Action Alert No. 04-35
September 9, 2004

NOTICE OF MEETINGS

OPEN BOARD MEETING
(Board meetings are available by audio webcast and telephone.)

Wednesday, September 15, 2004, 9:00 a.m.

  1. Equity-based compensation. The Board will meet with representatives of CISCO Systems, Genentech, Qualcomm, and Latham and Watkins to discuss measurement of employee stock options. This meeting is informational and no Board decisions are expected. (Estimated 2-hour discussion.)

  2. Short-term international convergence: phase one. The Board will redeliberate the issues related to its Exposure Draft, Exchanges of Productive Assets. (Estimated 1-hour discussion.)

Wednesday, September 15, 2004, 1:00 p.m.

  1. AcSEC document. The Board will meet with representatives of the AICPA's Accounting Standards Executive Committee (AcSEC) to consider clearance for reexposure of a revised Exposure Draft of a proposed AICPA Statement of Position (SOP), Accounting by Insurance Enterprises for Deferred Acquisition Costs on Internal Replacements Other Than Those Specifically Described in FASB Statement No. 97. (Estimated 1-hour discussion.)

  2. Real estate time-sharing. The Board will discuss a draft of a final Statement that will amend FASB Statement No. 67, Accounting for Costs and Initial Rental Operations of Real Estate Projects, to state that the accounting for (a) incidental operations and (b) costs incurred to sell real estate projects will not apply to real estate time-sharing transactions. The Board will be asked to approve this amendment, which is required to facilitate the issuance of the final AICPA SOP, Accounting for Real Estate Time-Sharing Transactions. (Estimated 15-minute discussion.)

  3. Open discussion. If necessary, the Board will allow time to discuss minor issues with staff members on technical projects or administrative matters. Those discussions are held following regular Board meetings as topics come up.

OPEN EDUCATION SESSION

Wednesday, September 15, 2004, immediately following the Board meeting

The Board will hold an educational, non-decision-making session to discuss topics that are anticipated to be discussed at the September 22, 2004 Board meeting. Those topics will be posted to the FASB calendar four days prior to the education session.

BOARD ACTIONS

The Board Actions are provided for the information and convenience of constituents who want to follow the Board’s deliberations. All of the conclusions reported are tentative and may be changed at future Board meetings. Decisions are included in an Exposure Draft for formal comment only after a formal written ballot. Decisions in an Exposure Draft may be (and often are) changed in redeliberations based on information provided to the Board in comment letters, at public roundtable discussions, and through other communication channels. Decisions become final only after a formal written ballot to issue a final Statement or Interpretation.

September 1, 2004 Board Meeting

Equity-based compensation (EBC). The Board continued its redeliberations of its March 2004 Exposure Draft, Share-Based Payment, an amendment of FASB Statements No. 123 and 95. The Board discussed issues related to the modified grant-date method and deep out-of-the-money stock options, fair value measurement, modifications and settlements, spinoffs, and transition alternatives for public entities. The Board made the following decisions regarding those issues.

Modified Grant-Date Method and Deep Out-of-the-Money Options

  1. The Board considered whether a notion of substantive vesting based on subsequent fluctuations in the value of equity instruments is theoretically consistent with the modified grant-date method and decided that such a notion is not theoretically consistent. Therefore, the Board decided not to propose any changes to the modified grant-date method for stock options that become deep out-of-the-money during the requisite service period.

Fair Value Measurement

The Board made the following tentative decisions relating to the measurement of equity-based awards granted to employees. (The Board noted that it will meet with a group of constituents on September 15, 2004, to discuss certain issues relating to the measurement of such awards.)

  1. The Board tentatively affirmed its conclusion that the grant-date fair value of EBC instruments issued by public entities is measurable with sufficient reliability for purposes of financial statement recognition.

  2. The Board affirmed its conclusion not to require the use of a specific model for estimating the grant-date fair value of employee stock options. The Board also discussed and decided to eliminate an explicit preference for the lattice model. In considering that issue, the Board agreed that the general measurement objectives and related principles in the proposed Statement provide sufficient guidance for evaluating and selecting an appropriate valuation method. The Board also directed the staff to make necessary changes to paragraphs B10—B12 to reflect those decisions in the final Statement.

