Official releases: FASB No. 123 (revised 2004) ... ethics interpretation.

Space considerations prevent publishing here the appendices to FASB Statement no. 123 (revised 2004). Since the appendices often are important to understanding FASB statements, readers are advised to obtain complete copies. For additional copies of FASB statements and/or information on applicable prices and discount rates, contact the FASB order department, 401 Merritt 7, P.O. Box 5116, Norwalk, Connecticut 06856-5116. Telephone: [phone].

Statement of Financial Accounting Standards No. 123 (revised 2004)--Share-Based Payment

SUMMARY

This Statement is a revision of FASB Statement No. 123, Accounting for Stock-Based Compensation. This Statement supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and its related implementation guidance.

Scope of This Statement

This Statement establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. It also addresses transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity's equity instruments or that may be settled by the issuance of those equity instruments. This Statement focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. This Statement does not change the accounting guidance for share-based payment transactions with parties other than employees provided in Statement 123 as originally issued and EITF Issue No. 96-18, "Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services." This Statement does not address the accounting for employee share ownership plans, which are subject to AICPA Statement of Position 93-6, Employers' Accounting for Employee Stock Ownership Plans.

Reasons for Issuing This Statement

The principal reasons for issuing this Statement are:

a. Addressing concerns of users and others. Users of financial statements, including institutional and individual investors, as well as many other parties expressed to the FASB their concerns that using Opinion 25's intrinsic value method results in financial statements that do not faithfully represent the economic transactions affecting the issuer, namely, the receipt and consumption of employee services in exchange for equity instruments. Financial statements that do not faithfully represent those economic transactions can distort the issuer's reported financial condition and results of operations, which can lead to the inappropriate allocation of resources in the capital markets. Part of the FASB's mission is to improve standards of financial accounting for the benefit of users of financial information. This Statement addresses users' and other parties' concerns by requiring an entity to recognize the cost of employee services received in share-based payment transactions, thereby reflecting the economic consequences of those transactions in the financial statements.

b. Improving the comparability of reported financial information by eliminating alternative accounting methods. Over the last few years, approximately 750 public companies have voluntarily adopted or announced their intention to adopt Statement 123's fair-value-based method of accounting for share-based payment transactions with employees. Other companies continue to use Opinion 25's intrinsic value method. The Board believes that similar economic transactions should be accounted for similarly (that is, share-based compensation transactions with employees should be accounted for using one method). Consistent with the conclusion in the original Statement 123, the Board believes that those transactions should be accounted for using a fair-value-based method. By requiring the fair-value-based method for all public entities, this Statement eliminates an alternative accounting method; consequently, similar economic transactions will be accounted for similarly.

c. Simplifying U.S. GAAP. The Board believes that U.S. generally accepted accounting principles (GAAP) should be simplified whenever possible. Requiring that all entities follow the same accounting standard and eliminating Opinion 25's intrinsic value method and its related detailed and form-driven implementation guidance simplifies the authoritative literature.

d. Converging with international accounting standards. This Statement will result in greater international comparability in the accounting for share-based payment transactions. In February 2004, the International Accounting Standards Board (IASB), whose standards are followed by entities in many countries, issued International Financial Reporting Standard (IFRS) 2, Share-based Payment. IFRS 2 requires that all entities recognize an expense for all employee services received in share-based payment transactions, using a fair-value-based method that is similar in most respects to the fair-value-based method established in Statement 123 and the improvements made to it by this Statement. Converging to a common set of high-quality financial accounting standards for share-based payment transactions with employees improves the comparability of financial information around the world and makes the accounting requirements for entities that report financial statements under both U.S. GAAP and international accounting standards less burdensome.

Key Provisions of This Statement

This Statement requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award (with bruited exceptions). That cost will be recognized over the period during which an employee is required to provide service in exchange for the award--the requisite service period (usually the vesting period). No compensation cost is recognized for equity instruments for which employees do not render the requisite service. Employee share purchase plans will not result in recognition of compensation cost if certain conditions are met; those conditions are much the same as the related conditions in Statement 123.

A nonpublic entity, likewise, will measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of those instruments, except in certain circumstances. Specifically, if it is not possible to reasonably estimate the fair value of equity share options and similar instruments because it is not practicable to estimate the expected volatility of the entity's share price, a nonpublic entity is required to measure its awards of equity share options and similar instruments based on a value calculated using the historical volatility of an appropriate industry sector index instead of the expected volatility of its share price.

A public entity will initially measure the cost of employee services received in exchange for an award of liability instruments based on its current fair value; the fair value of that award will be remeasured subsequently at each reporting date through the settlement date. Changes in fair value during the requisite service period will be recognized as compensation cost over that period. A nonpublic entity may elect to measure its liability awards at their intrinsic value through the date of settlement.

The grant-date fair value of employee share options and similar instruments will be estimated using option-pricing models adjusted for the unique characteristics of those instruments (unless observable market prices for the same or similar instruments are available). If an equity award is modified after the grant date, incremental compensation cost will be recognized in an amount equal to the excess of the fair value of the modified award over the fair value of the original award immediately before the modification.

Excess tax benefits, as defined by this Statement, will be recognized as an addition to paid-in capital. Cash retained as a result of those excess tax benefits will be presented in the statement of cash flows as financing cash inflows. The write-off of deferred tax assets relating to unrealized tax benefits associated with recognized compensation cost will be recognized as income tax expense unless there are excess tax benefits from previous awards remaining in paid-in capital to which it can be offset.

The notes to financial statements of both public and nonpublic entities will disclose information to assist users of financial information to understand the nature of share-based payment transactions and the effects of those transactions on the financial statements.

How This Statement Changes Practice and Improves Financial Reporting

This Statement eliminates the alternative to use Opinion 25's intrinsic value method of accounting that was provided in Statement 123 as originally issued. Under Opinion 25, issuing stock options to employees generally resulted in recognition of no compensation cost. This Statement requires entities to recognize the cost of employee services received in exchange for awards of equity instruments based on the grant-date fair value of those awards (with limited exceptions). Recognition of that compensation cost helps users of financial statements to better understand the economic transactions affecting an entity and to make better resource allocation decisions. Such information specifically will help users of financial statements understand the effect that share-based compensation transactions have on an entity's financial condition and results of operations. This Statement also will improve comparability by eliminating one of two different methods of accounting for share-based compensation transactions and thereby also will simplify existing U.S. GAAP. Eliminating different methods of accounting for the same transactions leads to improved comparability of financial statements because similar economic transactions will be accounted for similarly.

The fair-value-based method in this Statement is similar to the fair-value-based method in Statement 123 in most respects. However, the following are the key differences between the two:

a. Public entities are required to measure liabilities incurred to employees in share-based payment transactions at fair value. Nonpublic entities may elect to measure their liabilities to employees incurred in share-based payment transactions at their intrinsic value. Under Statement 123, all share-based payment liabilities were measured at their intrinsic value.

b. Nonpublic entities are required to account for awards of equity instruments using the fair-value-based method unless it is not possible to reasonably estimate the grant-date fair value of awards of equity share options and similar instruments because it is not practicable to estimate the expected volatility of the entity's share price. In that situation, the entity will account for those instruments based on a value calculated by substituting the historical volatility of an appropriate industry sector index for the expected volatility of its share price. Statement 123 permitted a nonpublic entity to measure its equity awards using either the fair-value-based method or the minimum value method.

c. Entities are required to estimate the number of instruments for which the requisite service is expected to be rendered. Statement 123 permitted entities to account for forfeitures as they occur.

d. Incremental compensation cost for a modification of the terms or conditions of an award is measured by comparing the fair value of the modified award with the fair value of the award immediately before the modification. Statement 123 required that the effects of a modification be measured as the difference between the fair value of the modified award at the date it is granted and the award's value immediately before the modification determined based on the shorter of (1) its remaining initially estimated expected life or (2) the expected life of the modified award.

e. This Statement also clarifies and expands Statement 123's guidance in several areas, including measuring fair value, classifying an award as equity or as a liability, and attributing compensation cost to reporting periods.

In addition, this Statement amends FASB Statement No. 95, Statement of Cash Flows, to require that excess tax benefits be reported as a financing cash inflow rather than as a reduction of taxes paid.

How the Conclusions of This Statement Relate to the FASB's Conceptual Framework

FASB Concepts Statement No. 1, Objectives of Financial Reporting by Business Enterprises, states that financial reporting should provide information that is useful in making business and economic decisions. Recognizing compensation cost incurred as a result of receiving employee services in exchange for valuable equity instruments issued by the employer will help achieve that objective by providing more relevant and reliable information about the costs incurred by the employer to obtain employee services in the marketplace.

FASB Concepts Statement No. 2, Qualitative Characteristics of Accounting Information, explains that comparability of financial information is important because information about an entity gains greatly in usefulness if it can be compared with similar information about other entities. Establishing the fair-value-based method of accounting as the required method will increase comparability because similar economic transactions will be accounted for similarly, which will improve the usefulness of financial information. Requiring the fair-value-based method also enhances the neutrality of the resulting financial reporting by eliminating the accounting bias toward using certain types of employee share options for compensation.

Completeness is identified in Concepts Statement 2 as an essential element of representational faithfulness and relevance. To faithfully represent the total cost of employee services to the entity, the cost of services received in exchange for awards of share-based compensation should be recognized in that entity's financial statements.

FASB Concepts Statement No. 6, Elements of Financial Statements, defines assets as probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events. Employee services received in exchange for awards of share-based compensation qualify as assets, though only momentarily--as the entity receives and uses them--although their use may create or add value to other assets of the entity. This Statement will improve the accounting for an entity's assets resulting from receipt of employee services in exchange for an equity award by requiring that the cost of such assets either be charged to expense when consumed or capitalized as part of another asset of the entity (as permitted by U.S. GAAP).

Costs and Benefits

The mission of the FASB is to establish and improve standards of financial accounting and reporting for the guidance and education of the public, including preparers, auditors, and users of financial information. In fulfilling that mission, the Board endeavors to determine that a proposed standard will fill a significant need and that the costs imposed to meet that standard, as compared with other alternatives, are justified in relation to the overall benefits of the resulting information. The Board's consideration of each issue in a project includes the subjective weighing of the incremental improvement in financial reporting against the incremental cost of implementing the identified alternatives. At the end of that process, the Board considers the accounting provisions in the aggregate and assesses the perceived benefits and the related perceived costs on a qualitative basis.

Several procedures were conducted before the issuance of this Statement to aid the Board in its assessment of the expected costs associated with implementing the required use of the fair-value-based accounting method. Those procedures included a review of the comment letters received on the Exposure Draft, a field visit program, a survey of commercial software providers, and discussions with members of the Option Valuation Group that the Board established to provide information and advice on how to improve the guidance in Statement 123 on measuring the fair value of share options and similar instruments issued to employees in compensation arrangements. That group included valuation experts from the compensation consulting, risk management, investment banking, and academic communities. The Board also discussed the issues in the project with other valuation experts, compensation consultants, and numerous other constituents. After considering the results of those cost-benefit procedures, the Board concluded that this Statement will sufficiently improve financial reporting to justify the costs it will impose.

The Effective Dates and Transition Requirements of This Statement

This Statement is effective:

a. For public entities that do not file as small business issuers--as of the beginning of the first interim or annual reporting period that begins after June 15, 2005

b. For public entities that file as small business issuers--as of the beginning of the first interim or annual reporting period that begins after December 15, 2005

c. For nonpublic entities--as of the beginning of the first annual reporting period that begins after December 15, 2005.

This Statement applies to all awards granted after the required effective date and to awards modified, repurchase& or cancelled after that date. The cumulative effect of initially applying this Statement, if any, is recognized as of the required effective date.

As of the required effective date, all public entities and those nonpublic entities that used the fair-value-based method for either recognition or disclosure under Statement 123 will apply this Statement using a modified version of prospective application. Under that transition method, compensation cost is recognized on or after the required effective date for the portion of outstanding awards for which the requisite service has not yet been rendered, based on the grant-date fair value of those awards calculated under Statement 123 for either recognition or pro forma disclosures. For periods before the required effective date, those entities may elect to apply a modified version of retrospective application under which financial statements for prior periods are adjusted on a basis consistent with the pro forma disclosures required for those periods by Statement 123. Nonpublic entities that used the minimum value method in Statement 123 for either recognition or pro forma disclosures are required to apply the prospective transition method as of the required effective date.

Early adoption of this Statement for interim or annual periods for which financial statements or interim reports have not been issued is encouraged.

