Bending to corporate and industry pressure, the Financial Accounting Standards Board has decided to delay by six months the effective date for public companies to implement Statement 123R, its proposed standard that would require companies to expense the value of employee stock options in the income statement.
FASB’s exposure draft had proposed an effective date for public companies of January 1, 2005 (that is, for fiscal periods beginning after December 15, 2004). After much debate on Wednesday, the board members agreed that the proposed rule should become effective for periods beginning after June 15, 2005, or the third quarter for companies on a calendar-year financial reporting cycle. FASB also agreed to allow companies to restate their profits for the first two quarters of 2005 to reflect options expensing using calculations from existing footnote disclosures.
Steven Getz, a spokesman for FASB, said the decision to delay the effective date was “a difficult balancing act.”
While there was a general desire among board members to implement the accounting rule as soon as possible to improve the quality of reported financial statements, the members also felt companies needed more time to properly evaluate and implement option valuation methods such as the lattice-based binomial model, to reconsider the structure of their compensation plans, and to educate investors.
Board members also were influenced by complaints about the rule putting preparers under too much strain in the first calendar quarter of 2005. For many companies, Section 404 of the Sarbanes-Oxley Act — which will guide how auditors report on companies’ assessments of their internal controls — becomes effective with their first fiscal year ending after November 15.
Securities and Exchange Commission chief accountant Donald Nicolaisen has publicly stated his support for a delay past the first quarter of 2005 to allow companies and auditors more time and energy to focus on the Sarbanes-Oxley 404 requirements.
Pete Mariani, controller and chief accounting officer at Guidant Corporation, wasn’t surprised by the delay given the “tremendous pressure” FASB was under. He says, however, that it’s “only a partial answer” and that companies might have trouble implementing the rule mid-year. He would have preferred that FASB require companies to start expensing at the start of a fiscal year to lessen potential investor confusion on earnings guidance – an option that a few board members favored. He also would like to see FASB spend more time evaluating option valuation models.
Separately, FASB reviewed aspects of the “fair value index-adjusted model,” a valuation model recently proposed by Cisco, Genentech, and Qualcomm, and rejected those suggestions in favor of the board’s existing proposal for measuring the fair value of employee stock options. Some critics of the companies’ proposal saw it as simply another attempt to slow down FASB’s efforts toward expensing options or to significantly reduce reported compensation expense.
Recent research from the CFA Institute found that the valuation approach proposed by the companies could easily result in zero expense — or even improve earnings. Kurt Schacht, executive director of advocacy for the institute, believes FASB “did exactly the right thing” in rejecting the model. Thomas Courtright, vice president of independent valuation firm Valuation Research Corp., also noted in a recent report that the companies’ method results in a variance of nearly 20 percent in option values and “dramatic swings in year-to-year volatility calculations” that “would not be comforting” to investors or auditors.
Rick White, Chairman of the International Employee Stock Option Coalition, blasted FASB’s decision-making, calling the delay “nothing more than the postponement of a fundamentally flawed expensing standard that will grossly overstate the value of employee stock options.”
FASB remains on target to issue its final statement before the end of this year. The standard-setters will address the effective date for non-public entities at a later meeting.