the costs it will impose.

Effective Date for Public Companies

The Board discussed the effective date for public companies and decided that:

  1. The final Statement would be effective for any interim or annual period beginning after June 15, 2005, meaning that an entity would apply the final Statement to all employee awards of share-based payment granted, modified, or settled in any interim or annual period beginning after June 15, 2005. Additionally, as of the beginning of the period in which the final Statement is first applied, compensation cost would be recognized for the portion of awards outstanding for which the requisite service has not been rendered as of that date; measurement and attribution of compensation cost for those awards would be based on the same estimate of the grant-date fair value and the same attribution method used previously for either (a) recognition or (b) pro forma disclosures under the original provisions of Statement 123. Any cumulative-effect adjustment required under the final Statement (for example, for a change in the method of estimating forfeitures) would be recognized as of the beginning of the period in which the final Statement is first applied.

  2. If an entity adopts the final Statement using the modified prospective application method in other than the first interim period of its fiscal year, it may use the modified retrospective application (MRA) method for those earlier interim periods. However, any cumulative-effect adjustment required under the final Statement (for example, for a change in the method of estimating forfeitures) would be recognized as of the beginning of the interim period in which the final Statement is first applied. Under the MRA method, an entity would recognize compensation cost for periods prior to the effective date in accordance with the original provisions of Statement 123; that is, an entity would recognize employee compensation cost in the amounts reported in the pro forma disclosures provided in accordance with Statement 123.

  3. Early adoption would be encouraged provided that financial statements for periods prior to the effective date have not been issued.