CONTENTS

Introduction/1-3
Standards of Financial Accounting and
  Reporting/4-85
   Scope/4
   Recognition Principle for Share-Based
    Payment Transactions/5-6
   Measurement Principle for Share-Based
    Payment Transactions/7-8
     Measurement Date for Share-Based
      Payment Transactions with
      Nonemployees/8
   Accounting for Share-Based Payment
    Transactions with Employees/9-57
      Certain Transactions with Related
       Parties and Other Economic interest
       Holders/11
      Employee Share Purchase Plans/12-14
      Measurement Principle for Share-Based
       Payment Transactions with
       Employees/15
      Measurement of Awards Classified as
       Equity/16-27
        Measurement Objective and
         Measurement Date for Equity
         Awards/16-20
        Nonvested and Restricted Equity
         Shares/21
        Equity Share Options/22
        Equity Instruments for Which It Is
         Not Possible to Reasonably
         Estimate Fair Value at the Grant
         Date/23-25
          Equity Instruments Granted by a
           Nonpublic Entity for Which It
           Is Not Possible to Reasonably
           Estimate Fair Value at the
           Grant Date Because It Is Not
           Practicable to Estimate the
           Expected Volatility of the
           Entity's Share Price/23
          Equity Instruments with Terms
           That Make It Not Possible to
           Reasonably Estimate Fair Value
           at the Grant Date/24-25
       Reload Options and Contingent
        Features/26-27
    Awards Classified as Liabilities/28-38
      Criteria for Classifying Awards as
       Liabilities/28-35
         Applying the Classification
          Criteria in Statement
          150/29-30
         Classification of Certain Awards
          with Repurchase
          Features/31-32
         Awards with Conditions Other
          Than Market, Performance, or
          Service Conditions/33
         Evaluating the Terms of a Share-Based
          Payment Award in
          Determining Whether It
          Qualifies as a Liability/34
         Broker-Assisted Cashless
          Exercises and Minimum
          Statutory Withholding
          Requirements/35
      Measurement Objective and
       Measurement Date for
       Liabilities/36-38
         Measurement of Liability Awards
          of Public Entities/37
         Measurement of Liability Awards
          of Nonpublic Entities/38
   Recognition of Compensation Cost for
    an Award Accounted for as an Equity
    Instrument/39-49
     Recognition of Compensation Cost
      over the Requisite Service
      Period/39-42
     Amount of Compensation Cost to
      Be Recognized over the Requisite
      Service Period/43-45
     Estimating the Requisite Service
      Period/46
     Effect of Market, Performance, and
      Service Conditions on
      Recognition and Measurement of
      Compensation Cost/47-49
       Market, Performance, and
        Service Conditions That Affect
        Vesting or Exercisability/47-48
       Market, Performance, and
        Service Conditions That Affect
        Factors Other Than Vesting or
        Exercisability/49
Recognition of Changes in the Fair
  Value or Intrinsic Value of Awards
  Classified as Liabilities/50
Modifications of Awards of Equity
  Instruments/51-57
    Inducements/52
    Equity Restructurings/53-54
    Repurchases or Cancellations of
       Awards of Equity Instruments/55
     Cancellation and Replacement of
       Awards of Equity
       Instruments/56-57
Accounting for Tax Effects of Share-Based
  Compensation Awards/58-63
Disclosures/64-65
Earnings per Share Implications/66-67
Amendments to Statement 95/68
Effective Dates and Transition/69-85
    Modified Prospective
     Application/74-75
    Modified Retrospective
     Application/76-78
    Transition as of the Required Effective
     Date for both Modified Prospective
     and Modified Retrospective Transition
     Methods/79-82
    Nonpublic Entities That Used the
     Minimum Value Method in Statement
     123/83
    Required Disdosures in the Period This
     Statement Is Adopted/84-85
Appendix A: Implementation
 Guidance/A1-A242
Appendix B: Basis for Conclusions/B1-B280
Appendix C: Background
 Information/C1-C26
Appendix D: Amendments to Existing
 Pronouncements/D1-D18
Appendix E: Glossary/E1
Appendix F: Status of Related Authoritative
 Literature/F1-F3

INTRODUCTION

1. This Statement requires that the cost resulting from all share-based payment transactions (1) be recognized in the financial statements. This Statement establishes fair value as the measurement objective in accounting for share-based payment arrangements and requires all entities to apply a fair-value-based measurement method in accounting for share-based payment transactions with employees except for equity instruments held by employee share ownership plans. However, this Statement provides certain exceptions to that measurement method if it is not possible to reasonably estimate the fair value of an award at the grant date. A nonpublic entity also may choose to measure its liabilities under share-based payment arrangements at intrinsic value. This Statement also establishes fair value as the measurement objective for transactions in which an entity acquires goods or services from nonemployees in share-based payment transactions. This Statement uses the terms compensation and payment in their broadest senses to refer to the consideration paid for goods or services, regardless of whether the supplier is an employee.

2. This Statement amends FASB Statement No. 95, Statement of Cash Flows, to require that excess tax benefits be reported as a financing cash inflow rather than as a reduction of taxes paid.

3. This Statement replaces FASB Statement No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees. This Statement also supersedes or amends other pronouncements indicated in Appendix D. Appendix A is an integral part of this Statement and provides implementation guidance on measurement and recognition of compensation cost resulting from share-based payment arrangements with employees. Appendix B provides the basis for the Board's conclusions, and Appendix C provides background information. Appendix E defines certain terms as they are used in this Statement, and Appendix F indicates the effect of this Statement on the status of related authoritative literature, including American Institute of Certified Public Accountants (AICPA) literature, Emerging Issues Task Force (EITF) issues, and Statement 133 implementation issues.

STANDARDS OF FINANCIAL ACCOUNTING AND REPORTING

Scope

4. This Statement applies to all share-based payment transactions in which an entity acquires goods or services by issuing (or offering to issue) its shares, share options, or other equity instruments (except for equity instruments held by an employee share ownership plan) (2) or by incurring liabilities to an employee or other supplier (a) in amounts based, at least in part (3), on the price of the entity's shares or other equity instruments or (b) that require or may require settlement by issuing the entity's equity shares or other equity instruments.

Recognition Principle for Share-Based Payment Transactions

5. An entity shall recognize the goods acquired or services received in a share-based payment transaction when it obtains the goods or as services are received. (4) The entity shall recognize either a corresponding increase in equity or a liability, depending on whether the instruments granted satisfy the equity or liability classification criteria (paragraphs 28-35). As the goods or services are disposed of or consumed, the entity shall recognize the related cost. For example, when inventory is sold, the cost is recognized in the income statement as cost of goods sold, and as services are consumed, the cost usually is recognized in determining net income of that period, for example, as expenses incurred for employee services. In some circumstances, the cost of services (or goods) may be initially capitalized as part of the cost to acquire or construct another asset, such as inventory, and later recognized in the income statement when that asset is disposed of or consumed. (5)

6. The accounting for all share-based payment transactions shall reflect the rights conveyed to the holder of the instruments and the obligations imposed on the issuer of the instruments, regardless of how those transactions are structured. For example, the rights and obligations embodied in a transfer of equity shares to an employee for a note that provides no recourse to other assets of the employee (that is, other than the shares) are substantially the same as those embodied in a grant of equity share options. Thus, that transaction shall be accounted for as a substantive grant of equity share options. The terms of a share-based payment award and any related arrangement affect its value and, except for certain explicitly excluded features, such as a reload feature, shall be reflected in determining the fair value of the equity or liability instruments granted. For example, the fair value of a substantive option structured as the exchange of equity shares for a nonrecourse note will differ depending on whether the employee is required to pay nonrefundable interest on the note. Assessment of both the rights and obligations in a share-based payment award and any related arrangement and how those rights and obligations affect the fair value of an award requires the exercise of judgment in considering the relevant facts and circumstances.

Measurement Principle for Share-Based Payment Transactions

7. If the fair value of goods or services received in a share-based payment transaction with nonemployees is more reliably measurable than the fair value of the equity instruments issued, the fair value of the goods or services received shall be used to measure the transaction. (6) In contrast, if the fair value of the equity instruments issued in a share-based payment transaction with nonemployees is more reliably measurable than the fair value of the consideration received, the transaction shall be measured based on the fair value of the equity instruments issued. A share-based payment transaction with employees shall be measured based on the fair value (or in certain situations specified in this Statement, a calculated value or intrinsic value) of the equity instruments issued.

Measurement Date for Share-Based Payment Transactions with Nonemployees

8. This Statement does not specify the measurement date for share-based payment transactions with nonemployees for which the measure of the cost of goods acquired or services received is based on the fair value of the equity instruments issued. EITF Issue No. 96-18, "Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services," establishes criteria for determining the measurement date for equity instruments issued in share-based payment transactions with nonemployees.

Accounting for Share-Based Payment Transactions with Employees

9. The objective of accounting for transactions under share-based payment arrangements with employees is to recognize in the financial statements the employee services received in exchange for equity instruments issued or liabilities incurred and the related cost to the entity as those services are consumed.

10. An entity shall account for the compensation cost from share-based payment transactions with employees in accordance with the fair-value-based method set forth in paragraphs 11-63 of this Statement. That is, the cost of services received from employees in exchange for awards (7) of share-based compensation generally shall be measured based on the grant-date fair value of the equity instruments issued or on the fair value of the liabilities incurred. The fair value of liabilities incurred in share-based transactions with employees shall be remeasured at the end of each reporting period through settlement. Paragraphs 23-25 and 38 set forth exceptions to the fair-value-based measurement of awards of share-based employee compensation.

Certain Transactions with Related Parties and Other Economic Interest Holders

11. Share-based payments awarded to an employee of the reporting entity by a related party or other holder of an economic interest in the entity as compensation for services provided to the entity are share-based payment transactions to be accounted for under this Statement unless the transfer is clearly for a purpose other than compensation for services to the reporting entity. The substance of such a transaction is that the economic interest holder makes a capital contribution to the reporting entity, and that entity makes a share-based payment to its employee in exchange for services rendered. An example of a situation in which such a transfer is not compensation is a transfer to settle an obligation of the economic interest holder to the employee that is unrelated to employment by the entity.

Employee Share Purchase Plans

12. An employee share purchase plan that satisfies all of the following criteria does not give rise to recognizable compensation cost (that is, the plan is noncompensatory):

a. The plan satisfies at least one of the following conditions:

(1) The terms of the plan are no more favorable than those available to all holders of the same class of shares. (8)

(2) Any purchase discount from the market price does not exceed the per-share amount of share issuance costs that would have been incurred to raise a significant amount of capital by a public offering. A purchase discount of 5 percent or less from the market price shall be considered to comply with this condition without further justification. A purchase discount greater than 5 percent that cannot be justified under this condition results in compensation cost for the entire amount of the discount. (9)

b. Substantially all employees that meet limited employment qualifications may participate on an equitable basis.

c. The plan incorporates no option features, other than the following:

(1) Employees are permitted a short period of time--not exceeding 31 days--after the purchase price has been fixed to enroll in the plan.

(2) The purchase price is based solely on the market price of the shares at the date of purchase, and employees are permitted to cancel participation before the purchase date and obtain a refund of amounts previously paid (such as those paid by payroll withholdings).

13. A plan provision that establishes the purchase price as an amount based on the lesser of the equity share's market price at date of grant or its market price at date of purchase is an example of an option feature that causes the plan to be compensatory. Similarly, a plan in which the purchase price is based on the share's market price at date of grant and that permits a participating employee to cancel participation before the purchase date and obtain a refund of amounts previously paid contains an option feature that causes the plan to be compensatory. Illustrations 19 (paragraphs A211-A219) and 20 (paragraphs A220 and A221) provide guidance on determining whether an employee share purchase plan satisfies the criteria necessary to be considered noncompensatory.

14. The requisite service period for any compensation cost resulting from an employee share purchase plan is the period over which the employee participates in the plan and pays for the shares.

Measurement Principle for Share-Based Payment Transactions with Employees

15. The cost of services received by an entity as consideration for equity instruments issued or liabilities incurred in share-based compensation transactions with employees shall be measured based on the fair value of the equity instruments issued or the liabilities settled. The portion of the fair value of an instrument attributed to employee service is net of any amount that an employee pays (or becomes obligated to pay) for that instrument when it is granted. For example, if an employee pays $5 at the grant date for an option with a grant-date fair value of $50, the amount attributed to employee service is $45.

Measurement of Awards Classified as Equity

Measurement Objective and Measurement Date for Equity Awards

16. The measurement objective for equity instruments awarded to employees is to estimate the fair value at the grant date of the equity instruments that the entity is obligated to issue when employees have rendered the requisite service and satisfied any other conditions necessary to earn the right to benefit from the instruments (for example, to exercise share options). That estimate is based on the share price and other pertinent factors, such as expected volatility, at the grant date.

17. To satisfy the measurement objective in paragraph 16, the restrictions and conditions inherent in equity instruments awarded to employees are treated differently depending on whether they continue in effect after the requisite service period. A restriction that continues in effect after an entity has issued instruments to employees, such as the inability to transfer vested equity share options to third parties or the inability to sell vested shares for a period of time, is considered in estimating the fair value of the instruments at the grant date. For equity share options and similar instruments, the effect of nontransferability (and nonhedgeability, which has a similar effect) is taken into account by reflecting the effects of employees' expected exercise and post-vesting employment termination behavior in estimating fair value (referred to as an option's expected term).

18. In contrast, a restriction that stems from the forfeitability of instruments to which employees have not yet earned the right, such as the inability either to exercise a nonvested equity share option or to sell nonvested shares, is not reflected in estimating the fair value of the related instruments at the grant date. Instead, those restrictions are taken into account by recognizing compensation cost only for awards for which employees render the requisite service.

19. Awards of share-based employee compensation ordinarily specify a performance condition or a service condition (or both) that must be satisfied for an employee to earn the right to benefit from the award. No compensation cost is recognized for instruments that employees forfeit because a service condition or a performance condition is not satisfied (that is, instruments for which the requisite service is not rendered). Some awards contain a market condition. The effect of a market condition is reflected in the grant-date fair value of an award. (10) Compensation cost thus is recognized for an award with a market condition provided that the requisite service is rendered, regardless of when, if ever, the market condition is satisfied. Illustrations 4 (paragraphs A86-A104), 5 (paragraphs A105-A110), and 10 (paragraphs A127-A133) provide examples of how compensation cost is recognized for awards with service and performance conditions.

20. The fair-value-based method described in paragraphs 16-19 uses fair value measurement techniques, and the grant-date share price and other pertinent factors are used in applying those techniques. However, the effects on the grant-date fair value of service and performance conditions that apply only during the requisite service period are reflected based on the outcomes of those conditions. The remainder of this Statement refers to the required measure as fair value.

Nonvested and Restricted Equity Shares

21. A nonvested equity share or nonvested equity share unit awarded to an employee shall be measured at its fair value as if it were vested and issued on the grant date. A restricted share (11) awarded to an employee, that is, a share that will be restricted after the employee has a vested right to it, shall be measured at its fair value, which is the same amount for which a similarly restricted share would be issued to third parties. Illustration 11 (a) (paragraphs A134-A136) provides an example of accounting for an award of nonvested shares.

Equity Share Options

22. The fair value of an equity share option or similar instrument shall be measured based on the observable market price of an option with the same or similar terms and conditions, if one is available (paragraph A7). (12) Otherwise, the fair value of an equity share option or similar instrument shall be estimated using a valuation technique such as an option-pricing model. For this purpose, a similar instrument is one whose fair value differs from its intrinsic value, that is, an instrument that has time value. For example, a share appreciation right (SAR) that requires net settlement in equity shares has time value; an equity share does not. Paragraphs A2-A42 provide additional guidance on estimating the fair value of equity instruments, including the factors to be taken into account in estimating the fair value of equity share options or similar instruments as described in paragraph A18.

