Magazine article The CPA Journal

Stock-Based Compensation Issues

Magazine article The CPA Journal

Stock-Based Compensation Issues

Article excerpt

SFAS No. 123, Accounting for StockBased Compensation, provides a choice between two acceptable accounting methods for measuring compensation cost in transactions with employees. Companies can measure compensation cost using the intrinsic value model prescribed by APB No. 25, Accounting for Stock Issued to Employees, or can measure compensation cost using the fair value model described in SFAS No. 123. There are a number of practical issues that should be considered before a company enters into compensation transactions using equity securities.

Accounting for Transactions with Other than Employees

Regardless of the method used by a company to account for stock-based transactions with its employees, transactions with nonemployees must be accounted for at fair value. SFAS No. 123 states that except for transactions with employees that are within the scope of APB No. 25, all transactions in which goods or services are the consideration received for the issuance of equity instruments should be accounted for based on the fair value of the consideration received or the fair value of the equity instruments issued, whichever is more reliably measurable.

This provision can present a problem for newly-formed companies and for companies in the process of raising capital by going public or otherwise. Such companies may be short on cash and might issue options or warrants to employees, attorneys, consultants, and others in lieu of making cash payments. While no compensation cost may be recognized for issuances to employees, these options or warrants may have a determinable fair value using an option pricing formula such as the Black-Scholes model. The transactions with nonemployees will have to be accounted for at fair value, which will result in expense recognition. If the company's stock is not publicly traded, an independent appraisal of the company may be required to value the options. This process can be costly and might not be practicable in the circumstances.

Expense recognition in stock-based transactions results in an increase to paidin-capital. Total stockholders' equity is unchanged. Accordingly, if a company is being evaluated based on total equity or tangible book value per share rather than earnings or earnings per share, such trans actions might not be of concern.

Definition of Employee. A question often arises as to the definition of an employee for this provision. For example, are members of a company's board of directors who are not otherwise full time employees considered to be employees for the purposes of this provision? SFAS No. 123 does not provide guidance on this issue.

At the December 1996 AICPA National Conference on Current SEC Developments, an SEC Professional Accounting Fellow discussed this question. The SEC staff had addressed an inquiry as to whether options issued to members of a company's advisory board would be considered employee options. Members of the advisory board had specific knowledge and expertise within the company's industry and were given equity instruments as compensation for advising the company on such matters as policy devel opment, future technology, and product improvement. The advisory board members were appointed for annual terms, met two or three times a year for three or four hours each meeting, and received a set number of options per meeting.

In evaluating whether the advisory board members were employees, some of the factors the SEC staff considered were whether the members a) received Forms 1099 or W-2, b) were eligible to participate in the company's employee benefit programs, c) had stated service periods, d) performed services for others while performing services for the company, e) received payment for services on a project or per meeting basis, and f) were subject to the company's personnel policies and procedures. In the particular situation discussed, the SEC staff determined the board members were not considered to be employees. …

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