FASB To Discuss Options Costs Today

The accounting standard-setting body will look at compensation-cost attribution and whether an option should be classified as liability or equity.
Craig SchneiderAugust 18, 2004

On Wednesday, the Financial Accounting Standards Board will hold a public meeting to discuss cost-attribution and classification issues raised by its exposure draft calling for companies to expense employee stock options.

The proposal has inspired nearly 14,000 responses that the board members will consider in writing the final standard. On August 4, at the first meeting to that end, FASB reaffirmed that publicly traded companies must estimate the fair value of employee stock options at the date they’re granted and then subtract that value from earnings.

But how that cost should be attributed over the life of the option remains a matter of vigorous debate. Specifically, the board has called for a graded vesting schedule, so that awards are considered separately. What’s more, under the proposed rule, the recognition of employee stock option expense is front-loaded, with more compensation cost attributed to early parts of the vesting period of an award and less to later portions.

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“If you look at them as separate grants, in the first year you have a very significant expense and that goes down over time,” explains G. Michael Crooch, a FASB member, who calls graded vesting “a better reflection of the economics of the transaction.”

Many comment letters, however, argue that costs should be spread evenly over the life of the option. “An award with graded vesting is in fact a single award, not a series of linked awards, and compensation costs for such awards should be recognized on a straight-line basis,” wrote Bob Laux, Microsoft director of technical accounting and reporting, in a letter to FASB.

Laux offers an example of a grant of stock awards to an employee that vest over a five-year period, with 20 percent of the awards vesting each year. Under the exposure draft, he notes, 46 percent of the compensation cost would be recognized in the first year, 26 percent in the second year, 15 percent in the third year, 9 percent in the fourth year, and 4 percent in the fifth year.

“We would find it difficult to understand why the employee’s service in the first year is almost twice as valuable as the service in the second year, three times more valuable than the third year, five times more valuable than the fourth year, and over ten times more valuable than the fifth year,” Laux concludes.

A KPMG letter makes a similar criticism, using a four-year, graded- vesting example. Under such a system, FASB’s approach would result in the recognition of about 65 percent of the total compensation cost of the arrangement in the first year; that would be 25 percent under an even-spread approach. Arguably, neither employer nor employee believes that the employee delivered nearly two-thirds of the total service in the first year, the accounting firm notes.

Dennis Powell, CFO of Cisco Systems, also recommends that FASB change its position. For Cisco, he notes in a letter, the proposed graded approach “would mean the tracking of over 43 million awards based on the number of grants, individual vesting periods within each grant, and contractual life of the awards.”

“In addition, both the management of a company and its employees do not view individual grants as multiple awards,” Powell added.

To be sure, FASB has some supporters. For instance, Joseph Sclafani, controller for J.P. Morgan Chase, notes that “the company agrees that awards vesting at different points in time should be recognized ratably over each separate vesting schedule.”

FASB will also try to clarify at the meeting whether an option should be classified as a liability or an equity.