At its meeting yesterday in London, the IASB approved the principle that the fair value of stock options given to employees (and others) should be recogised as expense. The Board considered and rejected allowing an option of disclosure in lieu of expensing. For employees, fair value would be measured at grant date; for options given to non-employees, a different measurement date would be used. IASB expects to publish an exposure draft in the fourth quarter. The target effective date would be 1 January 2004, though this is tentative, and the IFRS might include a 'look-back' period to cover options granted after the exposure draft is issued.

Decision Summary:

The Board reviewed a staff paper discussing the accounting treatment of employee share options, with the objective of drawing some overall conclusions, based on discussions of various accounting and measurement issues at earlier Board meetings.

Key decisions taken at earlier meetings:

• Share-based payment to employees. The fair value of share options and other share-based payment granted as part of employee remuneration should be recognised as an expense. Fair value of share-based payment to employees should be measured at grant date.
• Share-based payment to non-employees. The fair value of share-based payment given to non-employees is the fair value of the goods and services received measured at the date when the goods are received or the services are provided.
• No exemptions. The standard should not provide any exemptions from measuring fair value of employee share options.

Recognition vs. disclosure. The project manager noted that many respondents to the G4+1 paper had asked for convergence with the US approach, set out in FAS 123, which allows a choice between recognition and disclosure. She outlined the problems with the US approach that had caused the Board to reject it, noting in particular the considerable evidence that disclosure is not an adequate substitute for recognition.

Reliable measurement. The next issue was whether reliable measurement is possible, a question on which the Board had consulted with an advisory committee and had also recently met with a panel of experts. Two Board members reported on the outcome of the meeting with the panel of experts, which had included among others Myron Scholes, who had won the Nobel Prize for his work on the Black-Scholes model. There was wide agreement among the panel members that the Board had addressed the right issues and considered them thoroughly. In the light of these and earlier discussions, the Board concluded that it is possible to reliably estimate the fair value of share options. Accordingly, the Board agreed that a standard should require all share options granted to be measured at fair value and expensed.

The Board next considered a series of shorter papers dealing with specific accounting and measurement issues:

Other feature of employee share options. The discussion was concerned particularly with reload features that may make it difficult to measure fair value at grant date. Under FAS 123 a reload feature is treated as a new grant if it is too complex to include in the fair value measurement of the initial grant. The Board considered and rejected such an approach, favouring no exception to the general principles, no matter how complex an option may be.

Accounting for own shares held. It was agreed that the scope exclusion in SIC 16 should be removed, so that it would apply to such shares. It was also noted that, by the time a standard is issued, the requirements of SIC 16 may instead be reflected in IAS 32.

Accounting for tax effects of share-based payment transactions. Tax relief in respect of share options granted can arise at a different time from compensation expense, and can be for a different amount. The Board agreed that temporary differences are adequately dealt with by IAS 12; however, an issue arises where the amount of tax relief exceeds the compensation expense. It was noted that FAS 123 treats the excess in such circumstances as additional paid in capital. The majority of Board members favoured recognising any excess tax relief as a tax credit in the income statement as and when it arises. It was agreed, however, that the Board should look again at the extent to which this approach ties in with IAS 12.

Definition of grant date. In some circumstances, shareholder approval is required before an entity can enter into an employee share option plan. This raises the question of whether grant date should be the date that the plan is agreed with employees, subject only to shareholder approval, or the later date of that approval. The Board was asked to consider a proposal that grant date should be the date of substantive agreement with employees; however, after some discussion, the Board concluded that the word 'substantive' should be deleted, so that grant date would be the date that final authority was given to a plan.

Measurement date when the transaction is measured at the fair value of the goods or services received. The Board agreed that the fair value of such goods or services should be measured at the date of receipt, but this prompted a long discussion on whether this was consistent with the grant date approach proposed for employees. After some debate, the Board agreed that the approaches were consistent, noting that the reasons for favouring grant date for employees are as follows:

• the objective, whether measuring share options granted to employees or to third parties, is to measure the fair value of (goods or) services received;
• for third parties, it will generally be possible to measure this directly;
• for employees, it may not be possible to measure services directly, and therefore the fair value of share options granted should be used as a surrogate;
• the majority view of the Board is that the fair value of services is most likely to correspond to the fair value of options at the date agreement is reachedi.e. grant datebecause subsequent changes in option fair values are unlikely to reflect changes in the value of services. (In other words, the grant date value is recognised over the period of employee services, because this is the best estimate of the value of those services.)

'In substance' repricing. Issues arise when the terms of share options are amended after the grant date, for example by repricing or by cancellation (usually accompanied with a replacement issue). Should such changes be treated as an amendment to the original issue or as a new issue, and to what extent should accounting entries be reversed on a cancellation? The Board was asked to consider a proposal that a standard should avoid including a 'bright line' rule, and should instead give guidance on when a repricing has in substance occurred. This prompted considerable discussion, with the Board finally agreeing that:

• once options have been granted, the associated expense should continue to be recognised as long as the employee is providing the service, even if the options are subsequently cancelled;
• where replacement options are granted, these are treated as a new issue, and measured at full fair valueunless they are explicitly linked to cancelled options, in which case the incremental fair value will be measured.

Consequential amendments to other accounting standards. The Board noted that on issue of a share-based payments standard consequential amendments would be required to IAS 19, IAS 32, and SIC 16.

Employee share plans with cash alternatives. The key accounting issues for share plans that offer cash alternatives are whether and when a liability or equity interest arises, measurement of those liabilities and equity interest, and accounting for their settlement. There was general agreement that an equity interest arises when delivery of shares becomes more likely than a cash payment. At that time, the plan may result in a compound financial instrument that would have to be split into its equity and debt components. Although IAS 32 says that the equity component of a compound instrument is measured residually, in this case the equity component cannot be measured by subtracting the value of the debt instrument from the plan's entire value since that entire value is unknown. The liability component would have to be remeasured to fair value with changes in fair value going into the income statement. Disclosure should be required of the extent that such plans were subsequently settled in cash.

Transition. The Board considered transitional arrangements and agreed that the standard, including tax effects, should apply retrospectively, but only to options granted after the date of issue of an exposure draft of the standard. Liabilities in cash-settled schemes would require a full retrospective application. The same implementation requirements would be applicable for first-time adopters of IFRS. If an exposure draft is issued in the fourth quarter 2002, as planned, the final standard could not be issued much before the end of 2003. It was agreed that, if a standard is issued by the end of 2003, it should be effective for periods beginning on or after 1 January 2004.

Overall decision. After concluding discussion of the individual matters, the Chairman asked the Board members whether in principle they would agree to issue a standard based around these decisions. One Board member registered a preference for service date rather than grant date, but the large majority confirmed they would not oppose a standard. Accordingly, the project director was asked to begin drafting a standard for the Board to consider.

Two additional issues: The Board agreed that two final issues would be brought back to the Board later in the week:

• The interaction of the tax benefit proposal above with IAS 12.
• Certain issues over the remeasurement of cash stock appreciation rights (SARs) and the interaction with IAS 39.