The Financial Accounting Standards Board gave companies something to cheer about last Wednesday when it decided to tweak a proposed shortcut for calculating the tax benefits of stock-option grants in favor of a more profit-friendly approach.

The board’s discussion on FASB staff position 123R-c, which applies to the stock-option-expensing standard, addressed several issues raised during the comment period. Chief among them was the complaint that, in some cases, the proposed shortcut would reduce the size of the additional-paid-in-capital (APIC) pool — a measure of excess tax benefits.

The smaller the APIC pool, the smaller a company’s cushion against future tax deficiencies — and the greater the likelihood that tax-deduction benefits from stock compensation would be charged against the income statement. If, on the other hand, the APIC pool is large enough to absorb any future shortfall, according to Statement 123R the tax-deduction benefits would be written off against equity.

The threat of a smaller pool has most companies running back to the regular, more complicated method, says Chuong Pham, a senior manager with Deloitte Tax LLP. “They’re just not convinced that the shortcut method is a reasonable solution,” says Pham. Indeed, 4 of the 11 respondents that commented on FASB’s proposed staff position identified situations in which the simplified method for calculating the APIC pool would result in double counting of the compensation cost associated with awards that either were 1) recognized in the financial statements prior to the adoption of Statement 123R, or 2) partially vested upon adoption of Statement 123R.

Simply put, the respondents argued, those biases would result in inappropriate reductions of the APIC pool.

To be sure, noted the FASB staff, the simplified method also offers some “general upside biases” for companies, such as enhancements to the APIC pool resulting from exercises of awards granted prior to 1995, when FAS 123 was issued. The staff expressed to the FASB board, however, that this alone was not a sufficiently compelling reason to ignore the downside biases that respondents had commented on.

Accordingly, to avoid penalizing companies simply for being early adopters of the fair-value recognition provisions of Statement 123, FASB agreed to revise the simplified method. To calculate the beginning balance of the APIC pool, the board would now deduct only the cumulative compensation cost disclosed under Statement 123.

Some FASB board members nonetheless expressed frustration with their no-win situation. “The psychology is very interesting,” observed Michael Crooch during the meeting. “We give them this simplified method that digs them out of a hole, and now other people come along and say that because they did it right, they’re being punished vis-à-vis the people that didn’t do it at all.”

In addition, FASB would exclude compensation costs associated with partially vested awards, as well as costs associated with incentive stock options that did not result in a tax deduction prior to the adoption of 123R. (Those stock options are not generally tax deductible by the company that issues them.) Less favorable to companies, perhaps, was the board’s decision that these newly proposed changes would be required rather than elective. An exception would be if a company has insufficient information on its incentive stock options, in which case those costs are not excluded.

Another downside: The originally proposed simplified method was designed to use information available in the financial statements of every preparer, but the new version will compel managers to spend more time digging into their figures. “You might have to drill down a little bit into the supporting detail behind those number systems,” says FASB practice fellow Reggie Oakley.

The final version of the FASB staff position is expected to be available on the board’s website by the end of this week.

This Wednesday, the board will discuss:

• Performance reporting by business entities;

• Revenue recognition; and
• Approaches to income-tax accounting.

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