Equity Instruments for Which It Is Not Possible to Reasonably Estimate Fair Value at the Grant Date

Equity instruments granted by a nonpublic entity for which it is not possible to reasonably estimate fair value at the grant date because it is not practicable to estimate the expected volatility of the entity's share price

23. A nonpublic entity may not be able to reasonably estimate the fair value of its equity share options and similar instruments because it is not practicable for it to estimate the expected volatility of its share price. In that situation, the entity shall account for its equity share options and similar instruments based on a value calculated using the historical volatility of an appropriate industry sector index instead of the expected volatility of the entity's share price (the calculated value). (13) Paragraphs A43-A48 and Illustration 11(b) (paragraphs A137-A142) provide additional guidance on applying the calculated value method to equity share options and similar instruments granted by a nonpublic entity.

Equity instruments with terms that make it not possible to reasonably estimate fair value at the grant date

24. It should be possible to reasonably estimate the fair value of most equity share options and other equity instruments at the date they are granted. Appendix A illustrates techniques for estimating the fair values of several instruments with complicated features. However, in rare circumstances, it may not be possible to reasonably estimate the fair value of an equity share option or other equity instrument at the grant date because of the complexity of its terms.

25. An equity instrument for which it is not possible to reasonably estimate fair value at the grant date shall be accounted for based on its intrinsic value, remeasured at each reporting date through the date of exercise or other settlement. The final measure of compensation cost shall be the intrinsic value of the instrument at the date it is settled. Compensation cost for each period until settlement shall be based on the change (or a portion of the change, depending on the percentage of the requisite service that has been rendered at the reporting date) in the intrinsic value of the instrument in each reporting period. The entity shall continue to use the intrinsic value method for those instruments even if it subsequently concludes that it is possible to reasonably estimate their fair value.

Reload Options and Contingent Features

26. The fair value of each award of equity instruments, including an award of options with a reload feature (reload options), shall be measured separately based on its terms and the share price and other pertinent factors at the grant date. The effect of a reload feature in the terms of an award shall not be included in estimating the grant-date fair value of the award. Rather, a subsequent grant of reload options pursuant to that provision shall be accounted for as a separate award when the reload options are granted.

27. A contingent feature of an award that might cause an employee to return to the entity either equity instruments earned or realized gains from the sale of equity instruments earned for consideration that is less than fair value on the date of transfer (including no consideration), such as a clawback feature (paragraph A5, footnote 44), shall not be reflected in estimating the grant-date fair value of an equity instrument. Instead, the effect of such a contingent feature shall be accounted for if and when the contingent event occurs.

Awards Classified as Liabilities

Criteria for Classifying Awards as Liabilities

28. Paragraphs 29-35 of this Statement provide guidance for determining whether certain financial instruments awarded in share-based payment transactions are liabilities. In determining whether an instrument not specifically discussed in paragraphs 29-35 should be classified as a liability or as equity, an entity shall apply generally accepted accounting principles (GAAP) applicable to financial instruments issued in transactions not involving share-based payment.

Applying the classification criteria in Statement 150

29. FASB Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, excludes from its scope instruments that are accounted for under this Statement. Nevertheless, unless paragraphs 30-35 of this Statement require otherwise, an entity shall apply the classification criteria in paragraphs 8-14 of Statement 150, as they are effective at the reporting date, in determining whether to classify as a liability a freestanding financial instrument given to an employee in a share-based payment transaction. Paragraphs A230-A232 of this Statement provide criteria for determining when instruments subject to this Statement subsequently become subject to Statement 150 or to other applicable GAAP.

30. In determining the classification of an instrument, an entity shall take into account the deferrals contained in FSP FAS 150-3, "Effective Date, Disclosures, and Transition for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests under FASB Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." In addition, a call option (14) written on an instrument that is not classified as a liability because of the deferrals in FSP FAS 150-3 (for example, a call option on a mandatorily redeemable share for which liability classification is deferred under FSP FAS 150-3) also shall be classified as equity while the deferral is in effect unless liability classification is required under the provisions of paragraph 32 of this Statement.

Classification of certain awards with repurchase features

31. Statement 150 does not apply to outstanding shares embodying a conditional obligation to transfer assets, for example, shares that give the employee the right to require the employer to repurchase them for cash equal to their fair value (puttable shares). A puttable (or callable) share (15) awarded to an employee as compensation shall be classified as a liability if either of the following conditions is met: (a) the repurchase feature permits the employee to avoid bearing the risks and rewards normally associated with equity share ownership for a reasonable period of time from the date the requisite service is rendered and the share is issued, (16,17) or (b) it is probable that the employer would prevent the employee from bearing those risks and rewards for a reasonable period of time from the date the share is issued. For this purpose, a period of six months or more is a reasonable period of time. A puttable (or callable) share that does not meet either of those conditions shall be classified as equity. (18)

32. Options or similar instruments on shares shall be classified as liabilities if (a) the underlying shares are classified as liabilities or (b) the entity can be required under any circumstances to settle the option or similar instrument by transferring cash or other assets. For example, an entity may grant an option to an employee that, upon exercise, would be settled by issuing a mandatorily redeemable share that is not subject to the deferral in FSP FAS 150-3. Because the mandatorily redeemable share would be classified as a liability under Statement 150, the option also would be classified as a liability.

Awards with conditions other than market, performance, or service conditions

33. An award may be indexed to a factor in addition to the entity's share price. If that additional factor is not a market, performance, or service condition, the award shall be classified as a liability for purposes of this Statement, and the additional factor shall be reflected in estimating the fair value of the award. (19) Paragraph A53 provides examples of such awards.

Evaluating the terms of a share-based payment award in determining whether it qualifies as a liability

34. The accounting for an award of share-based payment shall reflect the substantive terms of the award and any related arrangement. Generally, the written terms provide the best evidence of the substantive terms of an award. However, an entity's past practice may indicate that the substantive terms of an award differ from its written terms. For example, an entity that grants a tandem award under which an employee receives either a stock option or a cash-settled SAR is obligated to pay cash on demand if the choice is the employee's, and the entity thus incurs a liability to the employee. In contrast, if the choice is the entity's, it can avoid transferring its assets by choosing to settle in stock, and the award qualifies as an equity instrument. However, if an entity that nominally has the choice of settling awards by issuing stock predominately settles in cash, or if the entity usually settles in cash whenever an employee asks for cash settlement, the entity is settling a substantive liability rather than repurchasing an equity instrument. In determining whether an entity that has the choice of settling an award by issuing equity shares has a substantive liability, the entity also shall consider whether (a) it has the ability to deliver the shares (20) and (b) it is required to pay cash if a contingent event occurs (paragraph 32).

Broker-assisted cashless exercises and mini mum statutory withholding requirements

35. A provision that permits employees to effect a broker-assisted cashless exercise of part or all of an award of share options through a broker does not result in liability classification for instruments that otherwise would be classified as equity if both of the following criteria are satisfied: (21)

a. The cashless exercise requires a valid exercise of the share options.

b. The employee is the legal owner of the shares subject to the option (even though the employee has not paid the exercise price before the sale of the shares subject to the option).

Similarly, a provision for either direct or indirect (through a net-settlement feature) repurchase of shares issued upon exercise of options (or the vesting of nonvested shares), with any payment due employees withheld to meet the employer's minimum statutory withholding requirements (22) resulting from the exercise, does not, by itself, result in liability classification of instruments that otherwise would be classified as equity. However, if an amount in excess of the minimum statutory requirement is withheld, or may be withheld at the employee's discretion, the entire award shall be classified and accounted for as a liability.

Measurement Objective and Measurement Date for Liabilities

36. At the grant date, the measurement objective for liabilities incurred under share-based compensation arrangements is the same as the measurement objective for equity instruments awarded to employees as described in paragraph 16. However, the measurement date for liability instruments is the date of settlement. Accordingly, liabilities incurred under share-based payment arrangements are remeasured at the end of each reporting period until settlement.

Measurement of liability awards of public entities

37. A public entity shall measure a liability award under a share-based payment arrangement based on the award's fair value remeasured at each reporting date until the date of settlement. Compensation cost for each period until settlement shall be based on the change (or a portion of the change, depending on the percentage of the requisite service that has been rendered at the reporting date) in the fair value of the instrument for each reporting period. Illustration 10 (paragraphs A127-A133) provides an example of accounting for an instrument classified as a liability using the fair-value-based method.

Measurement of liability awards of nonpublic entities

38. A nonpublic entity shall make a policy decision of whether to measure all of its liabilities incurred under share-based payment arrangements at fair value or to measure all such liabilities at intrinsic value. (23) Regardless of the method selected, a nonpublic entity shall remeasure its liabilities under share-based payment arrangements at each reporting date until the date of settlement. The fair-value-based method is preferable for purposes of justifying a change in accounting principle under APB Opinion No. 20, Accounting Changes. Illustration 10 (paragraphs A127-A133) provides an example of accounting for an instrument classified as a liability using the fair-value-based method. Illustration 11 (c) (paragraphs A143-A148) provides an example of accounting for an instrument classified as a liability using the intrinsic value method.

Recognition of Compensation Cost for an Award Accounted for as an Equity Instrument

Recognition of Compensation Cost over the Requisite Service Period

39. The compensation cost for an award of share-based employee compensation classified as equity shall be recognized over the requisite service period, with a corresponding credit to equity (generally, paid-in capital). The requisite service period is the period during which an employee is required to provide service in exchange for an award, which often is the vesting period. The requisite service period is estimated based on an analysis of the terms of the share-based payment award.

40. The requisite service period may be explicit or it may be implicit, being inferred from an analysis of other terms in the award, including other explicit service or performance conditions. The requisite service period for an award that contains a market condition can be derived from certain valuation techniques that may be used to estimate grant-date fair value (paragraph A60). An award may have one or more explicit, implicit, or derived service periods; however, an award may have only one requisite service period for accounting purposes unless it is accounted for as in-substance multiple awards. (24) Paragraphs A59-A74 provide guidance on estimating the requisite service period and provide examples of how that period should be estimated if an award's terms include more than one explicit, implicit, or derived service period.

41. The service inception date is the beginning of the requisite service period. If the service inception date precedes the grant date (paragraph A79), accrual of compensation cost for periods before the grant date shall be based on the fair value of the award at the reporting date. In the period in which the grant date occurs, cumulative compensation cost shall be adjusted to reflect the cumulative effect of measuring compensation cost based on fair value at the grant date rather than the fair value previously used at the service inception date (or any subsequent reporting date). Illustration 3 (paragraphs A79-A85) provides guidance on the concept of service inception date and how it is to be applied.

42. An entity shall make a policy decision about whether to recognize compensation cost for an award with only service conditions that has a graded vesting schedule (a) on a straight-line basis over the requisite service period for each separately vesting portion of the award as if the award was, in-substance, multiple awards or (b) on a straight-line basis over the requisite service period for the entire award (that is, over the requisite service period of the last separately vesting portion of the award). However, the amount of compensation cost recognized at any date must at least equal the portion of the grant-date value of the award that is vested at that date. Illustration 4(b) (paragraphs A97-A104) provides an example of the accounting for an award with a graded vesting schedule.

Amount of Compensation Cost to Be Recognized over the Requisite Service Period

43. The total amount of compensation cost recognized at the end of the requisite service period for an award of share-based compensation shall be based on the number of instruments for which the requisite service has been rendered (that is, for which the requisite service period has been completed). An entity shall base initial accruals of compensation cost on the estimated number of instruments for which the requisite service is expected to be rendered. That estimate shall be revised if subsequent information indicates that the actual number of instruments is likely to differ from previous estimates. The cumulative effect on current and prior periods of a change in the estimated number of instruments for which the requisite service is expected to be or has been rendered shall be recognized in compensation cost in the period of the change.

44. Accruals of compensation cost for an award with a performance condition shall be based on the probable (25) outcome of that performance condition--compensation cost shall be accrued if it is probable that the performance condition will be achieved and shall not be accrued if it is not probable that the performance condition will be achieved. If an award has multiple performance conditions (for example, if the number of options or shares an employee earns varies depending on which, if any, of two or more performance conditions is satisfied), compensation cost shall be accrued if it is probable that a performance condition will be satisfied. In making that assessment, it may be necessary to take into account the interrelationship of those performance conditions. Illustration 5 (paragraphs A105-A110) provides an example of how to account for awards with multiple performance conditions.

45. Previously recognized compensation cost shall not be reversed if an employee share option (or share unit) for which the requisite service has been rendered expires unexercised (or unconverted).

Estimating the Requisite Service Period

46. An entity shall make its initial best estimate of the requisite service period at the grant date (or at the service inception date if that date precedes the grant date) and shall base accruals of compensation cost on that period. An entity shall adjust that initial best estimate in light of changes in facts and circumstances. The initial best estimate and any subsequent adjustment to that estimate of the requisite service period for an award with a combination of market, performance, or service conditions shall be based on an analysis of (a) all vesting and exercisability conditions, (b) all explicit, implicit, and derived service periods, and (c) the probability that performance or service conditions will be satisfied. For such an award, whether and how the initial best estimate of the requisite service period is adjusted depends on both the nature of those conditions and the manner in which they are combined, for example, whether an award vests or becomes exercisable when either a market or a performance condition is satisfied or whether both conditions must be satisfied. Paragraphs A59-A66 provide guidance on adjusting the initial estimate of the requisite service period.

Effect of Market, Performance, and Service Conditions on Recognition and Measurement of Compensation Cost

Market, performance, and service conditions that affect vesting or exercisability

47. If an award requires satisfaction of one or more market, performance, or service conditions (or any combination thereof), compensation cost is recognized if the requisite service is rendered, and no compensation cost is recognized if the requisite service is not rendered. Paragraphs A49-A51 provide guidance on applying this provision to awards with market, performance, or service conditions (or any combination thereof).

48. Performance or service conditions that affect vesting are not reflected in estimating the fair value of an award at the grant date because those conditions are restrictions that stem from the forfeitability of instruments to which employees have not yet earned the right. However, the effect of a market condition is reflected in estimating the fair value of an award at the grant date (paragraph 19). For purposes of this Statement, a market condition is not considered to be a vesting condition, and an award is not deemed to be forfeited solely because a market condition is not satisfied. Accordingly, an entity" shall reverse previously recognized compensation cost for an award with a market condition only if the requisite service is not rendered.

