IASB Issues Exposure Draft on Options Expensing

The International Accounting Standards Board (IASB) has an exposure draft on how companies should account for stock options and other forms of equity compensation. "ED 2 Share-based Payment " is now available for public comment. The electronic text will be available free November 18. Until then, those interested can obtain paper copies at £15 each (€24/US$23) including postage, from IASB Publications Department, 30 Cannon Street, London EC4M 6XH, United Kingdom (Tel: +44 (0)20 7246 6410, Fax: +44 (0)20 7332 2749, email: [email protected]; Web: www.iasb.org.uk).

The proposal is similar to that now used by U.S. companies under Financial Accounting Standards Board Statement 123, which requires companies to calculate option value using a Black-Scholes or binomial model. These models calculate the current cost of an option based primarily on several factors:

• Volatility (the higher the volatility, the higher option's current cost)
• The expected life of the option (the longer the term, the higher option's current cost)
• The dividend rate of the stock (the higher the divined, the lower the option's current cost)
• The risk free investment rate (the higher the rate, the higher option's current cost)
• The grant price (the higher the grant price, the higher option's current cost)

Currently, US companies have to show this amount either on their income statements or in the footnotes. Accounting rules for other kinds of equity compensation, such as employee stock ownership plans or direct grants of stock to employees, follow different rules. The IASB proposal differs from the FASB proposal in that it would cover all forms of equity compensation. It also would make some changes in the approach used to calculate the value of the equity award. It could become effective as soon as the end of 2003 as a voluntary standard, and will be adopted by rule in Europe in 2005.

IASB chair Sir David Tweedle said that the proposal would not be as costly as some fear because it would allow companies to calculate the expected life of an option, not its full term. An option's expected life is how long the option is held before exercise, not how long it could be held. The original IASB discussion would have used the full term. FASB rules already allow an expected life calculation.

The proposed rules would allow companies to assume that volatility will be lower in the future than it has in the past, provided the company can justify why that will be the case. This is a somewhat more liberal interpretation than currently followed under FASB rules, which are based on calculations of previous volatility.

In the U.S. model, however, private companies do not factor volatility into their formulas. The IASB model would require this, increasing the option's impact on accounting statements.

Finally, the IASB rule would allow companies to estimate the percentage of shares that would not vest, and adjust current costs accordingly. Under current FASB procedures, expected unvested shares are not considered, but can be credited back if and when they do not vest.