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BASIS FOR CONCLUSIONS ON IFRS 2 OVERALL CONCLUSIONS ON ACCOUNTING FOR EMPLOYEE SHARE OPTIONS

BASIS FOR CONCLUSIONS ON IFRS 2 OVERALL CONCLUSIONS ON ACCOUNTING FOR EMPLOYEE SHARE OPTIONS

BASIS FOR CONCLUSIONS ON IFRS 2 OVERALL CONCLUSIONS ON ACCOUNTING FOR EMPLOYEE SHARE OPTIONS

The Board first considered all major issues relating to the recognition and measurement of share-based payment transactions, and reached conclusions on those issues. It then drew some overall conclusions, particularly on the treatment of employee share options, which is one of the most controversial aspects of the project. In arriving at those conclusions, the Board considered the following issues:
● convergence with US GAAP
● recognition versus disclosure of expenses arising from employee
share-based payment transactions
● reliability of measurement of the fair value of employee share options.

BASIS FOR CONCLUSIONS ON IFRS 2 OVERALL CONCLUSIONS ON ACCOUNTING FOR EMPLOYEE SHARE OPTIONS

Convergence with US GAAP

Some respondents to the Discussion Paper and ED 2 urged the Board to develop an IFRS that was based on existing requirements under US generally accepted accounting principles (US GAAP).

More specifically, respondents urged the Board to develop a standard based on SFAS 123. However, given that convergence of accounting standards was commonly given as a reason for this suggestion, the Board considered US GAAP overall, not just one aspect of it. The main pronouncements of US GAAP on share-based payment are Accounting Principles Board Opinion No. 25 Accounting for Stock Issued to Employees, and SFAS 123.

APB 25
APB 25 was issued in 1972. It deals with employee share plans only, and draws a distinction between non-performance-related (fixed) plans and performance-related and other variable plans.

For fixed plans, an expense is measured at intrinsic value (ie the difference between the share price and the exercise price), if any, at grant date. Typically, this results in no expense being recognised for fixed plans, because most share options granted under fixed plans are granted at the money. For performance-related and other variable plans, an expense is measured at intrinsic value at the measurement date. The measurement date is when both the number of shares or share options that the employee is entitled to receive and the exercise price are fixed. Because this measurement date is likely to be much later than grant date, any expense is subject to uncertainty and, if the share price is increasing, the expense for performance-related plans would be larger than for fixed plans.

BASIS FOR CONCLUSIONS ON IFRS 2 OVERALL CONCLUSIONS ON ACCOUNTING FOR EMPLOYEE SHARE OPTIONS

In SFAS 123, the FASB noted that APB 25 is criticised for producing anomalous results and for lacking any underlying conceptual rationale. For example, the requirements of APB 25 typically result in the recognition of an expense for performance-related share options but usually no expense is recognised for fixed share options. This result is anomalous because fixed share options are usually more valuable at grant date than performance-related share options. Moreover, the omission of an expense for fixed share options impairs the quality of financial statements: The resulting financial statements are less credible than they could be, and the financial statements of entities that use fixed employee share options extensively are not comparable to those of entities that do not make significant use of fixed options.

The Discussion Paper, in its discussion of US GAAP, noted that the different accounting treatments for fixed and performance-related plans also had the perverse effect of discouraging entities from setting up performance-related employee share plans.

BASIS FOR CONCLUSIONS ON IFRS 2 OVERALL CONCLUSIONS ON ACCOUNTING FOR EMPLOYEE SHARE OPTIONS

SFAS 123
SFAS 123 was issued in 1995. It requires recognition of share-based payment
transactions with parties other than employees, based on the fair value of the
shares or share options issued or the fair value of the goods or services received,
whichever is more reliably measurable. Entities are also encouraged, but not
required, to apply the fair value accounting method in SFAS 123 to share-based
payment transactions with employees. Generally speaking, SFAS 123 draws no
distinction between fixed and performance-related plans.

If an entity applies the accounting method in APB 25 rather than that in SFAS 123, SFAS 123 requires disclosures of pro forma net income and earnings per share in the annual financial statements, as if the standard had been applied. Recently, a significant number of major US companies have voluntarily adopted the fair value accounting method in SFAS 123 for transactions with employees.

The FASB regards SFAS 123 as superior to APB 25, and would have preferred recognition based on the fair value of employee options to be mandatory, not optional. SFAS 123 makes it clear that the FASB decided to permit the disclosure-based alternative for political reasons, not because it thought that it was the best accounting solution:

BASIS FOR CONCLUSIONS ON IFRS 2 OVERALL CONCLUSIONS ON ACCOUNTING FOR EMPLOYEE SHARE OPTIONS

… the Board … continues to believe that disclosure is not an adequate substitute for recognition of assets, liabilities, equity, revenues and expenses in financial statements … The Board chose a disclosure-based solution for stock-based employee compensation to bring closure to the divisive debate on this issue–not because it believes that solution is the best way to improve financial accounting and reporting.

BASIS FOR CONCLUSIONS ON IFRS 2 OVERALL CONCLUSIONS ON ACCOUNTING FOR EMPLOYEE SHARE OPTIONS

(SFAS 123, paragraphs 61 and 62)

Under US GAAP, the accounting treatment of share-based payment transactions differs, depending on whether the other party to the transaction is an employee or non-employee, and whether the entity chooses to apply SFAS 123 or APB 25 to transactions with employees. Having a choice of accounting methods is generally regarded as undesirable. Indeed, the Board recently devoted much time and effort to developing improvements to existing international standards, one of the objectives of which is to eliminate choices of accounting methods.

BASIS FOR CONCLUSIONS ON IFRS 2 OVERALL CONCLUSIONS ON ACCOUNTING FOR EMPLOYEE SHARE OPTIONS

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