Market, performance, and service conditions that affect factors other than vesting or exercisability

49. Market, performance, and service conditions (or any combination thereof) may affect an award's exercise price, contractual term, quantity, conversion ratio, or other factors that are considered in measuring an award's grant-date fair value. A grant-date fair value shall be estimated for each possible outcome of such a performance or service condition, and the final measure of compensation cost shall be based on the amount estimated at the grant date for the condition or outcome that is actually satisfied. Paragraphs A52-A54 provide additional guidance on the effects of market, performance, and service conditions that affect factors other than vesting or exercisability. Illustrations 5 (paragraphs A105-A110), 6 (paragraphs A111-A113), and 8 (paragraphs A121-A124) provide examples of accounting for awards with such conditions.

Recognition of Changes in the Fair Value or Intrinsic Value of Awards Classified as Liabilities

50. Changes in the fair value (or intrinsic value for a nonpublic entity that elects that method) of a liability incurred under a share-based payment arrangement that occur during the requisite service period shall be recognized as compensation cost over that period. The percentage of the fair value (or intrinsic value) that is accrued as compensation cost at the end of each period shall equal the percentage of the requisite service that has been rendered at that date. Changes in the fair value (or intrinsic value) of a liability that occur after the end of the requisite service period are compensation cost of the period in which the changes occur. Any difference between the amount for which a liability award is settled and its fair value at the settlement date as estimated in accordance with the provisions of this Statement is an adjustment of compensation cost in the period of settlement. Illustration 10 (paragraphs A 127-A133) provides an example of accounting for a liability award from the grant date through its settlement.

Modifications of Awards of Equity Instruments

51. A modification of the terms or conditions of an equity award shall be treated as an exchange of the original award for a new award. (26) In substance, the entity repurchases the original instrument by issuing a new instrument of equal or greater value, incurring additional compensation cost for any incremental value. The effects of a modification shall be measured as follows:

a. Incremental compensation cost shall be measured as the excess, if any, of the fair value of the modified award determined in accordance with the provisions of this Statement over the fair value of the original award immediately before its terms are modified, measured based on the share price and other pertinent factors at that date. (27) The effect of the modification on the number of instruments expected to vest also shall be reflected in determining incremental compensation cost. The estimate at the modification date of the portion of the award expected to vest shall be subsequently adjusted, if necessary, in accordance with paragraphs 43-45 and other guidance in Illustration 13 (paragraphs A 160-A170).

b. Total recognized compensation cost for an equity award shall at least equal the fair value of the award at the grant date unless at the date of the modification the performance or service conditions of the original award are not expected to be satisfied. Thus, the total compensation cost measured at the date of a modification shall be (1) the portion of the grant-date fair value of the original award for which the requisite service is expected to be rendered (or has already been rendered) at that date plus (2) the incremental cost resulting from the modification. Compensation cost shall be subsequently adjusted, if necessary, in accordance with paragraphs 43-45 and other guidance in Illustration 13 (paragraphs A160-A170).

c. A change in compensation cost for an equity award measured at intrinsic value in accordance with paragraph 25 shall be measured by comparing the intrinsic value of the modified award, if any, with the intrinsic value of the original award, if any, immediately before the modification.

Illustrations 12-14 (paragraphs A149-A189) provide additional guidance on, and illustrate the accounting for, modifications of both vested and nonvested awards, including a modification that changes the classification of the related financial instruments from equity to liability or vice versa, and modifications of vesting conditions. Illustration 22 (paragraphs A225-A232) provides additional guidance on accounting for modifications of certain freestanding financial instruments that initially were subject to this Statement but subsequently became subject to other applicable GAAP.

Inducements

52. A short-term inducement shall be accounted for as a modification of the terms of only the awards of employees who accept the inducement. Other inducements are modifications of the terms of all awards subject to them and shall be accounted for as such.

Equity Restructurings

53. Exchanges of share options or other equity instruments or changes to their terms in conjunction with an equity restructuring or a business combination are modifications for purposes of this Statement.

54. Except for a modification to add an anti-dilution provision that is not made in contemplation of an equity restructuring, accounting for a modification in conjunction with an equity, restructuring requires a comparison of the fair value of the modified award with the fair value of the original award immediately before the modification in accordance with paragraph 51. If those amounts are the same, for instance, because the modification is designed to equalize the fair value of an award before and after an equity restructuring, no incremental compensation cost is recognized. Illustration 12(e) (paragraphs A156-A159) provides further guidance on applying the provisions of this paragraph.

Repurchases or Cancellations of Awards of Equity Instruments

55. The amount of cash or other assets transferred (or liabilities incurred) to repurchase an equity award shall be charged to equity, to the extent that the amount paid does not exceed the fair value of the equity instruments repurchased at the repurchase date. Any excess of the repurchase price over the fair value of the instruments repurchased shall be recognized as additional compensation cost. An entity that repurchases an award for which the requisite service has not been rendered has, in effect, modified the requisite service period to the period for which service already has been rendered, and thus the amount of compensation cost measured at the grant date but not yet recognized shall be recognized at the repurchase date.

Cancellation and Replacement of Awards of Equity Instruments

56. Cancellation of an award accompanied by the concurrent grant of (or offer to grant) (28) a replacement award or other valuable consideration shall be accounted for as a modification of the terms of the cancelled award. Therefore, incremental compensation cost shall be measured as the excess of the fair value of the replacement award or other valuable consideration over the fair value of the cancelled award at the cancellation date in accordance with paragraph 51. Thus, the total compensation cost measured at the date of a cancellation and replacement shall be the portion of the grant-date fair value of the original award for which the requisite service is expected to be rendered (or has already been rendered) at that date plus the incremental cost resulting from the cancellation and replacement.

57. A cancellation of an award that is not accompanied by the concurrent grant of (or offer to grant) a replacement award or other valuable consideration shall be accounted for as a repurchase for no consideration. Accordingly, any previously unrecognized compensation cost shall be recognized at the cancellation date.

Accounting for Tax Effects of Share-Based Compensation Awards

58. Income tax regulations specify allowable tax deductions for instruments issued under share-based payment arrangements in determining an entity's income tax liability. For example, tinder U.S. tax law at the issuance date of this Statement, allowable tax deductions are generally measured as the intrinsic value of an instrument on a specified date. The time value component, if any, of the fair value of an instrument generally is not tax deductible. Therefore, tax deductions generally will arise in different amounts and in different periods from compensation cost recognized in financial statements.

59. The cumulative amount of compensation cost recognized for instruments classified as equity that ordinarily would result in a future tax deduction under existing tax law shall be considered to be a deductible temporary difference in applying FASB Statement No. 109, Accounting for Income Taxes. The deductible temporary difference shall be based on the compensation cost recognized for financial reporting purposes. The deferred tax benefit (or expense) that results from increases (or decreases) in that temporary difference, for example, an increase that results as additional service is rendered and the related cost is recognized or a decrease that results from forfeiture of an award, shall be recognized in the income statement. (29) Recognition of compensation cost for instruments that ordinarily do not result in tax deductions under existing tax law shall not be considered to result in a deductible temporary difference in applying Statement 109. A future event, such as an employee's disqualifying disposition of shares under U.S. tax law at the issuance date of this Statement, can give rise to a tax deduction for instruments that ordinarily do not result in a tax deduction. The tax effects of such an event shall be recognized only when it occurs.

60. The cumulative amount of compensation cost recognized for instruments classified as liabilities that ordinarily would result in a future tax deduction under existing tax law also shall be considered to be a deductible temporary difference. The deductible temporary difference shall be based on the compensation cost recognized for financial reporting purposes.

61. Statement 109 requires a deferred tax asset to be evaluated for future realization and to be reduced by a valuation allowance if, based on the weight of the available evidence, it is more likely than not that some portion or all of the deferred tax asset will not be realized. (30) Differences between (a) the deductible temporary difference computed pursuant to paragraph 59 of this Statement and (b) the tax deduction that would result based on the current fair value of the entity's shares shall not be considered in measuring the gross deferred tax asset or determining the need for a valuation allowance for a deferred tax asset recognized under this Statement.

62. If a deduction reported on a tax return for an award of equity instruments exceeds the cumulative compensation cost for those instruments recognized for financial reporting, any resulting realized tax benefit that exceeds the previously recognized deferred tax asset for those instruments (the excess tax benefit) shall be recognized as additional paid-in capital. (31) However, an excess of a realized tax benefit for an award over the deferred tax asset for that award shall be recognized in the income statement to the extent that the excess stems from a reason other than changes in the fair value of an entity's shares between the measurement date for accounting purposes and a later measurement date for tax purposes.

63. The amount deductible on the employer's tax return may be less than the cumulative compensation cost recognized for financial reporting purposes. The write-off of a deferred tax asset related to that deficiency, net of the related valuation allowance, if any, shall first be offset to the extent of any remaining additional paid-in capital from excess tax benefits from previous awards accounted for in accordance with this Statement or Statement 123. The remaining balance, if any, of the write-off of a deferred tax asset related to a tax deficiency shall be recognized in the income statement. An entity that continued to use Opinion 25's intrinsic value method as permitted by Statement 123 shall calculate the amount available for offset as the net amount of excess tax benefits that would have qualified as such had it instead adopted Statement 123 for recognition purposes pursuant to Statement 123's original effective date and transition method. In determining that amount, no distinction shall be made between excess tax benefits attributable to different types of equity awards, such as restricted shares or share options. An entity shall exclude from that amount both excess tax benefits from share-based payment arrangements that are outside the scope of this Statement, such as employee share ownership plans, and excess tax benefits that have not been realized pursuant to Statement 109, as noted in paragraph A94, footnote 82, of this Statement. Illustrations 4(a) (paragraphs A94-A96), 10 (paragraphs A132 and A133), 11(a) (paragraphs A135 and A136), and 14(a) (paragraphs A178-A180) of this Statement provide examples of accounting for the income tax effects of various awards.

Disclosures

64. An entity with one or more share-based payment arrangements shall disclose information that enables users of the financial statements to understand:

a. The nature and terms of such arrangements that existed during the period and the potential effects of those arrangements on shareholders

b. The effect of compensation cost arising from share-based payment arrangements on the income statement

C. The method of estimating the fair value of the goods or services received, or the fair value of the equity instruments granted (or offered to grant), during the period

d. The cash flow effects resulting from share-based payment arrangements.

Paragraphs A240 and A241 indicate the minimum information needed to achieve those objectives and illustrate how the disclosure requirements might be satisfied. In some circumstances, an entity may need to disclose information beyond that listed in paragraph A240 to achieve the disclosure objectives.

65. An entity that acquires goods or services other than employee services in share-based payment transactions shall provide disclosures similar to those required by paragraph 64 to the extent that those disclosures are important to an understanding of the effects of those transactions on the financial statements. In addition, an entity that has multiple share-based payment arrangements with employees shall disclose information separately for different types of awards under those arrangements to the extent that differences in the characteristics of the awards make separate disclosure important to an understanding of the entity's use of share-based compensation (paragraph A240).

Earnings per Share Implications

66. FASB Statement No. 128, Earnings per Share, requires that employee equity share options, nonvested shares, and similar equity instruments granted to employees be treated as potential common shares in computing diluted earnings per share. Diluted earnings per share shall be based on the actual number of options or shares granted and not yet forfeited, unless doing so would be antidilutive. If vesting in or the ability to exercise (or retain) an award is contingent on a performance or market condition, such as the level of future earnings, the shares or share options shall be treated as contingently issuable shares in accordance with paragraphs 30-35 of Statement 128. If equity share options or other equity instruments are outstanding for only part of a period, the shares issuable shall be weighted to reflect the portion of the period during which the equity instruments are outstanding.

67. Paragraphs 21-23 of Statement 128 provide guidance on applying the treasury stock method for equity instruments granted in share-based payment transactions in determining diluted earnings per share.

Amendments to Statement 95

68. Statement 95 is amended by adding the underlined wording as follows:

a. Paragraph 19, as amended by FASB Statements No. 117, Financial Statements of Not-for-Profit Organizations, and No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities:

Cash inflows from financing activities are:

a. Proceeds from issuing equity instruments

b. Proceeds from issuing bonds, mortgages, notes, and from other short- or long-term borrowing

c. Receipts from contributions and investment income that by donor stipulation are restricted for the purposes of acquiring, con structing, or improving property, plant, equipment, or other long-lived assets or establishing or increasing a permanent endowment or term endowment

d. Proceeds received (7a) from derivative instruments that include financing elements (7b) at inception

e. Cash retained as a result of the tax deductibility of increases in the value of equity instruments issued under share-based payment arrangements that are not included in the cost of goods or services that is recognizable for financial reporting purposes. For this purpose, excess tax benefits shall be determined on an individual award (or a portion thereof) basis.

b. Paragraph 23 as amended by FASB Statements No. 102, Statement of Cash Flows--Exemption of Certain Enterprises and Classification of Cash Flows from Certain Securities Acquired for Resale, and No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections:

Cash outflows for operating activities are:

a. Cash payments to acquire materials for manufacture or goods8d for resale, including principal payments on accounts and both short- and long-term notes payable to suppliers for those materials or goods.

b. Cash payments to other suppliers and employees for other goods or services.

c. Cash payments to governments for taxes, duties, fines, and other fees or penalties and the cash that would have been paid for income taxes if increases in the value of equity instruments issued under share-based payment arrangements that are not included in the cost of goods or services recognizable for financial purposes also had not been deductible in determining taxable income. (This is the same amount reported as a financing cash inflow pursuant to paragraph 19(e) of this Statement.)

d. Cash payments to lenders and other creditors for interest.

e. All other cash payments that do not stem from transactions defined as investing or financing activities, such as payments to settle lawsuits, cash contributions to charities, and cash refunds to customers.

c. Paragraph 27, as amended by Statement 117:

In reporting cash flows from operating activities, enterprises are encouraged to report major classes of gross cash receipts and gross cash payments and their arithmetic sum the net cash flow from operating activities (the direct method). Enterprises that do so should, at a minimum, separately report the following classes of operating cash receipts and payments: (11)

a. Cash collected from customers, including lessees, licensees, and the like

b. Interest and dividends received (11a)

c. Other operating cash receipts, if any

d. Cash paid to employees and other suppliers of goods or services, including suppliers of insurance, advertising, and the like

e. Interest paid

f. Income taxes paid and, separately, the cash that would have been paid for income taxes if increases in the value of equity instruments issued under share-based, payment arrangements that are not recognizable as a cost of goods or services for accounting purposes also had not been deductible in determining taxable income

g. Other operating cash payments, if any.

