SEC Staff Issues Soothing Guidelines on New Equity Expensing Rules

In Staff Accounting Bulletin No. 107, the SEC staff has issued guidelines intended largely to assure companies that it will provide some leeway in implementing FAS 123(R) to allow for a variety of "reasonable" interpretations. Most significantly, it will allow a number of valuation formulas. While the staff expects practice to normalize over time, initially, companies must simply show that their approach is one that would reasonably imitate what an outside purchaser of an equity award would offer at the time the award is granted. If future events provide the estimating technique inaccurate, that, in itself will not be a problem. Volatility assumptions can also use a variety of data and make defensible arguments about why certain data should be weighed more heavily.

The 62-page document provides guidance on a variety of other points, such as:

• Companies going public could continue to use a calculated value method for unvested awards granted prior to going public once they do go public, but fully vested awards would have to be modified to reflect their fair value after going public. These companies could not restate their awards using fair value methods after going public.
• Companies should not consider the fact that awards cannot be hedged or transferred as reducing their value.
• A formula for expected term is provided for companies that have difficulty in gathering enough data to provide a number. For instance, a 10-year option with graduated four-year vesting would have an expected term of 6.25 years.
• In certain cases, companies issuing equity awards provide rights for cash payments or other attributes. The guidance provides that these may be subject to accounting rules under ASR 268 dealing with redeemable financial instruments.
• When accelerating vesting for of out-of-the money options accounted for under APB 25, companies can reflect the resulting compensation cost as pro forma disclosures under FAS123.