FASB statement encourages recognition of stock compensation cost.

The Financial Accounting Standards board's final statement, Accounting for Stock-based Compensation (at press time expected to be issued in September), "encourages" but does not require companies to account for stock compensation awards based on their estimated fair value on the date they are granted.

Companies can continue to follow current accounting requirements, which generally do not result in an expense charge for most options. However, they must disclose in a footnote to their financial statements what the effect on net income would have been had they recognized expense for options based on the new statement.

New requirements

The statement includes the following changes from the FASB exposure draft on stock compensation issued in 1993.

Measurement method

* The option's fair value should be estimated based on expected life at the grant date, with no later adjustment for the difference between expected and actual life.

* A nonpublic entity need not consider volatility in using a pricing model in order to estimate the value of stock options, regardless of trading frequency.

* The statement provides additional guidance on selecting assumptions to be used in option-pricing models.

Recognition of compensation cost

* No prepaid compensation asset is recognized on the grant date.

Modifications and cash settlements of existing grants

* The method is generally simplified eliminating adjustment to compensation cost for remeasurement of original stock option at grant date using fur contractual life.

* The value of the original stock option at the modification date is based on the shorter of (1) its remaining original expected life or (2) the expected life of the new option.

Income tax accounting

* Income tax accounting is significantly revised because no prepaid compensation is recognized at the grant date. Income tax accounting in Accounting Principles Board Opinion no. 25, Accounting for Stock Issued to Employees, as discussed in FASB statement no. 109, Accounting for I come Taxes, is retained.

* Only stock-based awards that result in employer tax deductions receive net-of-tax recognition of compensation cost.

Disclosures

* Disclosure requirements apply to all entities, including those that continue to follow the measurement guidance in Opinion no. 25.

* The statement adds the following items that must be disclosed: the range of exercise prices for outstanding options at the balance sheet date, the weighted-average expected lives used to estimate value for stock options and separate disclosures by ranges of exercise prices if the range is wide.

* Other information, such as a range of values, may be disclosed if it is not misleading and does not discredit the required disclosures.

This final statement will become effective for calendar year 1996; however, companies will have to disclose information in their 1996 financial statements about stock options they granted in 1995.

A thorny issue

The FASB had earlier taken the position that such compensation resulted in compensation expense that should be recognized and expressed this in the 1993 exposure draft. That ED generated opposition from business, politicians and CPAs in 1994, leading FASB chairman Dennis R. Beresford to later state that "there simply was not enough support for the notion of requiring expense recognition." (See "FASB Revises Position on Stock Options," JofA, Feb.95, page 18.

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