The authors of “FASB Interpretation No. 44” (CPA Journal, July 2000) may have oversummarized, and some issues need clarification:
1) The article says that “with variable stock options, the number of options and the strike price are not established on the grant date.” In fact, because where the number of options is known but the strike price is not known until some later date (or vice versa) is also a variable option, a more accurate statement would be “with variable stock options, the number of options, the strike price, or both are not established on the grant date.”
2) Under “Scope of APBO No. 25,” the article says that the opinion applies to stock options granted to outside directors for their fiduciary role. It should also say that APB Opinion 25 applies only to outside directors elected by shareholders (unless considered only a formality) and if an outside director provides other services, stock-based awards for those services are considered nonemployee awards.
3) The authors say, “If cash is paid to settle options, compensation cost should be recorded at an amount equal to the original intrinsic value of the options, plus the excess of the cash paid to the employees over the intrinsic value at the original measurement date or the settlement date, whichever is less.” While this is correct, the excess should also be reduced by the strike price paid by the employee.
4) The authors say that “a modification that either renews or increases the life of an option plan results in a new measurement date.” In fact, such a modification has no effect on options granted after the plan modification date.
5) In discussing plan acceleration, the authors say, “The compensation cost that must be recognized is based on the estimated additional number of vesting options and the intrinsic value of those options at the new measurement date.” The interpretation requires compensation cost to be the intrinsic value at modification date in excess of original intrinsic value (if any) at the grant date.
6) Regarding EITF 87-33, the authors say that “companies are required to record compensation expense for the difference between the original strike price and the new strike price.” The EITF had reached a consensus that a repricing to reduce the exercise price of an option requires a new measurement date. If the market price has declined and the option is repriced to that lower market price (which is usually the case), using a new measurement date does not result in compensation expense.
The article also says that many companies may be unaware of this EITF issue, without offering a basis for this statement. Nonetheless, Interpretation 44 effectively supersedes Issue 87-33.
7) The article says that “variable-plan accounting would ... be applied from the date of modification until the date of exercise” and that “[f]rom the grant date until the exercise date, cumulative compensation expense is measured by multiplying the number of options by the difference between the market price of the stock and the strike price.” This is true but does not go far enough: The compensation expense is measured not only to the date the option is exercised, but also to the date it is forfeited or the date it expires unexercised.
8) “From the grant date until the exercise date, cumulative compensation expense is measured by multiplying the number of options by the difference between the market price of the stock and the strike price.” While this statement applies to options with cliff vesting, it is not true for those with graded vesting.
9) According to the paragraph on earnings per share, “The assumed conversion of these options will have an effect on both the numerator and the denominator of the company’s earnings per share (EPS). The increase in the numerator is due to the elimination of the compensation expense that occurs under the EPS assumption that the options are converted at the beginning of the year, or when issued if that date is later. As a consequence, variable options can be antidilutive.” This position is not in accordance with FASB 128 (Earnings per Share) because the “if converted” method (which seems to be the method the authors describe) does not apply to variable options. They should describe the treasury stock method where, in computing diluted earnings per share, there is no increase in the numerator and antidilution will result when there is a net loss for the period.
10) Last, they say that accountants “need to be aware that events during the transition period ... will result in variable plan treatment.” In fact, accountants need to be mindful at all times, not only during the transition period.
Robert N. Waxman, CPA
Corporate Finance Advisory
New York, N.Y.
Editor’s Note: The writer chairs the NYSSCPA SEC Practice Committee.
The authors respond:
Although we agree that much more can be written about this complex FASB interpretation, our article was meant as a survey of the more important issues addressed by FASB. As such, it was not our objective to provide in-depth discussions of every issue, and we agree with Waxman that in many areas the article could have been expanded. In response to each of his following comments, observations, and recommendations:
1) We completely concur with Waxman’s proposed definition of variable stock options. In fact, the definition in our original manuscript was essentially the same as Waxman’s. Unfortunately, the wording was altered in editing, and we accept responsibility for failing to request changes in this section.
2) Waxman suggests that the discussion under “Scope of APBO No. 25” should be expanded slightly and notes that this is “one of the more complex FASB interpretations.” We agree that details could be added to every section of the article. Even Waxman struggles with what to include and what to omit when he states that we have said “if an outside director provides other services,” but he does not tell us what these other services might be.
3) Waxman recommends modifying the section that begins “If cash is paid to settle options, compensation cost should be recorded at an amount equal to the original intrinsic value of the options plus the excess of the cash paid to the employee over the intrinsic value at the original measurement date or the settlement date, whichever is less.” While technically correct, his recommendation is unnecessary and probably confusing. No strike price has been paid on options that are still outstanding. He also cautions us to remember to always subtract zero from the above amount. His recommendation more appropriately belongs with the section that describes the repurchase of recently issued shares.
4) Waxman says that the recognition of compensation expense (as is illustrated in EITF 87-33) would not usually occur when options are repriced. Because most accountants would not need to be concerned with the recognition of compensation expense in this situation, we are surprised at the strong reaction to our suggestion that many company accountants “may be unaware” of this issue. After all, according to Waxman himself, many company accountants would not need to be aware of this issue.
5) Waxman suggests that we made a statement charging improper accounting in published financial reports, and he notes our failure to provide supporting evidence. Because we neither made nor imagined this charge, we provided no evidence. However, even if a few financial reporting errors have occurred, this would not be a calamity. The accounting profession does not claim that financial statements or the underlying accounting records are perfect.
6) We also agree that Interpretation 44 effectively supersedes EITF 87-33.
7) This appears to be another request for a longer article. However, in this instance we tend to agree with Waxman that it would have been a simple matter to include a sentence similar to the one he suggests.
8) We assumed that it was as clear to everyone as it was to Waxman that we were discussing cliff vesting.
9) The only area of dispute between Waxman and ourselves regarding the calculation of earnings per share concerns the proper handling of compensation expense. A company with a variable stock option plan will frequently recognize an annual charge for employee compensation expense due to those options. In calculating diluted EPS, we assume that the options are converted at the beginning of the year, or when issued if that date is later, as does Waxman. Thus, the options are assumed to no longer exist. If one assumes that options do not exist, should the diluted EPS numerator be charged for compensation expense from those options? We would remove the compensation expense, whereas Waxman would not. SFAS No. 128 provides many specifics on how to apply the treasury stock method, but it does not say one way or the other what should be done with the compensation expense, which is an element of earnings. Waxman adopts the position in this case that accounting procedures are not permitted unless specifically required by GAAP. Our position is that many items are not currently addressed by GAAP, and accountants should use their professional judgment in such situations. We are not asserting that Waxman’s view is wrong, but that we believe that our interpretation will produce a more meaningful value for diluted EPS.
10) The final comment requires no response.
Anthony F. Cocco, PhD, CPA, and Glenn Vent, PhD, CPA
University of Nevada, Las Vegas
Editor’s Note: Douglas Reynolds, CPA, practice fellow at FASB, concurred with Robert Waxman that the statements and their interpretations indicate no adjustments to the numerator when applying the treasury stock method. Reynolds also indicated that the example referenced by Waxman is highly hypothetical.
One might argue that a change to the denominator could be expected to affect the numerator too. FASB may have believed that the expense associated with the options would have been incurred as salary if no options had been granted.
A challenge to our readers: The editors encourage readers to elucidate the accounting logic behind this result. Readers with comments or opinions are encouraged to share them at the FASB 128 Debate Center at www.cpajournal.com.
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