Financial Accounting Standards Board FASB Statement No. 123(R): Share-Based Payment June 13, 2006 John Sarno FASB Practice Fellow
Disclaimer The views expressed in this presentation are the views of the individual presenters and do not represent positions of the FASB Positions of the FASB are arrived at only after extensive due process and deliberations
Share-Based Payment • Recent Developments • Liability Classification • Grant-Date • Income Taxes
Liability Classification • FSP FAS 123(R)-1 • Freestanding financial instrument issued to an employee in exchange for past or future employee services that is subject to FAS 123R shall continue to be subject to the recognition and measurement provisions of FAS 123R throughout the life of the instrument, unless modified when the holder is no longer an employee • Indefinitely defers requirement to re-evaluate classification of a share-based payment award to an employee under other applicable GAAP • Likely the Board will revisit this issue upon completion of the current liabilities and equity project
Liability Classification • FSP FAS 123(R)-e • Amends FSP FAS 123(R)-1 • Addresses situations in which an entity modified an award when an individual is no longer employed and the only modification is as a result of an equity restructuring or a business combination
Liability Classification • FSP FAS 123(R)-4 • Amends paragraphs 32 and A229 of Statement 123(R) • Addresses the classification of options and similar instruments issued as employee compensation that allow for cash settlement upon the occurrence of a contingent event • Allows an entity to classify an option or similar instrument as equity if the cash settlement feature can only be exercised upon the occurrence of a contingent event and the contingent event is not probable of occurring
Liability Classification • FSP FAS 123(R)-e • Not considered a modification for purposes of applying FSP FAS 123(R)-1 if the following conditions are met: • Either there is no increase in value to the holders of the instrument or the exchange or change to the terms of the award is not made in contemplation of an equity restructuring or business combination • All holders of the same class of equity instruments are treated in a similar manner
Grant-Date • FSP FAS 123(R)-2 • Assuming all other criteria in the grant date definition have been met, a mutual understanding of the key terms of an award shall be presumed to exist when an award is approved in accordance with an entity’s governance requirement if: • Recipient is not permitted to negotiate the key terms with the employer • Key terms and conditions of the award are expected to be communicated within a relatively short time period • Relatively short time period is that period an entity could reasonably complete all actions necessary to communicate the awards to the recipients in accordance with the entity’s customary human resource practices.
Income Tax Accounting • FSP FAS 123(R)-3 • Simplified method comprises • A computational component that establishes a beginning balance of the APIC pool • A simplified method to determine the subsequent impact on the APIC pool of awards that are fully vested and outstanding upon the adoption of Statement 123(R) • Guidance related to cash flow classification • Entities that elect modified retrospective application may adopt the simplified method but the election should not impact reporting of the retrospective periods. • A lot of systems work may be needed to track the APIC pool going forward
Share-based Payments Temple University June 13, 2006 Alison T. Spivey Associate Chief Accountant Office of the Chief Accountant
Disclaimer • The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. Therefore, the views expressed today are my own, and do not necessarily reflect the views of the Commission or the other members of the staff of the Commission.
Presentation Overview Valuation Vesting conditions Requisite service period ASR 268 Disclosures
Accounting for Share-Based Payment Arrangements • Statement 123R • Issued December 2004 • Staff Accounting Bulletin No. 107 • Released in March 2005
Expected Volatility Assumption • Objective is to determine assumption that marketplace participant would be likely to use when pricing an option. • Consider relevant sources of information: • Implied volatility • Historical volatility • Weighting of relevant information is subjective and requires careful evaluation.
Expected Term Assumption • Several different sources of data may be considered. • Currently there are minimal sources of publicly available information. • SAB 107 permits use of “simplified” method for “plain vanilla” options.
Market Instruments A market instrument is an instrument that is designed to be sold into the market at a value intended to be reasonably equivalent to the fair value of employee share options. • A statement providing the former Chief Accountant’s views on market instruments is available at http://www.sec.gov/news/speech/spch090905dtn.htm • Chairman Cox’s statement is available at http://www.sec.gov/news/press/2005-129.htm
“Other” Vesting Conditions • Statement 123R defines three types of conditions: • Service conditions • Performance conditions • Market conditions • Awards may be indexed to factors that are not service, performance, or market conditions. • Classify award as a liability • Reflect factor when estimating award’s fair value
Nonsubstantive Vesting Conditions • Accounting for nonsubstantive vesting conditions • Grants to retirement eligible employees • Effect of adoption of Statement 123R
Non-Compete Agreements • Effect of non-compete agreements on the determination of the requisite service period • Statement 123R – Illustration 15 • Share award with a clawback feature • Statement 123R – Illustration 16 • In-substance requisite service period
Service Inception Date Date when requisite service period begins. Service inception date precedes grant date if certain criteria are met.
