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Accounting for stock-based compensation.

Due to perceived deficiencies in Accounting Principles Board (APB) Opinion No. 25 (Accounting for Stock Issued to Employees), the AICPA, Accounting Standards Executive Committee, the SEC and various accounting firms asked the Board to reconsider the accounting specified in Opinion No. 25. In response, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 123 (Accounting for Stock-Based Compensation).

The purpose of SFAS No. 123 is to establish additional financial accounting and reporting standards to correct the deficiencies of APB Opinion No. 25. The effective date of SFAS No. 123 is for all transactions entered into beginning with fiscal years starting after December 15, 1995.

All stock compensation arrangements will be required to be accounted for according to SFAS No. 123, except for transactions with employees that are within the scope of APB Opinion No. 25. SFAS No. 123 establishes the fair value-based method of accounting as the measurement basis for the following:

* all agreements/plans that employees receive shares of stock or other equity instruments of the employer;

* employer incurs liabilities to employees based on the price of the employer's stock;

* transactions in which the entity issues its equity instruments to acquire goods or services from non-employees.

Fair value, defined by FASB, is the amount at which an asset could be bought or sold in a current transaction between willing parties - that is, other than in a forced or liquidation sale. Quoted market prices in active markets are the best evidence of fair value and are to be used as the basis for measurement, if available.

Under the fair value-based method, stock compensation costs are measured at the grant date based on the expected fair value of the award that the employees become entitled to when they have rendered the requisite service. The compensation costs are recorded over the required service period, usually the vesting period.

SFAS No. 123 doesn't require that all entities adopt this method of accounting for all stock compensation plans. Entities that have been using the intrinsic value method (APB Opinion No. 25) may still use this method but are required to make pro forma disclosures of net income and earning per share, as if SFAS No. 123 had been adopted.

APB Opinion No. 25 prescribes using the intrinsic value-based method of accounting to measure stock-based compensation cost. Intrinsic value, defined by FASB, is the amount by which the market price of the underlying stock exceeds the exercise price of an option. Under the intrinsic value-based method, compensation cost is the excess of the quoted market price, at the grant date or another stated measurement date, over the price the employees must pay to acquire the stock. Due to the market price of the stock at the grant date being less than or equal to the stock option price generally, this would result in stock-based compensation costs being recorded at zero. One of the main reasons FASB prefers the fair value method over the intrinsic value method is because the intrinsic value method usually doesn't record or account for the stock compensation cost.

In summary, SFAS No. 123 encourages all entities to adopt the fair value method for calculating stock-based compensation cost. Adopting this method does justify as a change in an accounting principle, under APB Opinion No. 20 (Accounting Changes). All transactions entered into after fiscal years beginning on December 16, 1995, or later must account for stock-based compensation cost using the fair value method. The only exception would be for those entities that qualify to have stock-based compensation plans accounted for under APB Opinion No. 25, but these entities must make the pro forma disclosures per SFAS No. 123.

Accountants with clientele that have stock-based compensation plans should order a copy of SFAS No. 123 by writing:

Order Department Financial Accounting Standards Board 401 Merritt 7 P.O. Box 5116 Norwalk, Connecticut 06856-5116
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Author:Reynolds, Brian M.
Publication:The National Public Accountant
Date:Jan 1, 1996
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