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
2
Share-Based Payment
• Recent Developments
– Liability Classification
– Grant-Date
– Income Taxes
3
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
4
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
5
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
6
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
7
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.
8
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
9
Share-based Payments
Temple University
June 13, 2006
Alison T. Spivey
Associate Chief Accountant
Office of the Chief Accountant
10
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.
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Presentation Overview
Valuation
Vesting conditions
Requisite service period
ASR 268
Disclosures
12
Accounting for Share-Based
Payment Arrangements
Statement 123R
 Issued December 2004
Staff Accounting Bulletin No. 107
 Released in March 2005
13
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.
14
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.
15
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
16
“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
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Nonsubstantive Vesting Conditions
Accounting for nonsubstantive vesting
conditions
 Grants to retirement eligible employees
 Effect of adoption of Statement 123R
18
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
19
Service Inception Date
Date when requisite service period begins.
Service inception date precedes grant date
if certain criteria are met.
20
ASR 268
Section E of SAB 107
 ASR 268 applies to share-based payment
arrangements
 Updates to EITF Topic D-98
21
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
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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.
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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
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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
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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
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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)

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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
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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
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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
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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
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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
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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
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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
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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

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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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Keeping Current with PCAOB
Standards Activities

www.pcaobus.org
 Interim
Standards
 Proposed and final standards
 Staff Q&A
 Standing Advisory Group (SAG)
 Live and archived webcasts
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Questions?
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