Enterprises are encouraged to provide Further breakdowns of operating cash receipts and payments that they consider meaningful and feasible. For example, a retailer or manufacturer might decide to further divide cash paid to employees and suppliers (category (d) above) into payments for costs of inventory and payments for selling, general, and administrative expenses.

Effective Dates and Transition

69. This Statement is effective:

a. For public entities that do not file as small business issuers--as of the beginning of the first interim or annual reporting period that begins after June 15, 2005

b. For public entities that file as small business issuers--as of the beginning of the first interim or annual reporting period that begins after December 15, 2005

C. For nonpublic entities--as of the beginning of the first annual reporting period that begins after December 15, 2005.

The effective date for a nonpublic entity that becomes a public entity after June 15, 2005, and does not file as a small business issuer is the first interim or annual reporting period beginning after the entity becomes a public entity. If the newly public entity files as a small business issuer, the effective date is the first interim or annual reporting period beginning after December 15, 2005, for which the entity is a public entity.

70. This Statement applies to all awards granted after the required effective date. This Statement shall not be applied to awards granted in periods before the required effective date except to the extent that prior periods' awards are modified, repurchased, or cancelled after the required effective date and as required by paragraph 74. The cumulative effect of initially applying this Statement, if any, shall be recognized as of the required effective date (paragraphs 79-82).

71. As of the required effective date, all public entities and those nonpublic entities that used the fair-value-based method for either recognition or disclosure under Statement 123 shall apply the modified prospective application transition method (paragraphs 74 and 75). For periods before the required effective date, those entities may elect to apply the modified retrospective application transition method (paragraphs 76-78).

72. Nonpublic entities that used the minimum value method in Statement 123 for either recognition or pro forma disclosures are required to apply the prospective transition method (paragraph 83) as of the required effective date.

73. Early adoption of this Statement for interim or annual periods for which financial statements or interim reports have not been issued is encouraged. (32)

Modified Prospective Application

74. As of the required effective date, all public entities and those nonpublic entities that used the fair-value-based method for either recognition or disclosure under Statement 123, including such nonpublic entities that become public entities after June 15, 2005, shall adopt this Statement using a modified version of prospective application (modified prospective application). Under modified prospective application, this Statement applies to new awards and to awards modified, repurchased, or cancelled after the required effective date. Additionally, compensation cost for the portion of awards for which the requisite service has not been rendered that are outstanding as of the required effective date shall be recognized as the requisite service is rendered on or after the required effective date. The compensation cost for that portion of awards shall be based on the grant-date fair value of those awards as calculated for either recognition or pro forma disclosures under Statement 123. Changes to the grant-date fair value of equity awards granted before the required effective date of this Statement are precluded. (33) The compensation cost for those earlier awards shall be attributed to periods beginning on or after the required effective date of this Statement using the attribution method that was used under Statement 123, except that the method of recognizing forfeitures only as they occur shall not be continued (paragraph 80). Any unearned or deferred compensation (contra-equity accounts) related to those earlier awards shall be eliminated against the appropriate equity accounts.

75. An entity that does not choose modified retrospective application (paragraphs 76-78 of this Statement) shall apply the amendments to Statement 95 in paragraph 68 of this Statement only for the interim or annual periods for which this Statement is adopted.

Modified Retrospective Application

76. All public entities and those nonpublic entities that used the fair-value-based method for either recognition or disclosure under Statement 123, including such nonpublic entities that become public entities after June 15, 2005, may apply a modified version of retrospective application (modified retrospective application) to periods before the required effective date. Modified retrospective application may be applied either (a) to all prior years for which Statement 123 was effective (34) or (b) only to prior interim periods in the year of initial adoption if the required effective date of this Statement does not coincide with the beginning of the entity's fiscal year. An entity that chooses to apply the modified retrospective method to all prior years for which Statement 123 was effective shall adjust financial statements for prior periods to give effect to the fair-value-based method of accounting for awards granted, modified, or settled in cash in fiscal years beginning after December 15, 1994, on a basis consistent with the pro forma disclosures required for those periods by Statement 123, as amended by FASB Statement No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure, (35) and by paragraph 30 of APB Opinion No. 28, Interim Financial Reporting. Accordingly, compensation cost and the related tax effects will be recognized in those financial statements as though they had been accounted for under Statement 123. (36) Changes to amounts as originally measured on a pro forma basis are precluded.

77. If an entity applies the modified retrospective application method to all prior years for which Statement 123 was effective and does not present all of those years in comparative financial statements, the beginning balances of paid-in capital, deferred taxes, and retained earnings for the earliest year presented shall be adjusted to reflect the results of modified retrospective application to those prior years not presented. The effects of any such adjustments shall be disclosed in the year of adoption. If an entity applies the modified retrospective application method only to prior interim periods in the year of initial adoption, there would be no adjustment to the beginning balances of paid-in capital, deferred taxes, or retained earnings for the year of initial adoption.

78. The amendments to Statement 95 in paragraph 68 of this Statement shall be applied to the same periods for which the modified retrospective application method is applied,

Transition as of the Required Effective Date for both Modified Prospective and Modified Retrospective Transition Methods

79. Transition as of the required effective date for instruments that are liabilities under the provisions of this Statement shall be as follows:

a. For an instrument that had been classified as equity but is classified as a liability under this Statement, recognize a liability at its fair value (or portion thereof, if the requisite service has not been rendered). If (1) the fair value (or portion thereof) of the liability is greater or less than (2) previously recognized compensation cost for the instrument, the liability shall be recognized first, by reducing equity (generally, paid-in capital) to the extent of such previously recognized cost and second, by recognizing the difference (that is, the difference between items (1) and (2)) in the income statement, net of any related tax effect, as the cumulative effect of a change in accounting principle.

b. For an outstanding instrument that previously was classified as a liability and measured at intrinsic value, recognize the effect of initially measuring the liability at its fair value, net of any related tax effect, as the cumulative effect of a change in accounting principle. (37)

80. As of the required effective date, an entity that had a policy of recognizing the effect of forfeitures only as they occurred shall estimate the number of outstanding instruments for which the requisite service is not expected to be rendered. Balance sheet amounts related to any compensation cost (excluding nonrefundable dividend payments), net of related tax effects, for those instruments previously recognized in income because of that policy for periods before the effective date of this Statement shall be eliminated and recognized in income as the cumulative effect of a change in accounting principle as of the required effective date.

81. Except as required by paragraph 80, no transition adjustment as of the required effective date shall be made for any deferred tax assets associated with outstanding equity instruments that continue to be accounted for as equity instruments tinder this Statement. For purposes of calculating the available excess tax benefits if deferred tax assets need to be written off in subsequent periods, an entity shall include as available for offset only the net excess tax benefits that would have qualified as such had the entity adopted Statement 123 for recognition purposes for all awards granted, modified, or settled in cash for fiscal years beginning after December 15, 1994. In determining that amount, an entity shall exclude excess tax benefits that have not been realized pursuant to Statement 109 (paragraph A94, footnote 82, of this Statement). An entity that previously has recognized deferred tax assets for excess tax benefits prior to their realization shall discontinue that practice prospectively and shall follow the guidance in this Statement and in Statement 109.

82. Outstanding equity instruments that are measured at intrinsic value under Statement 123 at the required effective date because it was not possible to reasonably estimate their grant-date fair value shall continue to be measured at intrinsic value until they are settled.

Nonpublic Entities That Used the Minimum Value Method in Statement 123

83. Nonpublic entities, including those that become public entities after June 15, 2005, that used the minimum value method of measuring equity share options and similar instruments for either recognition or pro forma disclosure purposes under Statement 123 shall apply this Statement prospectively to new awards and to awards modified, repurchased, or cancelled after the required effective date. Those entities shall continue to account for any portion of awards outstanding at the date of initial application using the accounting principles originally applied to those awards (either the minimum value method under Statement 123 or the provisions of Opinion 25 and its related interpretive guidance).

Required Disclosures in the Period This Statement Is Adopted

84. In the period that this Statement is adopted, an entity shall disclose the effect of the change from applying the original provisions of Statement 123 (38) on income from continuing operations, income before income taxes, net income, cash flow from operations, cash flow from financing activities, and basic and diluted earnings per share. In addition, if awards under share-based payment arrangements with employees are accounted for under the intrinsic value method of Opinion 25 for any reporting period for which an income statement is presented, all public entities shall continue to provide the tabular presentation of the following information that was required by paragraph 45 of Statement 123 for all those periods:

a. Net income and basic and diluted earnings per share as reported

b. The share-based employee compensation cost, net of related tax effects, included in net income as reported

c. The share-based employee compensation cost, net of related tax effects, that would have been included in net income if the fair-value-based method had been applied to all awards (39)

d. Pro forma net income as if the fair-value-based method had been applied to all awards

e. Pro forma basic and diluted earnings per share as if the fair-value-based method had been applied to all awards.

The required pro forma amounts shall reflect the difference in share-based employee compensation cost, if any, included in net income and the total cost measured by the fair-value-based method, as well as additional tax effects, if any, that would have been recognized in the income statement if the fair-value-based method had been applied to all awards. The required pro forma per-share amounts shall reflect the change in the denominator of the diluted earnings per share calculation as if the assumed proceeds under the treasury stock method, including measured but unrecognized compensation cost and any excess tax benefits credited to additional paid-in capital, were determined under the fair-value-based method.

85. A nonpublic entity that used the minimum value method for pro forma disclosure purposes under the original provisions of Statement 123 shall not continue to provide those pro forma disclosures for outstanding awards accounted for under the intrinsic value method of Opinion 25.

The provisions of this Statement need not be applied to immaterial items.

This Statement was adopted by the unanimous vote of the seven members of the Financial Accounting Standards Board:

Robert H. Herz, Chairman

George J. Batavick

G. Michael Crooch

Gary S. Schieneman

Katherine Schipper

Leslie E Seidman

Edward W. Trott

GLOSSARY

E1. This appendix contains definitions of certain terms or phrases used in this Statement.

Blackout period. A period of time during which exercise of an equity share option is contractually or legally prohibited.

Broker-assisted cashless exercise. The simultaneous exercise by an employee of a share option and sale of the shares through a broker (commonly referred to as a broker-assisted exercise).

Generally, under this method of exercise:

a. The employee authorizes the exercise of an option and the immediate sale of the option shares in the open market.

b. On the same day, the entity notifies the broker of the sale order.

c. The broker executes the sale and notifies the entity of the sales price.

d. The entity determines the minimum statutory tax-withholding requirements.

e. By the settlement day (generally three days later), the entity, delivers the stock certificates to the broker.

f. On the settlement day, the broker makes payment to the entity for the exercise price and the minimum statutory withholding taxes and remits the balance of the net sales proceeds to the employee.

Calculated value. A measure of the value of a share option or similar instrument determined by substituting the historical volatility of an appropriate industry sector index for the expected volatility of a nonpublic entity's share price in an option-pricing model.

Closed-form model. A valuation model that uses an equation to produce an estimated fair value. The Black-Scholes-Merton formula is a closed-form model. In the context of option valuation, both close&form models and lattice models are based on risk-neutral valuation and a contingent claims framework. The payoff of a contingent claim, and thus its value, depends on the value(s) of one or more other assets. The contingent claims framework is a valuation methodology that explicitly recognizes that dependency and values the contingent claim as a function of the value of the underlying asset(s). One application of that methodology is risk-neutral valuation in which the contingent claim can be replicated by a combination of the underlying asset and a risk-flee bond. If that replication is possible, the value of the contingent claim can be determined without estimating the expected returns on the underlying asset. The Black-Scholes-Merton formula is a special case of that replication.

Combination award. An award with two or more separate components, each of which can be separately exercised. Each component of the award is actually a separate award, and compensation cost is measured and recognized for each component.

Cross-volatility. A measure of the relationship between the volatilities of the prices of two assets taking into account the correlation between movements in the prices of the assets. (Refer to the definition of volatility.)

Derived service period. A service period for an award with a market condition that is inferred from the application of certain valuation techniques used to estimate fair value. For example, the derived service period for an award of share options that the employee can exercise only if the share price increases by 25 percent at any time during a 5-year period can be inferred from certain valuation techniques. In a lattice model, that derived service period represents the duration of the median of the distribution of share price paths on which the market condition is satisfied. That median is the middle share price path (the midpoint of the distribution of paths) on which the market condition is satisfied. The duration is the period of time from the service inception date to the expected date of satisfaction (as inferred from the valuation technique). If the derived service period is three years, the estimated requisite service period is three years and all compensation cost would be recognized over that period, unless the market condition was satisfied at an earlier date. (170) Further, award of fully vested, deep out-of-the-money share options has a derived service period that must be determined from the valuation techniques used to estimate fair value. (Refer to the definitions of explicit service period, implicit service period, and requisite service period.)

Economic interest in an entity. Any type or form of pecuniary interest or arrangement that an entity could issue or be a party to, including equity securities; financial instruments with characteristics of equity, liabilities, or both: long-term debt and other debt-financing arrangements; leases; and contractual arrangements such as management contracts, service contracts, or intellectual property licenses.

Employee. An individual over whom the grantor of a share-based compensation award exercises or has the right to exercise sufficient control to establish an employer-employee relationship based on common law as illustrated in case law and currently under U.S. Internal Revenue Service Revenue Ruling 87-41. (171) Accordingly, a grantee meets the definition of an employee if the grantor consistently represents that individual to be an employee under common law. The definition of an employee for payroll tax purposes under the U.S. Internal Revenue Code includes common law employees. Accordingly, a grantor that classifies a grantee potentially subject to U.S. payroll taxes as an employee for purposes of applying this Statement also must represent that individual as an employee for payroll tax purposes (unless the grantee is a leased employee as described below). A grantee does not meet the definition of an employee for purposes of this Statement solely because the grantor represents that individual as an employee for some, but not all, purposes. For example, a requirement or decision to classify a grantee as an employee for U.S. payroll tax purposes does not, by itself, indicate that the grantee is an employee for purposes of this Statement because the grantee also must be an employee of the grantor under common law.