  3. The Board affirmed the guidance in the proposed Statement relating to estimating the expected volatility of the price of the underlying share and its decision not to prescribe a single method of estimating volatility. That is, the Board affirmed that an entity should make a reasonable and supportable estimate of expected volatility that is consistent with the stated fair value objective. The Board also considered requests to provide additional guidance on estimating volatility and agreed to include additional guidance on the process an entity might follow in estimating volatility, including explicit guidance that an entity may consider the implied volatility of outstanding convertible debt instruments, if any.

  4. The Board decided to include in Appendix B a discussion of additional factors that may affect an employee's early exercise decision, such as an employee's age, length of service at the entity, the evolution of the stock price during the option term, and an employee's home jurisdiction (that is, domestic or foreign). The Board also agreed to note that entities should calibrate early exercise algorithms used in estimating a stock option's expected term based on actual exercise experience.

  5. The Board considered a number of alternatives for accounting for the effect of an employee stock option's nontransferability suggested by constituents and affirmed its support for the notion of expected term as described in the proposed Statement. The Board affirmed that using the expected term provides an objective and theoretically sound methodology for estimating the effect of nontransferability on the value of an employee stock option. The Board also directed the staff to include an explicit section related to nontransferability in Appendix B of the final Statement.

  6. The Board affirmed the proposed treatment of awards with reload features. That treatment requires that each reload grant be accounted for as a new award, if and when granted; consequently, the effect of a reload feature would not be considered when measuring the grant-date fair value of an award.

  7. The Board agreed and tentatively affirmed that the guidance in the final Statement would not preclude an entity from considering the effect of clauses that accelerate vesting of an award upon death and disability in estimating the expected term of an employee stock option. The Board decided it is not necessary to include explicit guidance on that point in the final Statement.

  8. The Board affirmed the proposed accounting for certain contingent features (often referred to as clawback provisions) related to "noncompete," nonsolicitation, or fraudulent behavior. Contingent features that require an employee to transfer equity shares earned or realized gains from the sale of equity instruments earned as a result of share-based payment arrangements to the issuing entity for consideration that is less than fair value on the date of transfer (including no consideration), such as a clawback feature, should not be considered in estimating the fair value of an equity instrument on the date it is granted. Those features are to be accounted for if and when the contingent event occurs.

  9. The Board also considered, but decided not to provide, additional guidance on the following matters relating to measurement:

    1. The meaning of statistical significance
    2. Guidance in those situations in which historical information is not available
    3. The number of steps needed to construct a binomial lattice.

  10. The Board agreed that the guidance in Appendix B of the proposed Statement implies that an entity must have evidence supporting the fair value estimate. That guidance explicitly states in many instances that assumptions must be reasonable and supportable. The Board agreed that that guidance is sufficient.

  11. The Board decided that changes in valuation techniques should be accounted for as changes in estimate; consequently, the Board directed the staff to combine paragraphs B17 and B18 of the proposed Statement and further modify them as necessary to reflect the decisions made during this meeting.

  12. The Board decided to retain the alternative measurement method for situations in which it is not possible to reasonably estimate fair value. That method requires that compensation cost be measured at the award's intrinsic value through the date of exercise, forfeiture, or other settlement.

Modifications and Settlements

  1. The Board decided to retain the guidance in paragraph 35(b) of the proposed Statement on the accounting for Type III modifications. That guidance specifies that total recognized compensation cost for an award rarely will be less than the fair value of the award at the grant date unless at the date of the modification the performance or service conditions of the original award are not expected to be satisfied. Thus, the total compensation cost measured at the date of a modification would be (a) the portion of the grant-date fair value of the original award for which the requisite service is expected to be rendered (or has already been rendered) at that date plus (b) the incremental cost resulting from the modification. Compensation cost would be subsequently adjusted, if necessary, in accordance with paragraph 26 of the proposed Statement.

