May 2000

FASB Issues Guidance on Stock Compensation

The Financial Accounting Standards Board recently issued Accounting for Certain Transactions Involving Stock Compensation, interpretive guidance on several issues related to APB Opinion 25 on accounting for stock issued to employees. Among other things, the interpretation clarifies the definition of "employee."

The board decided that, for purposes of applying Opinion 25, an individual would be considered an employee if the company granting the stock options has sufficient control over the individual as to establish an employer-employee relationship as established by case law and IRS regulations. The board granted an exception to this definition for elected outside members of the company's board of directors.

"The board agreed with many of the comment letters received on this issue that directors serve the company in a unique capacity and should be granted employee status when determining the accounting for options under Opinion 25," FASB Chair Edmund L. Jenkins said.

Under APB Opinion 25, fixed option plans for employees--i.e., those plans whose terms, including price and number of shares granted, remain the same throughout the duration of the plan--have no compensation expense associated with the options when the exercise price is equal to or greater than the fair value of the stock at the grant date. Plans whose terms are not fixed--for example, the number of shares and the exercise price may change--do have an element of compensation expense under Opinion 25.

The interpretation addresses the accounting consequences when a fixed plan is repriced because the original fixed terms are no longer serving the employer's objectives. The recent bear market in technology stocks may find some employers with stock options that are priced too high to serve as an incentive to their employees.

"The board concluded that, when a company directly or indirectly reprices options, it has changed the terms of the plan, which would make it a variable plan under Opinion 25," Jenkins said.

He further stated that the interpretation will bring needed consistency to the reporting of stock option plans and reduce uncertainty over the appropriate accounting for such plans. The interpretation is generally effective beginning July 1 and applies prospectively at that date for repricings that occurred after December 15, 1998. It also applies prospectively on July 1 to new awards granted after December 15, 1998, for purposes of applying the employee definition.

Contact the FASB order department at (800) 748-0659 for copies of the interpretation. *