Accounting & Tax

Divergence of the Twain

The clash between FASB and IASB over how to record the tax benefits of equity-based pay sets up a roadblock to overall U.S.-international accountin...
Craig SchneiderDecember 1, 2003

Efforts to converge U.S. and international accounting standards were dealt a major blow in mid-November when standard setters split over how best to account for the income-tax benefits of stock-based compensation.

The Financial Accounting Standards Board and the International Accounting Standards Board are at odds over the correct way to divide up the tax benefits between the income statement and the shareholder’s equity section of the balance sheet.

The split in allocation methodology seems to have spawned at least a temporary sticking point in the boards’ plans to meld their stock-options accounting standards by 2005. On November 19, after learning of the IASB’s approach — reached the prior day — the FASB approved its own allocation method and then voted 4-3 not to converge the standards on the taxation issue, despite stated goals to the contrary.

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Ed Trott, a FASB member, says the vote reflected the majority belief that the U.S.-based approach would be “sufficiently better for financial reporting” than the IASB version. He also notes, however, that the two allocation approaches are not so different. “You end up with the same split,” Trott adds. “The difference is the pattern in which that split is made.”

Nevertheless, Jim Leisenring, an IASB member, says he was disappointed by the decisions made by his U.S-based counterparts. And unless the FASB develops a modified approach for his board to consider, he adds, “we’re not going to change to theirs.”

Across the Great Divide

With the FASB preparing to issue an exposure draft of a stock-based-compensation accounting standard for public comment in February, the board’s constituents will have their say about whether or not the board should reconsider its approach to taxation, as well as many other issues. For its part, the IASB is already on track to issue a final accounting standard on stock-based compensation in the first quarter of 2004. Says Trott: “Both sides will try to sell their respective approaches as the superior one.”

The IASB tentatively approved an allocation approach that estimates the tax benefits based on the stock price at the end of each reporting period. Under the proposed rule, if the tax deduction is less than, or equal to, the compensation expense, the associated tax benefits would be recognized in the income statement.

If the estimated — or actual — tax deduction exceeds the compensation expense, the excess would be recognized as a change in stockholder’s equity on the balance sheet.

In practice, FASB’s approach should reach the same final answer. But it proposes that companies should first record an estimate of the tax benefits associated with the compensation expense in the income statement as if those benefits actually were the tax deduction. As much as several years later, when the stock options are actually exercised and the tax deduction is determined, companies would reconcile the estimate with the actual deduction.

Froggie Went-a Courtin’

Part of the challenge in getting the standards in sync are the differing schedules of the two standard setters. Although the boards “end up at the same place [they] work on the project in a different sequence,” Trott explains. That creates a situation in which the boards are continually “leapfrogging” over each other, he adds.

When the FASB introduced Statement 123, Accounting for Stock-Based Compensation, for instance, it was more definitive than any IASB standard on the issue of stock-option costs, Trott notes. But then the IASB took the concept behind FAS 123 to a new level, requiring that companies record option costs as an expense item on the income statement.

Up to that point, while the FASB preferred expensing, it also allowed companies to account for stock-option expenses in the footnotes of the income statement. The FASB has only recently decided to require that companies report such details solely in the income statement itself.

There’s a chance that the leapfrogging could get less frequent. “We recognize the problem and are working to better coordinate our agendas to work together on more projects at approximately the same time,” Trott says.

Convergence or Bust

It’s unclear whether the boards will ultimately see other projects fall short of planned convergence. Besides the stock-option issue, the IASB and the FASB are also working jointly towards that goal for projects on business-purchase procedures, revenue recognition, and reporting financial performance.

Both boards have targeted January 1, 2005, as the effective date for the standard on stock-based compensation. Despite their differences on the tax-benefit issue, both sides still hope to achieve overall convergence.

If the approaches to the tax-benefit issue differ, adjustments can be made down the road, says Trott. “At some point in the future we would look at that after some experience had been gained working under both approaches,” he adds.