Financial Accounting Standards Board

Financial Accounting Standards Board

FASB Statement No. 123(R): Share-Based Payment

June 13, 2006

John Sarno

FASB Practice Fellow

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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

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• Recent Developments–Liability Classification

–Grant-Date

– Income Taxes

Share-Based Payment

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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

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• 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

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• 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

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• 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

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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.

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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

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Share-based PaymentsShare-based PaymentsShare-based PaymentsShare-based Payments

Temple UniversityJune 13, 2006

Alison T. SpiveyAssociate Chief Accountant

Office of the Chief Accountant

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The Securities and Exchange The Securities and Exchange Commission, as a matter of policy, Commission, as a matter of policy, disclaims responsibility for any disclaims responsibility for any private publication or statement by private publication or statement by any of its employees. Therefore, the any of its employees. Therefore, the views expressed today are my own, views expressed today are my own, and do not necessarily reflect the and do not necessarily reflect the views of the Commission or the other views of the Commission or the other members of the staff of the members of the staff of the Commission.Commission.

DisclaimerDisclaimer

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Presentation OverviewPresentation Overview

Valuation Valuation

Vesting conditionsVesting conditions

Requisite service periodRequisite service period

ASR 268ASR 268

DisclosuresDisclosures

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Accounting for Share-Based Accounting for Share-Based Payment ArrangementsPayment Arrangements

Statement 123RStatement 123R Issued December 2004Issued December 2004

Staff Accounting Bulletin No. 107Staff Accounting Bulletin No. 107 Released in March 2005Released in March 2005

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Expected Volatility AssumptionExpected Volatility Assumption

Objective is to determine assumption that Objective is to determine assumption that marketplace participant would be likely to marketplace participant would be likely to use when pricing an option.use when pricing an option.

Consider relevant sources of information:Consider relevant sources of information: Implied volatilityImplied volatility

Historical volatilityHistorical volatility

Weighting of relevant information is Weighting of relevant information is subjective and requires careful evaluation.subjective and requires careful evaluation.

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Expected Term AssumptionExpected Term Assumption

Several different sources of data may be Several different sources of data may be considered.considered. Currently there are minimal sources of publicly Currently there are minimal sources of publicly

available information.available information.

SAB 107 permits use of “simplified” SAB 107 permits use of “simplified” method for “plain vanilla” options.method for “plain vanilla” options.

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Market InstrumentsMarket Instruments

A market instrument is an instrument that is A market instrument is an instrument that is designed to be sold into the market at a value designed to be sold into the market at a value intended to be reasonably equivalent to the fair intended to be reasonably equivalent to the fair value of employee share options.value of employee share options.

A statement providing the former Chief Accountant’s A statement providing the former Chief Accountant’s views on market instruments is available at views on market instruments is available at http://www.sec.gov/news/speech/spch090905dtn.htmhttp://www.sec.gov/news/speech/spch090905dtn.htm

Chairman Cox’s statement is available at Chairman Cox’s statement is available at http://www.sec.gov/news/press/2005-129.htmhttp://www.sec.gov/news/press/2005-129.htm

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““Other” Vesting ConditionsOther” Vesting Conditions

Statement 123R defines three types of conditions:Statement 123R defines three types of conditions: Service conditionsService conditions

Performance conditionsPerformance conditions

Market conditionsMarket conditions

Awards may be indexed to factors that are not Awards may be indexed to factors that are not service, performance, or market conditions.service, performance, or market conditions. Classify award as a liabilityClassify award as a liability

Reflect factor when estimating award’s fair valueReflect factor when estimating award’s fair value

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Nonsubstantive Vesting ConditionsNonsubstantive Vesting Conditions

Accounting for nonsubstantive vesting Accounting for nonsubstantive vesting conditionsconditions Grants to retirement eligible employeesGrants to retirement eligible employees

Effect of adoption of Statement 123REffect of adoption of Statement 123R

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Non-Compete AgreementsNon-Compete Agreements

Effect of non-compete agreements on the Effect of non-compete agreements on the determination of the requisite service determination of the requisite service periodperiod Statement 123R – Illustration 15Statement 123R – Illustration 15

Share award with a clawback featureShare award with a clawback feature

Statement 123R – Illustration 16Statement 123R – Illustration 16

In-substance requisite service periodIn-substance requisite service period

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Service Inception DateService Inception Date

Date when requisite service period begins.Date when requisite service period begins.

Service inception date precedes grant date Service inception date precedes grant date if certain criteria are met.if certain criteria are met.

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ASR 268ASR 268

Section E of SAB 107Section E of SAB 107 ASR 268 applies to share-based payment ASR 268 applies to share-based payment

arrangementsarrangements

Updates to EITF Topic D-98Updates to EITF Topic D-98

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DisclosuresDisclosures

Section M of SAB 107Section M of SAB 107 Refining estimates of assumptionsRefining estimates of assumptions

Modifying plans or individual awardsModifying plans or individual awards

Section H of SAB 107Section H of SAB 107 First interim period of adoptionFirst interim period of adoption

Section G of SAB 107Section G of SAB 107 Non-GAAP financial measuresNon-GAAP financial measures

SFAS 123R SFAS 123R Auditing ConsiderationsAuditing Considerations

June 13, 2006

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DisclaimerDisclaimer

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 Auditing Fair Value Measurements of Employee Share OptionsEmployee 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 Applicability of Auditing LiteratureLiterature

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 SEC Staff Accounting Bulletin 107107

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 ProcessEvaluating 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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AssumptionsAssumptions 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 AssumptionExpected 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 Expected Volatility AssumptionAssumption

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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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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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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Consider company’s use of implied volatilityStaff 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 ModelValidation 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 ModelValidation 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 SpecialistUsing 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 Keeping Current with PCAOB Standards ActivitiesStandards 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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