Accounting for environmental costs and reload stock options.

This month's column discusses two consensuses reached at a recent meeting of the Financial Accounting Standards Board emerging issues task force (EITF or task force) concerning how to account for costs incurred to treat environmental contamination and the accounting for a reload stock option feature in a stock option plan.

EITF Abstracts, copyrighted by the FASB, is available in soft-cover and loose-leaf versions and may be obtained by contacting the FASB order department at 401 Merritt 7, PO. Box 5116, Norwalk, Connecticut 06856-5116. Phone: [phone]. ISSUE NO. 90-8 This EITF issue, Capitalization of Costs to Treat Environmental Contamination, is expected to affect corporations with increasing frequency as they incur costs to remove, contain, neutralize or prevent existing or future environmental contamination (environmental contamination treatment costs). These costs take many forms, including:

* Contamination removal costs, such as those caused by leakage from underground tanks;

* Costs to acquire tangible property, such as air pollution control equipment;

* Costs of environmental studies;

* Costs of fines levied environmental laws.

Accounting issue: Should environmental

contamination treatment costs be capitalized or charged to expense?

Backqround: EITF issue no. 8913, Accounting for the Cost of Asbestos Removal (see J of A, Feb.90,

age 93), addressed only the accounting

for costs incurred to remove or

contain asbestos and stated those

costs may be capitalized as a betterment 

project, subject to an impairment test for the related property.

Subsequent to that consensus, the question arose whether the conclusions from issue no. 89-13 should apply to all kinds of environmental cleanup costs or be limited only to asbestos removal costs.

Arguments: Three views were posed. Proponents of the first view suggest a distinction be made between costs for repairs, which should be expensed, and betterments, which should be capitalized. They believe the criteria to distinguish between costs to be expensed and costs to be capitalized need to be clarified. For example, to qualify as a betterment, the condition of the property after the cleanup must be improved relative to its condition when built or acquired.

Advocates of the view that all environmental cleanup costs should be expensed asked to change the consensus on asbestos to conform to that view. They believe the treatment of asbestos is a repair, not a betterment, because the costs incurred merely restore the building to a safe condition. (The presumption is the building was safe when it was built because the asbestos was sealed in.)

Proponents of the view that cleanup costs should be capitalized believe cleanup of existing environmental contamination is analogous to the removal of asbestos as in issue no. 89-13.

Consensus: The task force concluded that, in general, environmental contamination treatment costs should be charged to expense. Those costs may be capitalized if recoverable, but only if any one of the following criteria is met:

* The costs extend the life, increase the capacity or improve the safety or efficiency of property owned by the company. For purposes of this criterion, the condition of that property after the cleanup costs are incurred must be improved as compared with the condition of the property when originally constructed or acquired, if later.

* The costs mitigate or prevent environmental contamination that has yet to occur and that otherwise may result from future operations or activities. In addition, the costs improve the property compared with its condition when constructed or acquired, if later.

* The costs are incurred to prepare property currently held for sale.

The task force also confirmed its earlier consensus on issue no. 89-13, noting that capitalization of asbestos treatment costs could be justified under the first capitalization criterion mentioned above.

The task force provided as an exhibit to the consensus examples of and specific accounting guidance for various types of contamination costs. ISSUE NO. 90-7

This EITF issue, Accounting for a Reload Stock Option, discusses how a stock option plan should account for a special feature contained in certain plans. That feature, called a reload stock option, is provided by a company that wants officers and other key employees to own more of its stock. It gives officers and employees the benefit of future appreciation on their shares without the expenditure of cash on their part.

It works like this: A new option is automatically granted for each share tendered in a stock-for-stock exercise. For example, if an employee tenders 625 shares (rather than cash) to exercise an award of 1,000 options, 625 new options are automatically awarded at the then-current market price in addition to the 1,000 shares already received. Employees are thereby encouraged to exercise options early and retain option shares.

Accounting issue: Should a plan with a reload stock option feature be accounted for as a fixed or variable plan?

Arguments: The distinction between a fixed and variable plan depends on the relationship between the measurement date and the grant date. In a fixed (nonvariable) plan, the measurement date is considered the grant date; in a variable plan, the measurement date follows the grant date. Paragraph 10(b) of APB Opinion no. 25, Accounting for Stock Issued to Employees, says the measurement date for determining compensation cost in stock option plans is the first date on which are known both (a) the number of shares that an individual employee is entitled to receive and (b) the option or purchase price, if any.

Those who believe the plan is variable argue that at the date of the grant, the company awarded an unknown number of options. In a reload option, the minimum award of 1,000 options from the above example is established, but the ultimate number of options is unknown because of two variable factors: (a) the market price at the date of exercise and (b) whether the employee will elect a stock-for-stock exercise, cash-for-stock exercise or a combination of both. The market price at the date of exercise will determine the number of shares required for the exercise and the number of additional shares that may be received.

Supporters of variable plan accounting also link this issue to a previous consensus on accounting for a tandem fixed award in a declining market, which was discussed in EITF issue no. 87-33, Stock Compensation Issues Related to Market Decline. In that issue, the decline in the market price of the subsidiary's stock does not precipitate a change in the terms of the stock options.

Rather, the entity grants a new option for a specific number of shares with a specific exercise price and with the stipulation that each share acquired through exercise under the new grant cancels a proportionate number of shares under the original grant and vice versa. The task force concluded in that issue such awards should be treated as variable because the stipulation causes the number of shares the employee will elect to exercise and the exercise price to be unknown as of the grant date. Thus, two linked fixed stock options are accounted for in the aggregate as a variable plan. Some view reload options as similar to that issue and therefore advocate variable plan accounting.

Proponents of fixed plan accounting argue that a stock option plan with a reload feature does not result in one award with an unknown amount of shares to be acquired. Rather, it results in the possibility of a number of separate awards each containing terms that are determined at the date of the respective award in accordance with paragraph 10(b) of Opinion no. 25.

Proponents of fixed plan accounting also argue that even though the company grants an unknown number of options, the net new shares actually issued will never exceed the original number of shares available under the original option grant. This result occurs because the employer obtains a treasury share for each reload option.

Consensus: The task force decided a reload option plan is a series of fixed grants that should be accounted for as a fixed plan provided two conditions are met. First, each reload grant must be exercisable at the market price on the reload grant date. Second, the shares exchanged must satisfy the holding period discussed in EITF issue no. 84-18, Stock Option Pyramiding.

Although the task force did not reach a consensus on the duration of the holding period, a majority of task force members felt six months would be acceptable.

The task force also discussed the relationship of EITF issue no. 90-7 to issue no. 87-33. They concluded reload stock option plans are not analogous to the variable tandem award plans because the number of shares the employee may receive net of shares tendered is fixed at the date of grant in reload plans. n