Questions of Value

But there's the rub. Under FAS 123, fair value is measured at the grant date; subsequent adjustments are not generally allowed. Yet even this relatively simple fair-value application is challenging.

Coca-Cola, for example, won praise for its plan to value options by averaging bids solicited from investment banks. But some observers suspect those bids will simply represent an outsourcing of the Black-Scholes calculation, not executable market transactions. Real market prices would include discounts for unique features of stock-options such as nontransferability. (FAS 123 does not allow such discounts for companies applying valuation techniques internally.)

Coke's 2001 estimate of its stock-options expense would have cut its earnings that year by $202 million. But John Finnerty, of Analysis Group/Economics, says if a market existed, the actual expense might be as little as half that amount, simply because Black-Scholes ignores the illiquidity of the grants.

"I actually believe a market could be created in hedging of stock options," says Herz. Finnerty agrees, noting that there's more than enough profit potential tied up in stock options to interest investment banks. He believes a developed market for stock option instruments is only a matter of time. "There are smart guys in these investment banks who have solved similar problems in the past," he says. —T.R.

Rule, Britannia?

While the Financial Accounting Standards Board's published agenda is already loaded with complex and controversial issues, chairman Robert H. Herz has suggested in recent speeches that the board revisit pension accounting.

International accounting standards offer little clue about what this may mean for pension smoothing — IAS differ from U.S. generally accepted accounting principles only in the technical detail of application. But before he was chair of the International Accounting Standards Board, Sir David Tweedie oversaw the development of FRS 17 in UK GAAP — a virtually unsmoothed pension technique that requires measuring the liabilities and assets of pension funds and recording the year-over-year change as income or expense.

Herz would seem sympathetic to that approach: In addition to being a CPA, he is a UK-chartered accountant and unapologetic Anglophile who considers Tweedie an ally in the struggle to improve accounting standards. In fact, when interviewed by CFO during his IASB tenure, Herz suggested hypothetically that one way of circumventing the technical differences between the IAS and U.S. GAAP pension accounting was to simply eliminate pension smoothing.

So is this an area of convergence where the UK's answer would trump both GAAP and IAS?

"Clearly, that is a concern," says General Electric comptroller Philip D. Ameen, former chair of the Financial Executives International's Committee on Corporate Reporting. "FEI would not care for that. We think that pensions have to be viewed with a very long-term horizon, [and are concerned about] the extreme volatility we could see in short-term operating results."

Ameen can take some comfort in Herz's thoughts on FRS 17. "I'm not quite there," says Herz of eliminating smoothing entirely. Because measuring the liability is an actuarial exercise, he believes some smoothing should be preserved. "But on the asset side, I would eliminate expected return and just record value of the assets."

Herz is quick to point out that his personal opinion isn't necessarily shared by FASB's six other members, so that approach is far from a foregone conclusion. But whatever the outcome, it's clear Herz is serious about addressing pensions. "As a citizen, beyond my standards-setting capacity, this is a very important issue with regard to the whole retirement structure of our nation. My concern is that we have constructed accounting methods that prompt strange behavior. It's like stock options — if accounting prompts strange behavior solely because of the accounting, that's not a good answer." —T.R.

Where Fair Is Fair

Accounting standards in which fair value plays a prominent role for initial recognition or ongoing valuation.

• « previous
• 1
• 2
• 3
• 4