A leased individual is deemed to be an employee of the lessee for purposes of this Statement if all of the following requirements are met:

a. The leased individual qualifies as a common law employee of the lessee, and the lessor is contractually required to remit payroll taxes on the compensation paid to the leased individual for the services provided to the lessee.

b. The lessor and lessee agree in writing to all of the following conditions related to the leased individual:

1. The lessee has the exclusive right to grant stock compensation to the individual for the employee service to the lessee.

2. The lessee has a right to hire, fire, and control the activities of the individual. (The lessor also may have that right.)

3. The lessee has the exclusive right to determine the economic value of the services performed by the individual (including wages and the number of units and value of stock compensation granted).

4. The individual has the ability to participate in the lessee's employee benefit plans, if any, on the same basis as other comparable employees of the lessee.

5. The lessee agrees to and remits to the lessor funds sufficient to cover the complete compensation, including all payroll taxes, of the individual on or before a contractually agreed upon date or dates.

A nonemployee director does not satisfy this definition of employee. Nevertheless, for purposes of this Statement, nonemployee directors acting in their role as members of a board of directors are treated as employees if those directors were (a) elected by the employer's shareholders or (b) appointed to a board position that will be filled by shareholder election when the existing term expires. However, that requirement applies only to awards granted to nonemployee directors for their services as directors. Awards granted to those individuals for other services shall be accounted for as awards to nonemployees for purposes of this Statement.

Employee share ownership plan. An employee benefit plan that is described by the Employment Retirement Income Act of 1974 and the Internal Revenue Code of 1986 as a stock bonus plan, or combination stock bonus and money purchase pension plan, designed to invest primarily in employer stock.

Equity restructuring. A nonreciprocal transaction between an entity and its shareholders that causes the per-share fair value of the shares underlying an option or similar award to change, such as a stock dividend, stock split, spinoff, rights offering, or recapitalization through a large, nonrecurring cash dividend.

Excess tax benefit. The realized tax benefit related to the amount (caused by changes in the fair value of the entity's shares after the measurement date for financial reporting) of deductible compensation cost reported on an employer's tax return for equity instruments in excess of the compensation cost for those instruments recognized for financial reporting purposes.

Explicit service period. A service period that is explicitly stated in the terms of a share-based payment award. For example, an award stating that it vests after three years of continuous employee service from a given date (usually the grant date) has an explicit service period of three years. (Refer to derived service period, implicit service period, and requisite service period.)

Fair value. The amount at which an asset (or liability) could be bought (or incurred) or sold (or settled) in a current transaction between willing parties, that is, other than in a forced or liquidation sale.

Freestanding financial instrument. A financial instrument that is entered into separately and apart from any of the entity's other financial instruments or equity transactions or that is entered into in conjunction with some other transaction and is legally detachable and separately exercisable.

Grant date. The date at which an employer and an employee reach a mutual understanding of the key terms and conditions of a share-based payment award. The employer becomes contingently obligated on the grant date to issue equity instruments or transfer assets to an employee who renders the requisite service. Awards made under an arrangement that is subject to shareholder approval are not deemed to be granted until that approval is obtained unless approval is essentially a formality (or perfunctory), for example, if management and the members of the board of directors control enough votes to approve the arrangement. Similarly, individual awards that are subject to approval by the board of directors, management, or both are not deemed to be granted until all such approvals are obtained. The grant date for an award of equity instruments is the date that an employee begins to benefit from, or be adversely affected by, subsequent changes in the price of the employer's equity shares. (Refer to the definition of service inception date.)

Implicit service period. A service period that is not explicitly stated in the terms of a share-based payment award but that may be inferred from an analysis of those terms and other facts and circumstances. For instance, if an award of share options vests upon the completion of a new product design and it is probable that the design will be completed in 18 months, the implicit service period is 18 months. (Refer to derived service period, explicit service period, and requisite service period.)

Intrinsic value. The amount by which the fair value of the underlying stock exceeds the exercise price of an option. For example, an option with an exercise price of $20 on a stock whose current market price is $25 has an intrinsic value of $5. (A nonvested share may be described as an option on that share with an exercise price of zero. Thus, the fair value of a share is the same as the intrinsic value of such an option on that share.)

Issued, issuance, or issuing of an equity instrument. An equity instrument is issued when the issuing entity receives the agreed-upon consideration, which may be cash, an enforceable right to receive cash or another financial instrument, goods, or services. An entity may conditionally transfer an equity instrument to another party under an arrangement that permits that party to choose at a later date or for a specified time whether to deliver the consideration or to forfeit the right to the conditionally transferred instrument with no further obligation. In that situation, the equity instrument is not issued until the issuing entity has received the consideration. For that reason, this Statement does not use the term issued for the grant of stock options or other equity instruments subject to vesting conditions.

Lattice model. A model that produces an estimated fair value based on the assumed changes in prices of a financial instrument over successive periods of time. The binomial model is an example of a lattice model. In each time period, the model assumes that at least two price movements are possible. The lattice represents the evolution of the value of either a financial instrument or a market variable for the purpose of valuing a financial instrument. In this context, a lattice model is based on risk-neutral valuation and a contingent claims framework. (Refer to dosed-form model for an explanation of the terms risk-neutral valuation and contingent claims framework.)

Market condition. A condition affecting the exercise price, exercisability, or other pertinent factors used in determining the fair value of an award under a share-based payment arrangement that relates to the achievement of (a) a specified price of the issuer's shares or a specified amount of intrinsic value indexed solely to the issuer's shares or (b) a specified price of the issuer's shares in terms of a similar (172) (or index of similar) equity security, (securities).

Measurement date. The date at which the equity share price and other pertinent factors, such as expected volatility, that enter into measurement of the total recognized amount of compensation cost for an award of share-based payment are fixed.

Modification. A change in any of the terms or conditions of a share-based payment award.

Nonpublic entity. Any entity other than one (a) whose equity securities trade in a public market either on a stock exchange (domestic or foreign) or in the over-the-counter market, including securities quoted only locally or regionally, (b) that makes a filing with a regulatory agency in preparation for the sale of any class of equity securities in a public market, or (c) that is controlled by an entity covered by (a) or (b). An entity that has only debt securities trading in a public market (or that has made a filing with a regulatory agency in preparation to trade only debt securities) is a nonpublic entity for purposes of this Statement.

Nonvested shares. Shares that an entity has not yet issued because the agreed-upon consideration, such as employee services, has not yet been received. Nonvested shares cannot be sold. The restriction on sale of nonvested shares is due to the forfeitability of the shares if specified events occur (or do not occur).

Performance condition. A condition affecting the vesting, exercisability, exercise price, or other pertinent factors used in determining the fair value of an award that relates to both (a) an employee's rendering service for a specified (either explicitly or implicitly) period of time and (b) achieving a specified performance target that is defined solely by reference to the employer's own operations (or activities). Attaining a specified growth rate in return on assets, obtaining regulatory approval to market a specified product, selling shares in an initial public offering or other financing event, and a change in control are examples of performance conditions for purposes of this Statement. A performance target also may be defined by reference to the same performance measure of another entity or group of entities. For example, attaining a growth rate in earnings per share that exceeds the average growth rate in earnings per share of other entities in the same industry is a performance condition for purposes of this Statement. A performance target might pertain either to the performance of the enterprise as a whole or to some part of the enterprise, such as a division or an individual employee.

Public entity. An entity (a) with equity securities that trade in a public market, which may be either a stock exchange (domestic or foreign) or an over-the-counter market, including securities quoted only locally or regionally, (b) that makes a filing with a regulatory agency in preparation for the sale of any class of equity securities in a public market, or (c) that is controlled by an entity covered by (a) or (b). That is, a subsidiary of a public entity is itself a public entity. An entity that has only debt securities trading in a public market (or that has made a filing with a regulatory agency in preparation to trade only debt securities) is not a public entity for purposes of this Statement.

Related party. An affiliate of the reporting entity; another entity for which the reporting entity's investment is accounted for by the equity method; trusts for the benefit of employees, such as pension and profit-sharing trusts that are managed by or under the trusteeship of management; principal owners and management of the entity; members of the immediate families of principal owners of the entity and its management; and other parties with which the entity may deal if one party controls or can significantly influence the management or operating policies of the other to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests. Another party also is a related party if it can significantly influence the management or operating policies of the transacting parties or if it has an ownership interest in one of the transacting parties and can significantly influence the other to an extent that one or more of the transacting parties might be prevented from fully pursuing its own separate interests. This definition is the same as the definition of related parties in paragraph 24 of FASB Statement No. 57, Related Party Disclosures.

Reload feature and reload option. A reload feature provides for automatic grants of additional options whenever an employee exercises previously granted options using the entity's shares, rather than cash, to satisfy the exercise price. At the time of exercise using shares, the employee is automatically granted a new option, called a reload option, for the shares used to exercise the previous option.

Replacement award. An award of share-based compensation that is granted (or offered to grant) concurrently with the cancellation of another award.

Requisite service period (and requisite service). The period or periods during which an employee is required to provide service in exchange for an award under a share-based payment arrangement. The service that an employee is required to render during that period is referred to as the requisite service. The requisite service period for an award that has only a service condition is presumed to be the vesting period, unless there is clear evidence to the contrary. If an award requires future service for vesting, the entity cannot define a prior period as the requisite service period. Requisite service periods may he explicit, implicit, or derived, depending on the terries of the share-based payment award.

Restricted share. A share for which sale is contractually or governmentally prohibited for a specified period of time. Most grants of shares to employees are better termed nonvested shares because the limitation on sale stems solely from the forfeitability of the shares before employees have satisfied the necessary service or performance condition(s) to earn the rights to the shares. Restricted shares issued for consideration other than employee services, on the other hand, are fully paid for immediately. For those shares, there is no period analogous to a requisite service period during which the issuer is unilaterally obligated to issue shares when the purchaser pays for those shares, but the purchaser is not obligated to buy the shares. This Statement uses the term restricted shares to refer only to fully vested and outstanding shares whose sale is contractually or governmentally prohibited for a specified period of time. (173) (Refer to the definition of nonvested shares.)

Restriction. A contractual or governmental provision that prohibits sale (or substantive sale by using derivatives or other means to effectively terminate the risk of future changes in the share price) of an equity instrument for a specified period of time.

Service condition. A condition affecting the vesting, exercisability, exercise price, or other pertinent factors used in determining the fair value of an award that depends solely on an employee rendering service to the employer for the requisite service period. A condition that results in the acceleration of vesting in the event of an employee's death, disability, or termination without cause is a service condition.

Service inception date. The date at which the requisite service period begins. The service reception date usually is the grant date, but the service inception date may differ from the grant date (refer to Illustration 3, paragraphs A79-A85).

Settle, settled, or settlement of an award. An action or event that irrevocably extinguishes the issuing entity's obligation under a share-based payment award. Transactions and events that constitute settlements include (a) exercise of a share option or lapse of an option at the end of its contractual term, (b) vesting of shares, (c) forfeiture of shares or share options due to failure to satisfy a vesting condition, and (d) an entity's repurchase of instruments in exchange for assets or for fully vested and transferable equity instruments. The vesting of a share option is not a settlement as that term is used in this Statement because the entity remains obligated to issue shares upon exercise of the option.

Share option. A contract that gives the holder the right, but not the obligation, either to purchase (to call) or to sell (to put) a certain number of shares at a predetermined price for a specified period of time. Most share options granted to employees under share-based compensation arrangements are call options, but some may be put options.

Share unit. A contract under which the holder has the right to convert each unit into a specified number of shares of the issuing entity.

Share-based payment (or compensation) arrangement. An arrangement under which (a) one or more suppliers of goods or services (including employees) receive awards of equity shares, equity share options, or other equity instruments or (b) the entity incurs liabilities to suppliers (1) in amounts based, at least in part (174), on the price of the entity's shares or other equity instruments or (2) that require or may require settlement by issuance of the entity's shares. For purposes of this Statement, the term shares" includes various forms of ownership interest that may not take the legal form of securities (for example, partnership interests), as well as other interests, including those that are liabilities in substance but not in form. Equity shares refers only to shares that are accounted for as equity.

Share-based payment (or compensation) transaction. A transaction under a share-based payment arrangement, including a transaction in which an entity acquires goods or services because related parties or other holders of economic interests in that entity awards a share-based payment to an employee or other supplier of goods or services for the entity's benefit.

Short-term inducement. An offer by the entity that would result in modification or settlement of an award to which an award holder may subscribe for a limited period of time. Small business issuer. A public entity that is an SEC registrant that files as a small business issuer under the Securities Act of 1933 or the Securities Exchange Act of 1934. At the date this Statement was issued, a small business issuer was defined as an entity that meets all of the following criteria:

a. It has revenues of less than $25 million.

b. It is a U.S. or Canadian issuer.

c. It is not an investment company.

d. If the entity is a majority-owned subsidiary, the parent company also is a small business issuer.

However, regardless of whether it satisfies those criteria, an entity is not a small business issuer if the aggregate market value of its outstanding securities held by nonaffiliates is $25 million or more.

The definition of a small business issuer is a matter of U.S. federal securities law and is subject to change. The effective date provisions of this Statement for a small business issuer apply only to an entity that files as a small business issuer under the related definition at that date.

Tandem award. An award with two (or more) components in which exercise of one part cancels the other(s).

Terms of a share-based payment award. The contractual provisions that determine the nature and scope of a share-based payment award. For example, the exercise price of share options is one of the terms of an award of share options. As indicated in paragraph 34 of this Statement, the written terms of a share-based payment award and its related arrangement, if any, usually provide the best evidence of its terms. However, an entity's past practice or other factors may indicate that some aspects of the substantive terms differ from the written terms. The substantive terms of a share-based payment award as those terms are mutually understood by the entity and a party (either an employee or a nonemployee) who receives the award provide the basis for determining the rights conveyed to a party and the obligations imposed on the issuer, regardless of how the award and related arrangement, if any, are structured. Also refer to paragraph 6 of this Statement.