  2. The Board agreed to change paragraph 36 of the proposed Statement regarding equity restructurings to add the following clarifications: (a) a change to the terms of an award in accordance with antidilution provisions that are designed to equalize an option's value before and after an equity restructuring is a modification of an award (such modifications generally would not result in additional compensation cost, however, if the antidilution provisions were properly structured) and (b) a change to the terms of an award in contemplation of an equity restructuring or to add antidilution provisions in contemplation of an equity restructuring is a modification. However, a change to the terms of an award to add antidilution provisions in the absence of a contemplated equity restructuring is a modification that should not result in incremental compensation cost.

  3. The Board decided to change the guidance for a modification from a liability award to an equity award in a manner that is similar to the guidance in IFRS 2, Share-based Payment. That is, an entity would compare the fair value of the instrument immediately before the modification with the fair value of the modified award and recognize any incremental compensation cost in accordance with the guidance in the proposed Statement. The modified award would be accounted for as an equity award from the date of modification.

Spinoffs

  1. The Board reconsidered the modification guidance for equity restructurings and decided there would be no exceptions to that guidance for spinoff transactions. In connection with a spinoff transaction and as a result of the related modification, employees of the former parent may receive unvested equity instruments of the former subsidiary, or employees of the former subsidiary may retain unvested equity instruments of the former parent. The Board decided that, based on the current accounting model for spinoff transactions, the former parent and former subsidiary should recognize compensation cost related to the unvested modified awards for those employees that provide service to each respective entity. For example, if an employee of the former subsidiary retains unvested equity instruments of the former parent, the former subsidiary would recognize in its financial statements the remaining unrecognized compensation cost pertaining to those instruments. In those cases, the former parent would recognize no compensation cost related to its unvested equity instruments held by those former employees that subsequent to the spinoff provide services solely to the former subsidiary. The Board directed the staff to include an example in the final Statement that illustrates the accounting described above.

Transition Alternatives for Public Entities

  1. The Board affirmed its support for the modified prospective transition method in the proposed Statement. Under that transition method, an entity would recognize share-based employee compensation cost from the beginning of the fiscal year in which the recognition provisions are first applied as if the fair-value-based accounting method in the final Statement had been used to account for all employee awards granted, modified, or settled in fiscal years beginning after the effective date of the final Statement. The Board will discuss effective date at a future Board meeting. As of the effective date, compensation cost related to the nonvested portion of awards outstanding as of that date would be based on the grant-date fair value of those awards as calculated under the original provisions of Statement 123; that is, an entity would not remeasure the grant-date fair value estimate of the unvested portion of awards granted prior to the effective date of the final Statement.

  2. The Board decided to permit the use of a modified restrospective method of transition. Under that transition method, an entity would recognize employee compensation cost for prior periods presented in accordance with the original provisions of Statement 123; that is, an entity would recognize employee compensation cost in the amounts reported in the pro forma disclosures provided in accordance with Statement 123.

  3. The Board affirmed that an alternative transition method would not be permitted for those entities that previously adopted Statement 123 under the prospective transition method permitted by FASB Statement No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure.

FUTURE OPEN MEETINGS

The following is a list of open meetings tentatively scheduled through September. Because schedules may change, please check the FASB calendar before finalizing your plans. Revisions to this list since the last issue of Action Alert are highlighted in bold.

Monday, September 20, 2004—Liaison Meeting with the American Gas Association
Tuesday, September 21, 2004—Fair Value Measurement Roundtable Discussion
Wednesday, September 22, 2004—FASB Board Meeting
Wednesday, September 22, 2004—FASB Education Session (if needed)
Thursday, September 23, 2004—Financial Accounting Standards Advisory Council Meeting
Friday, September 24, 2004—FASB Education Session
Wednesday, September 29, 2004—FASB Board Meeting
Wednesday, September 29, 2004—Emerging Issues Task Force Meeting
Thursday, September 30, 2004—Emerging Issues Task Force Meeting