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Observations on Employee Ownership

FASB Issues Final Accounting Rules

Corey Rosen

February 2005

(Corey Rosen)The Financial Accounting Standards Board (FASB) has ended the suspense about expensing by issuing its final revision to FAS 123. Statement of Financial Accounting Standards No. 123 (Revised 2004), or FAS 123(R), was released December 16, 2004. Unlike its predecessor, FAS 123(R) will be mandatory. In the eight and a half months between FASB's release of its exposure draft and mid-December, the accounting board made several announcements about revisions it planned to make to the exposure draft's proposals, leaving few surprises for FAS 123(R).

Beginning in 2005, companies will have to show the fair value of their stock option awards on their income statements. That value will be determined using an option-pricing model. In the past, under FAS 123, companies have shown the Black-Scholes value of their stock options in the footnotes to their income statements, but not reflected them as a line item. Most other kinds of equity compensation already show up as an expense on companies' income statements.

FAS 123(R) allows companies to choose among lattice models, the Black- Scholes model, and Monte Carlo simulation models to put a dollar value on their unvested equity awards. Unlike the exposure draft, which expressed a preference for a binomial lattice model, the final statement does not express a preference. Acceptable models must, at a minimum, take into account: the exercise price of the option; the expected term of the option; the current price of the underlying shares; the expected volatility of the price of the underlying shares for the expected term of the option; the expected dividends on the underlying shares; and the risk-free interest rate. The new standard goes into effect for reporting periods that start after June 15 for public companies, with the exception of small business with revenue of less than $25 million, which have until December 15. Nonpublic companies must begin using the standard in fiscal years that begin after December 15, but unlike public companies do not have to use the standard for interim reporting periods before that.

Other changes from the exposure draft include:

Changes that FAS 123(R) makes to the existing FAS 123 include:

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