ASR 268 • Section E of SAB 107 • ASR 268 applies to share-based payment arrangements • Updates to EITF Topic D-98
Disclosures • Section M of SAB 107 • Refining estimates of assumptions • Modifying plans or individual awards • Section H of SAB 107 • First interim period of adoption • Section G of SAB 107 • Non-GAAP financial measures
SFAS 123R Auditing Considerations June 13, 2006
Disclaimer The views expressed are my views and do not necessarily reflect the views of the Board, individual Board members, or the staff.
Auditing Fair Value Measurements of Employee Share Options • Applicability of auditing literature • SEC Staff Accounting Bulletin 107 • Management’s process • Expected term • Expected volatility • Historical volatility • Implied volatility • Validation of data and model • Use of specialist
Applicability of Auditing Literature • AU sec. 328, Auditing Fair Value Measurements and Disclosures • AU sec. 342, Auditing Accounting Estimates • AU sec. 316, Consideration of Fraud in a Financial Statement Audit • AU sec. 336, Using the Work of a Specialist • AU sec. 329, Analytical Procedures • PCAOB Auditing Standard No. 2, An Audit of Internal Control Over Financial Reporting Performed in Conjunction with a Audit of Financial Statements • PCAOB Auditing Standard No. 3, Audit Documentation
SEC Staff Accounting Bulletin 107 • Provides the SEC staff’s views on certain aspects of FAS 123R • Auditors should be aware of SAB 107 direction regarding: • Model selection • Expected volatility • Expected term • Simplified method for expected term • SAB 107 not limited to the above topics
Evaluating the Process • Obtain an understanding of company’s process for determining fair value measurements and disclosures and of relevant controls sufficient to develop an effective audit approach (AU 328.09) • Review and test process used to develop estimate (AU 342.10a) • Consider internal controls under AS No. 2 • Assess fraud risk (AU 316.54)
Assumptions • Auditor should consider (AU sec 328.12): • Process used to develop and apply management assumptions, including whether management used available market information to develop the assumptions • Documentation supporting management’s assumptions • Process used to monitor changes in assumptions • Range of reasonable assumptions
Expected Term Assumption • Evaluate reasonableness of company’s consideration of factors affecting expected term • Historical experience • Vesting period • Post-vesting employee behavior • Expected volatility of underlying shares • Employee groups • Whether currently available information indicates future is reasonably expected to differ from past
Expected Volatility Assumption • Evaluate company’s consideration of factors affecting expected volatility • Volatility of the share price • The implied volatility of the share price • The length of time an entity’s shares have been publicly traded. • Appropriate and regular intervals for price observations • Corporate and capital structure
Expected Volatility Assumption • Evaluate company’s use of historical volatility • Starting point for estimating expected volatility under FAS 123R • SAB 107 factors for exclusive use of historical volatility • Company’s consideration of the extent to which currently available information indicates that future volatility will differ from historical volatility • Adjustments to historical volatility
Expected Volatility Assumption • Consider SEC staff positions on adjustments to historical volatility • If a company disregards a period of historical volatility, it should be prepared to support conclusion that historical share price during that period is not relevant to expected volatility due to one or more discrete and specific historical events and that similar events are not expected to occur during the expected term. The SEC staff believes that these situations would be rare. • Estimate of expected volatility that places “extreme emphasis on the most recent periods” may not be consistent with paragraph A32(a) of FAS 123R
Expected Volatility Assumption • Consider company’s use of implied volatility • Staff Accounting Bulletin 107 provided items for a company to consider when evaluating the extent of its reliance on the implied volatility derived from its traded options, including the exclusive use of implied volatility
Validation of Data and Model • Auditor should consider (AU sec 328.12): • Controls over the consistency, timeliness, and reliability of data used in valuation models • Integrity of change controls and security procedures for valuation models and relevant information systems, including approval processes
Validation of Data and Model • Test data used to develop fair value measurements and disclosures and evaluate whether they have been properly determined from data and management’s assumptions (AU sec 328.39) • Obtain evidence that option-pricing model is accurately calculating the fair value • Consider internal control, under AS No. 2
Using the Work of a Specialist • Auditor should : • Consider whether to use a specialist to evaluate financial statement assertions (AU 328.20) • Evaluate professional qualifications of specialist (AU 336.08) • Obtain understanding of work performed by specialist (AU 336.12) • Make appropriate tests of data provided to specialist (AU 336.12) • Evaluate whether specialist’s findings support the related assertions in the financial statements (AU 336.12)
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