SEC Issues Option Accounting Guidance

New guidance from the Chief Accountant tells companies how to respond to various outcomes of internal investigations into backdating and other stoc...
Helen ShawSeptember 19, 2006

In a public letter to the accounting industry issued Tuesday, the chief accountant of the Securities and Exchange Commission issued new guidance describing how companies should account for stock options. The letter, a response to the ongoing backdating scandal, addresses a range of issues that arise as companies review past option granting practices. Currently, more than 100 companies have publicly announced that they are involved in either internal or SEC investigations related to options granting practices.

In the guidance letter, SEC chief accountant Conrad Hewitt, drew attention to Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” the principles that many public companies followed before the Financial Accounting Standards Board issued Statement No. 123, “Share-Based Payment”.

The letter uses several scenarios to address questions regarding the accounting treatment for determining the measurement date of previously awarded stock option grants, and renders an opinion on each situation. The scenarios include dating an option award to predate the actual award date; option grants with administrative delays; uncertainty about the individual award recipients; options granted before employment begins; and incomplete documentation of option granting activities, among others.

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The staff gave a clear cut example of how to determine the measurement date. It noted that under Opinion 25, the measurement date is the first date on which two factors are known: the number of shares that an individual employee is entitled to receive, and the option or purchase price, if any. In some instances, companies claim that their measurement date appeared incorrect because grants were subject to administrative delays, such as waiting for oral authorization from the board on a grant. But the letter pointed out that a company’s option plan usually describes the actions required to make the grant effective (also known as “required granting actions”). Without those stipulations, the effective grant date is considered the measurement date.

The staff also noted that when trying to determine whether the measurement date occurred before the completion of the required granting actions, the company’s conduct in granting options must be considered carefully. If a company rescinds awards or changes the terms of the options, the staff believes that the company should delay the measurement date for all its stock option awards until all required granting actions have been completed.

Hewitt emphasizes that the staff’s views are limited to the financial statement impact, adding that each company’s circumstances are different, and evidence of stock option fraud would need further analysis. As is usual with guidance letters, the staff opinion was not approved by the Commission.