New SEC Rule Delays Expensing Requirement Until January 1, 2006 for Calendar Year Companies

The SEC has adopted a new rule that delays required stock option and other share plan expensing under the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (FAS 123R), for most public companies until their first fiscal year beginning after June 15, 2005; the compliance date for small business issuers is their first fiscal year beginning after December 15, 2005.

FAS 123R requires that the compensation cost relating to stock options, stock appreciation rights, restricted stock or units, employee stock purchase plans and other share-based payment transactions, measured based on the "fair value" of the awards, be recognized in financial statements. FAS 123R replaces FAS 123, Accounting for Stock-Based Compensation, and supersedes APB 25, Accounting for Stock Issued to Employees.

The New Effective Dates for FAS 123R. Before this amendment, public companies (other than small business issuers) were required to begin expensing stock options as of the beginning of the first interim or annual reporting period that begins after June 15, 2005 (December 15, 2005 for small business issuers).

The SEC's new rule allows companies to implement FAS 123R starting at the beginning of their next fiscal year, instead of the next reporting period, that begins after June 15, 2005 (December 15, 2005 for small business issuers). This means that financial statements for calendar year-end companies do not need to comply with FAS 123R until the interim financial statements included in Form 10-Q for the first quarter of 2006. However, some companies do not get a six-month reprieve. For example, financial statements for companies with a June 30 year-end must comply with FAS 123R in the Form 10-Q for the quarter beginning July 1, 2005.

The SEC reiterated in its press release that the new rule does not change the accounting required by FAS 123R, and that companies are still encouraged to voluntarily implement FAS 123R earlier than required. The SEC noted that "implementing the new standard at the beginning of a fiscal year allows companies to change their accounting systems in a more orderly fashion, and should allow auditors to conduct more consistent audit and review procedures."

SEC Issues Option Expensing Guidance

The SEC's Office of Chief Accountant recently issued Staff Accounting Bulletin 107 (SAB 107) regarding the interaction between FAS 123R and SEC rules and regulations, and the SEC staff's views regarding the valuation of share-based payment arrangements for public companies. SAB 107 specifically provides guidance on:

• share-based payment transactions with nonemployees;
• companies that become public companies;
• valuation methods (including expected volatility and expected term assumptions);
• how to classify compensation expense;
• non-GAAP financial measures;
• capitalizing compensation cost related to share-based payment arrangements;
• accounting for income tax effects of share-based payment arrangements on adoption of FAS 123R;
• modifying employee share options before adopting FAS 123R; and
• MD&A disclosure after adopting FAS 123R.

SAB 107 also reminds public companies of the importance of including disclosures within filings made with the SEC relating to the accounting for share-based payment transactions, particularly during the transition to FAS 123R.

Additional Information

You can find the full text of the SEC press release announcing the new rule delaying compliance with FAS 123R at http://www.sec.gov/news/press/2005-57.htm. The SEC will post the full text of the release for this new rule on its website at http://www.sec.gov/rules/final.shtml. The full text of FAS 123R and its appendices is available on the FASB's website at http://www.fasb.org/pdf/fas123r.pdf. You can find the full text of SAB 107 on the SEC's website at http://www.sec.gov/interps/account/sab107.pdf. You can also find a memorandum on option valuation issues under 123R by the SEC Office of Economic Analysis on the SEC's website at http://www.sec.gov/interps/account/secoeamemo032905.pdf. You can find discussion of other recent laws, regulations and rule proposals of interest to public companies on our website.