Time value of an option. The portion of the fair value of an option that exceeds its intrinsic value. For example, a call option with an exercise price of $20 on a stock whose current market price is $25 has intrinsic value of $5. If the fair value of that option is $7, the time value of the option is $2 ($7-$5).

Vest, Vesting, or Vested. To earn the rights to. A share-based payment award becomes vested at the date that the employee's right to receive or retain shares, other instruments, or cash under the award is no longer contingent on satisfaction of either a service condition or a performance condition. Market conditions are not vesting conditions for purposes of this Statement.

For convenience and because the terms are commonly used in practice, this Statement refers to vested or nonvested options, shares, awards, and the like, as well as vesting, date. The stated vesting provisions of an award often establish the requisite service period, and an award that has reached the end of the requisite service period is vested. However, as indicated in the definition of requisite service period, the stated vesting period may differ from the requisite service period in certain circumstances. Thus, the more precise (but cumbersome) terms would be options, shares, or awards for which the requisite service has been rendered and end of the requisite service period.

Volatility. A measure of the amount by which a financial variable such as a share price has fluctuated (historical volatility) or is expected to fluctuate (expected volatility) during a period. Volatility also may be defined as a probability-weighted measure of the dispersion of returns about the mean. The volatility of a share price is the standard deviation of the continuously compounded rates of return on the share over a specified period. That is the same as the standard deviation of the differences in the natural logarithms of the stock prices plus dividends, if any, over the period. The higher the volatility, the more the returns on the shares can be expected to vary--up or down. Volatility is typically expressed in annualized terms.

Ethics Interpretation

Ethics interpretations and rulings are promulgated by the executive committee of the professional ethics division to provide guidelines as to the scope and application of the rules but are not intended to limit such scope or application. Publication of an interpretation or ethics ruling in the Journal of Accountancy constitutes notice to members. A member who departs from interpretations or rulings shall have the burden of justifying such departure in any disciplinary hearing.

(The Professional Ethics Executive Committee has revised Ethics Interpretation 101-3, under Rule 101 [AICPA, Professional Standards, vol. 2, ET section 101.05] to clarify the applicability and intent of the interpretation and ensure its continued effectiveness in promoting independence when a member renders nonattest services to an attest client. Added text is in boldface italics; deleted text is struck through).

.05 101-3--Performance of nonattest services. Before a member or his or her firm ("member") performs nonattest services (for example, tax or consulting services) for an attest client, (4) the member should determine that the requirements described in this interpretation have been met. In cases where the requirements have not been met during the period of the professional engagement or the period covered by the financial statements, the member's independence would be impaired.

Engagements Subject to Independence Rules of Certain Regulatory Bodies

This interpretation requires compliance with independence regulations of authoritative regulatory bodies (such as the Securities and Exchange Commission [SEC], the General Accounting Office [GAO], the Department of Labor [DOL], and state boards of accountancy) where a member performs nonattest services for an attest client and is required to be independent of the client under the regulations of the applicable regulatory body. Accordingly, failure to comply with the nonattest services provisions contained in the independence rules of the applicable regulatory body that are more restrictive than the provisions of this interpretation would constitute a violation of this interpretation.

General Requirements for Performing Nonattest Services

1. The member should not perform management functions or make management decisions for the attest client. However, the member may provide advice, research materials, and recommendations to assist the client's management in performing its functions and making decisions.

2. The client must agree to perform the following functions in connection with the engagement to perform nonattest services:

a. Make all management decisions and perform all management functions;

b. Designate an <begin strikethrough>competent employee<end strikethrough> individual who possesses suitable skill, knowledge, and/or experience, preferably within senior management, to oversee the services;

c. Evaluate the adequacy and results of the services performed;

d. Accept responsibility for the results of the services; and

e. Establish and maintain internal controls, including monitoring ongoing activities.

The member should be satisfied that the client will be able to meet all of these criteria and make an informed judgment on the results of the member's nonattest services. In assessing whether the <begin strikethrough>competency of the client's<end strikethrough> designated individual <begin strikethrough>employee<end strikethrough> possesses suitable skill, knowledge, and/or experience, the member should be satisfied that such individual understands the services to be performed sufficiently to oversee them. However, the individual is not required to possess the expertise to perform or re-perform the services.

In cases where the client is unable or unwilling to assume these responsibilities (for example, the client does not have an individual with <begin strikethrough>the<end strikethrough> suitable skill, knowledge, and/or experience <begin strikethrough>necessary competence<end strikethrough> to oversee the nonattest services provided, or is unwilling to perform such functions due to lack of time or desire), the member's provision of these services would impair independence.

3. Before performing nonattest services, the member should establish and document in writing (5) his or her understanding with the client (board of directors, audit committee, or management, as appropriate in the circumstances) regarding the following:

a. Objectives of the engagement

b. Services to be performed

c. Client's acceptance of its responsibilities

d. Member's responsibilities

e. Any limitations of the engagement

The documentation requirement does not apply to:

<begin strikethrough>a. Certain routine activities performed by the member such as providing advice and responding to the client's technical questions as part of the normal client member relationship.<end strikethrough>

<begin strikethrough>b.<end strikethrough>a. Nonattest services performed prior to January 1, 2005.

<begin strikethrough>c.<end strikethrough>b. Nonattest services performed prior to the client becoming an attest client. (6)

General requirements 2 and 3 above do not apply to certain routine activities performed by the member such as providing advice and responding to the client's questions as part of the normal client-member relationship.

General Activities

The following are some general activities that would <begin strikethrough>be considered to<end strikethrough> impair a member's independence:

* Authorizing, executing or consummating a transaction, or otherwise exercising authority on behalf of a client or having the authority to do so

* Preparing source documents (7) in electronic or other form, evidencing the occurrence of a transaction

* Having custody of client assets

* Supervising client employees in the performance of their normal recurring activities

* Determining which recommendations of the member should be implemented

* Reporting to the board of directors on behalf of management

* Serving as a client's stock transfer or escrow agent, registrar, general counsel or its equivalent

Specific Examples of Nonattest Services

The examples in [the table on pages 109-110] identify the effect that performance of certain nonattest services for an attest client can have on a member's independence. These examples presume that the general requirements in the previous section "General Requirements for Performing Nonattest Services" have been met and are not intended to be all-inclusive of the types of nonattest services performed by members.

Appraisal, Valuation, and Actuarial Services Independence would be impaired if a member performs an appraisal, valuation, or actuarial service for an attest client where the results of the service, individually or in the aggregate, would be material to the financial statements and the appraisal, valuation, or actuarial service involves a significant degree of subjectivity.

Valuations performed in connection with, for example, employee stock ownership plans, business combinations, or appraisals of assets or liabilities generally involve a significant degree of subjectivity. Accordingly, if these services produce results that are material to the financial statements, independence would be impaired.

An actuarial valuation of a client's pension or postemployment benefit liabilities generally produces reasonably consistent results because the valuation does not require a significant degree of subjectivity. Therefore, such services would not impair independence. In addition, appraisal, valuation, and actuarial services performed for nonfinancial statement purposes would not impair independence. (10) However, in performing such services, all other requirements of this interpretation should be met, including that all significant assumptions and matters of judgment are determined or approved by the client and the client is in a position to have an informed judgment on, and accepts responsibility for, the results of the service.

Internal Audit Assistance Services

Internal audit services involve assisting the client in the performance of its internal audit activities, sometimes referred to as "internal audit outsourcing." In evaluating whether independence would be impaired with respect to an attest client, the nature of the service needs to be considered.

Assisting the client in performing financial and operational (11) internal audit activities would impair independence unless the member takes appropriate steps to ensure that the client understands its responsibility for establishing and maintaining the internal control system (12) and directing the internal audit function, including the management thereof. Accordingly, any outsourcing of the internal audit function to the member whereby the member in effect manages the internal audit activities of the client would impair independence.

In addition to the general requirements of this interpretation, the member should ensure that client management:

* Designates an <begin strikethrough>competent (13)<end strikethrough> individual or individuals, who possess suitable skill, knowledge, and/or experience, preferably within senior management, to be responsible for the internal audit function;

* Determines the scope, risk, and frequency of internal audit activities, including those to be performed by the member providing internal audit assistance services;

* Evaluates the findings and results arising from the internal audit activities, including those performed by the member providing internal audit assistance services; and

* Evaluates the adequacy of the audit procedures performed and the findings resulting from the performance of those procedures by, among other things, obtaining reports from the member.

The member should also be satisfied that the client's board of directors, audit committee, or other governing body is informed about the member's and management's respective roles and responsibilities in connection with the engagement. Such information should provide the client's governing body a basis for developing guidelines for management and the member to follow in carrying out these responsibilities and monitoring how well the respective responsibilities have been met.

The member is responsible for performing the internal audit procedures in accordance with the terms of the engagement and reporting thereon. The performance of such procedures should be directed, reviewed, and supervised by the member. The report should include information that allows the individual responsible for the internal audit function to evaluate the adequacy of the audit procedures performed and the findings resulting from the performance of those procedures.

This report may include recommendations for improvements in systems, processes, and procedures. The member may assist the individual responsible for the internal audit function in performing preliminary audit risk assessments, preparing audit plans, and recommending audit priorities. However, the member should not undertake any responsibilities that are required, as described above, to be performed by the individual responsible for the internal audit function.

The following are examples of activities (in addition to those listed in the "General Activities" section of this interpretation) that, if performed as part of an internal audit assistance engagement, would impair independence:

* Performing ongoing monitoring activities or control activities (for example, reviewing loan originations as part of the client's approval process or reviewing customer credit information as part of the customer's sales authorization process) that affect the execution of transactions or ensure that transactions are properly executed, accounted for, or both, and performing routine activities in connection with the client's operating or production processes that are equivalent to those of an ongoing compliance or quality control function

* Determining which, if any, recommendations for improving the internal control system should be implemented

* Reporting to the board of directors or audit committee on behalf of management or the individual responsible for the internal audit function

* Approving or being responsible for the overall internal audit work plan including the determination of the internal audit risk and scope, project priorities, and frequency of performance of audit procedures

* Being connected with the client as an employee or in any capacity equivalent to a member of client management (for example, being listed as an employee in client directories or other client publications, permitting himself or herself to be referred to by title or description as supervising or being in charge of the client's internal audit function, or using the client's letterhead or internal correspondence forms in communications)

The foregoing list is not intended to be all-inclusive.

Services involving an extension of the procedures that are generally of the type considered to be extensions of the member's audit scope applied in the audit of the client's financial statements, such as confirming of accounts receivable and analyzing fluctuations in account balances, are not considered internal audit assistance services and would not impair independence even if the extent of such testing exceeds that required by generally accepted auditing standards. In addition, engagements performed under the attestation standards would not be considered internal audit assistance services and therefore would not impair independence.

Transition

Independence would not be impaired as a result of the more restrictive requirements of interpretation 101-3, provided the provision of any such nonattest services are pursuant to arrangements in existence on December 31, 2003, and are completed by December 31, 2004, and the member was in compliance with the pre-existing requirements of this interpretation.

Impact on Independence of Performance of Nonattest Services

Type of
Nonattest
Service        Independence Would Not Be Impaired

Bookkeeping    * Record transactions for which management
               has determined or approved the appropriate
               account classification, or post coded transactions
               to a client's general ledger.
               * Prepare financial statements based on
               information in the trial balance.
               * Post client-approved entries to a client's trial
               balance.
               * Propose standard, adjusting, or correcting
               journal entries or other changes affecting the
               financial statements to the client provided the
               client reviews the entries and the member is satisfied
               that management understands the nature of the
               proposed entries and the impact the entries have
               on the financial statements.

Payroll        * Using payroll time records provided and approved
and other      by the client, generate unsigned checks, or process
disbursement   client's payroll.
               * Transmit client-approved payroll or other
               disbursement information to a financial institution
               provided the client has authorized the member to
               make the transmission and has made arrangements
               for the financial institution to limit the corresponding
               individual payments as to amount and payee. In
               addition, once transmitted, the client must authorize
               the financial institution to process the information.
               * Make electronic payroll tax payments in
               accordance with U.S. Treasury Department or
               comparable guidelines provided the client has
               made arrangements for its financial institution
               to limit such payments to a named payee. (8)

Benefit plan   * Communicate summary plan data to plan
adminis-       trustee.
tration (9)    * Advise client management regarding the
               application or impact of provisions of the plan
               document.
               * Process transactions (e.g., investment/benefit
               elections or increase/decrease contributions to
               the plan; data entry; participant confirmations; and
               processing of distributions and loans) initiated by
               plan participants through the member's electronic
               medium, such as an interactive voice response
               system or Internet connection or other media.
               * Prepare account valuations for plan participants
               using data collected through the member's
               electronic or other media.
               * Prepare and transmit participant statements to
               plan participants based on data collected through
               the member's electronic or other medium.

Investment--   * Recommend the allocation of funds that a client
advisory or    should invest in various asset classes, depending upon
management     the client's desired rate of return, risk tolerance,
               etc.
               * Perform recordkeeping and reporting of client's
               portfolio balances including providing a comparative
               analysis of the client's investments to third-party
               benchmarks.
               * Review the manner in which a client's portfolio
               is being managed by investment account managers,
               including determining whether the managers are (1)
               following the guidelines of the client's investment
               policy statement; (2) meeting the client's investment
               objectives; and (3) conforming to the client's stated
               investment styles.
               * Transmit a client's investment selection to a
               broker-dealer or equivalent provided the client
               has authorized the broker-dealer or equivalent to
               execute the transaction.

Corporate      * Assist in developing corporate strategies.
finance--      * Assist in identifying or introducing the client to
consulting     possible sources of capital that meet the client's
or advisory    specifications or criteria.
               * Assist in analyzing the effects of proposed
               transactions including providing advice to a client
               during negotiations with potential buyers, sellers,
               or capital sources.
               * Assist in drafting an offering document or
               memorandum.
               * Participate in transaction negotiations in an
               advisory capacity.
               * Be named as a financial adviser in a client's private
               placement memoranda or offering documents.

Executive      * Recommend a position description or candidate
or employee    specifications.
search         * Solicit and perform screening of candidates and
               recommend qualified candidates to a client based on
               the client-approved criteria (e.g., required skills and
               experience).
               * Participate in employee hiring or compensation
               discussions in an advisory capacity.

Business       * Provide assistance in assessing the client's business
Risk           risks and control processes.
consulting     * Recommend a plan for making improvements
               to a client's control processes and assist in
               implementing these improvements.

Information    * Install or integrate a client's financial information
systems--      system, that was not designed or developed by the
design,        member (e.g., an off-the-shelf accounting package).
installation   * Assist in setting up the client's chart of accounts
or             and financial statement format with respect to the
integration    client's financial information system.
               * Design, develop, install, or integrate a client's
               information system that is unrelated to the client's
               financial statements or accounting records.
               * Provide training and instruction to client
               employees on an information and control system.

Type of
Nonattest
Service        Independence Would Be Impaired

Bookkeeping    * Determine or change journal entries,
               account codings or classification for
               transactions, or other accounting records
               without obtaining client approval.
               * Authorize or approve transactions.
               * Prepare source documents.
               * Make changes to source documents
               without client approval.

Payroll        * Accept responsibility to authorize payment
and other      of client funds, electronically or otherwise,
disbursement   except as specifically provided for with
               respect to electronic payroll tax payments.
               * Accept responsibility to sign or cosign
               client checks, even if only in emergency
               situations.
               * Maintain a client's bank account or
               otherwise have custody of a client's funds
               or make credit or banking decisions for the
               client.
               * Sign payroll tax return on behalf of
               client management.
               * Approve vendor invoices for payment

Benefit plan   * Make policy decisions on behalf of
adminis-       client management.
tration (9)    * When dealing with plan participants,
               interpret the plan document on behalf
               of management without first obtaining
               management's concurrence.
               * Make disbursements on behalf of the plan.
               * Have custody of assets of a plan.
               * Serve a plan as a fiduciary as defined by
               ERISA.

Investment-    * Make investment decisions on behalf
advisory or    of client management or otherwise have
management     discretionary authority over a client's
               investments.
               * Execute a transaction to buy or sell a
               client's investment.
               * Have custody of client assets, such as
               taking temporary possession of securities
               purchased by a client.

Corporate      * Commit the client to the terms of a
finance--      transaction or consummate a transaction
consulting     on behalf of the client.
or advisory    * Act as a promoter, underwriter,
               broker-dealer, or guarantor of client
               securities, or distributor of private
               placement memoranda or offering
               documents.
               * Maintain custody of client securities.

Executive      * Commit the client to employee
or employee    compensation or benefit arrangements.
search         * Hire or terminate client employees.

Business       * Make or approve business risk decisions.
Risk           * Present business risk considerations to the
consulting     board or others on behalf of management.

Information    * Design or develop a client's financial
systems--      information system.
design,        * Make other than insignificant
installation   modifications to source code underlying
or             a client's existing financial information
integration    system.
               * Supervise client personnel in the daily
               operation of a client's information system.
               * Operate a client's local area network
               (LAN) system.

(1) Terms defined in Appendix E, the glossary, are set in boldface type the first tune they appear.

(2) AICPA Statement of Position 93-6, Employers' Accounting for Employee Stock Ownership Plans, specifies the accounting by employers for employee share ownership plans.

(3) The phrase at least in part is used because an award of share-based compensation may be indexed to both the price of an entity's shares and something else that is neither the price of the entity's shares nor a market, performance, or service condition.

(4) An entity may need to recognize an asset before it actually receives goods or services if it first exchanges share based payment for an enforceable right to receive those goods or services. Nevertheless, the goods or services themselves are not recognized before they are received.

(5) This Statement refers to recognizing compensation cost rather than compensation expense because any compensation cost that is capitalized as part of the cost to acquire or construct an asset would not be recognized as compensation expense in the income statement.

(6) The consideration received for issuing equity instruments, like the consideration involved in a repurchase of treasury shares, may include stated or unstated rights. FASB Technical Bulletin No. 85-6, Accounting for a Purchase of Treasury Shares at a Price Significantly in Excess of the Current Market Price of the Shares and the Income Statement Classification of Costs Incurred in Defending against a Takeover Attempt, provides pertinent guidance.

(7) This Statement uses the term award as the collective noun for multiple instruments with the same terms and conditions granted at the same time either to a single employee or to a group of employees. An award may specify multiple vesting dates, referred to as graded vesting, and different parts of an award may have different expected terms. Provisions of this Statement that refer to an award also apply to a portion of an award.

(8) A transaction subject to an employee share purchase plan that involves a class of equity shares designed exclusively for and held only by current or former employees or their beneficiaries may be compensatory depending on the terms of the arrangement.

(9) An entity that justifies a purchase discount in excess of 5 percent shall reassess at least annually, and no later than the first share purchase offer during the fiscal year, whether it can continue to justify that discount pursuant to paragraph 12(a)(2) of this Statement.

(10) Valuation techniques have been developed to value path-dependent options as well as other options with complex terms. Awards with market conditions, as defined in this Statement, are path-dependent options.

(11) Nonvested shares granted to employees usually are referred to as restricted shares, but this Statement reserves that term for fully vested and outstanding shares whose sale is contractually or governmentally prohibited for a specified period of time.

(12) As of the issuance of this Statement, such market prices for equity share options and similar instruments granted to employees are generally not available; however, they may become so in the future.

(13) Throughout the remainder of this Statement, provisions that apply to accounting for share options and similar instruments at fair value also apply to calculated value.

(14) Refer to the definition of share option in Appendix E.

(15) A put right may be granted to the employee in a transaction that is related to a share-based compensation arrangement. If exercise of such a put right would require the entity to repurchase shares issued under the share-based compensation arrangement, the shares shall be accounted for as puttable shares.

(16) A repurchase feature that can be exercised only upon the occurrence of a contingent event that is outside the employee's control (such as an initial public offering) would not meet condition (a) until it becomes probable that the event will occur within the reasonable period of time.

(17) An employee begins to bear the risks and rewards normally associated with equity share ownership when all the requisite service has been rendered.

(18) SEC registrants are required to consider the guidance in ASR No. 268, Presentation in Financial Statements of "Redeemable Deferred Stocks." Under that guidance, shares subject to mandatory redemption requirements or whose redemption is outside the control of the issuer are classified outside permanent equity.

(19) For this purpose, an award of equity share options granted to an employee of an entity's foreign operation that provides for a fixed exercise price denominated either in the foreign operation's functional currency or in the currency in which the employee's pay is denominated shall not be considered to contain a condition that is not a market, performance, or service condition. Therefore, such an award is not required to be classified as a liability if it other wise qualifies as equity. For example, equity share options with an exercise price denominated in Euros granted to employees of a U.S. entity's foreign operation whose functional currency is the Euro are not required to be classified as liabilities if those options otherwise qualify as equity. In addition, such options are not required to he classified as liabilities even if the functional currency of the foreign operation is the U.S. dollar, provided that the employees to whom the options are granted are paid in Euros.

(20) Federal securities law generally requires that transactions involving offerings of shares under employee share option arrangements be registered, unless there is an available exemption. For purposes of this Statement, such requirements do not, by themselves, imply that an entity does not have the ability to deliver shares and thus do not require an award that otherwise qualifies as equity to be classified as a liability.

(21) A broker that is a related party of the entity must sell the shares in the open market within a normal settlement period, which generally is three days, for the award to qualify as equity.

(22) Minimum statutory withholding requirements are to be based on the applicable minimum statutory withholding rates required by the relevant tax authority (or authorities, for example, federal, state, and local), including the employee's share of payroll taxes that are applicable to such supplemental taxable income.

(23) Consistent with the guidance in paragraph 23, foot note 13, a nonpublic entity that is not able to reasonably estimate the fair value of its equity share options and similar instruments because it is not practicable for it to estimate the expected volatility of its share price shall make a policy choice of whether to measure its liabilities under share-based payment arrangements at calculated value or at intrinsic value.

(24) An award with a graded vesting schedule that is accounted for as in-substance multiple awards is an example of an award that has more than one requisite service period (paragraph 42).

(25) Probable is used in the same sense as in FASB Statement No. 5, Accounting for Contingencies: "the future event or events are likely to occur" (paragraph 3).

(26) A modification of a liability award also is accounted for as the exchange of the original award for a new award. However, because liability awards are remeasured at their fair value (or intrinsic value for a nonpublic entity that elects that method) at each reporting date, no special guidance is necessary in accounting for a modification of a liability, award that remains a liability, after the modification.

(27) As indicated in paragraph 23. footnote 13, references to fair value throughout paragraphs 24-85 of this Statement should be read also to encompass calculated value.

(28) The phrase offer to grant is intended to cover situations in which the service inception date precedes the grant date.

(29) Compensation cost that is capitalized as part of the cost of an asset, such as inventory, shall be considered to be part of the tax basis of that asset for financial reporting purposes.

(30) Paragraph 21 of Statement 109 states, "Future realization of the tax benefit of an existing deductible temporary difference or carry forward ultimately depends on the existence of sufficient taxable income of the appropriate character (for example, ordinary income or capital gain) within the carryback, carryforward period available under the tax law." That paragraph goes on to describe the four sources of taxable income that may be available under the tax law to realize a tax benefit for deductible temporary differences and carry forwards.

(31) If only a portion of an award is exercised, determination of the excess tax benefits shall be based on the portion of the award that is exercised.

(32) If an entity early adopts this Statement pursuant to paragraph 73, then the required effective date would be the first date in the initial period of adoption.

(33) The prohibition in paragraphs 74 and 76 of changes to the grant date fair value of equity awards granted before the required effective date of this Statement does not apply if the entity/needs to correct an error.

(34) A nonpublic entity shall apply this method to all prior years for which Statement 123's fair-value-based method was adopted for recognition or pro forma disclosures if that date is later than when Statement 123 was first effective.

(35) For convenience, the remaining discussion in this Statement refers only to Statement 123. Those references should be understood as referring to Statement 123, as amended Statement 148.

(36) This provision applies to all awards regardless of whether they were accounted for as fixed or variable under Opinion 25.

(37) If share-based compensation cost has been previously capitalized as part of another asset, an entity should consider whether the carrying amount of that asset should be adjusted to reflect amounts calculated pursuant to paragraphs 79(a) and 79(b).

(38) The effect of the change for the period in which this Statement is adopted will differ depending on whether a public entity, had previously adopted the fair-value-based method (or a nonpublic entity bad adopted the minimum value method) of Statement 123 or had continued to use the intrinsic value method in Opinion 25.

(39) For paragraphs 84(c)-84(e), all awards refers to awards granted, modified, or settled in cash in fiscal periods be ginning after December 15, 1994.

(170) Compensation cost would not be recognized beyond three years even if after the grant date the entity determines that it is not probable that the market condition will be satisfied within that period.

(171) A reporting entity based in a foreign jurisdiction would determine whether an employee-employer relationship exists based on the pertinent laws of that jurisdiction.

(172) The term similar as used in this definition refers to an equity security of another entity' that has the same type of residual rights. For example, common stock of one entity generally would be similar to the common stock of another entity for this purpose.

(173) Vested equity instruments that are transferable to an employee's immediate family members or to a trust benefits only those family members are restricted if the transferred instruments retain the same prohibition on sale to third parties.

(174) The phrase at least in part is used because an award may be indexed to both the price of the entity's shares and something other than either the price of the entity's shares or a market, performance, or service condition.

(4) A member who performs a compilation engagement for a client should modify the compilation report to indicate a lack of independence if the member does not meet all of the conditions set out in this interpretation when providing a nonanest service to that client (see Statement on Standard) for Accounting and Review Services No. 1, Compilation and Review of Financial Statements [AR section 100.19]).

(5) A<begin strikethrough>n isolated and inadvetent<end strikethrough> failure to prepare the required documentation would not impair independence, but would be considered a violation of Rule 202--Compliance with Standards, provided that the member did establish the understanding with the client.<begin strikethrough>,the member documents the understanding promptly upons discovery of the failure to do so, and all other provisions of the interpretation are met.<end strikethrough>

(6) However, upon the acceptance of an attest engagement, the member should prepare written documentation demonstrating his or her compliance with the other general requirements during the period covered by the financial statements, including the requirement to establish an understanding with the client.

(7) Source documents are the documents upon which evidence of an accounting transaction are initially recorded. Source documents are often followed by the creation of many additional records and reports, which do not, however, qualify as initial recordings. Examples of source documents are purchase orders, payroll time cards, and customer orders.

(8) Although thus type of transaction may be considered by some to be similar to signing checks or disbursing funds, the Professional Ethics Executive Committee concluded that making electronic payroll tax payments under the specified criteria would not impair a member's independence.

(9) When auditing plans subject to the Employee Retirement Income Security Act (ERISA), Department of Labor (DOL) regulations, which may be more restrictive, must be followed.

(10) Examples of such services may include appraisal, valuation, and actuarial services performed for tax planning or tax compliance, estate and gift taxation, and divorce proceedings.

(11) For example, a member may assess whether performance is in compliance with management's policies and procedures, to identify opportunities for improvement, and to develop recommendations for improvement or further action for management consideration and decision making.

(12) As part of its responsibility to establish and maintain internal control, management monitors internal control to assess the quality of its performance over time. Monitoring can be accomplished through ongoing activities, separate evaluations, or a combination of both. Ongoing monitoring activities are the procedures designed to assess the quality of internal control performance over time and built into the normal recurring activities of an entity; they include regular management and supervisory activities, comparisons, reconciliations, and other routine actions. Separate evaluations focus on the continued effectiveness of a client's internal control. A member's independence would not be impaired by the performance of separate evaluations of the effectiveness of a client's internal control, including separate evaluations of the client's ongoing monitoring activities.

<begin strikethrough>(13) A competent individual would have an understanding of internal audit activities sufficient to oversee the services performed by the member. [Footnote added, effective December 31, 2003, by the Professional Ethics Executive Committee.<end strikethrough>

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