Bear, Stearns study on impact of expensing stock options

04 Apr 2005

If US public companies had been required to expense employee stock options in 2004, as will be required under FASB Statement 123R Share-Based Payment starting in third-quarter 2005: the reported 2004 post-tax net income from continuing operations of the S&P 500 companies would have been reduced by 5%, and 2004 NASDAQ 100 companies' post-tax net income from continuing operations would have been reduced by 22%. Those are key findings of a study conducted by the Equity Research group at Bear, Stearns &Co.

Inc. The purpose of the study is to help investors gauge the impact that expensing employee stock options will have on the 2005 earnings of US public companies. The Bear, Stearns analysis was based on the 2004 stock option disclosures in the most recently filed 10Ks of companies that were S&P 500 and NASDAQ 100 constituents as of 31 December 2004. Exhibits to the study present the results by company, by sector, and by industry. Visitors to IAS Plus are likely to find the study of interest because the requirements of FAS 123R for public companies are very similar to those of IFRS 2. We are grateful to Bear, Stearns for giving us permission to post the study on IAS Plus. The report remains copyright Bear, Stearns & Co. Inc., all rights reserved. Click to Download 2004 Earnings Impact of Stock Options on the S&P 500 & NASDAQ 100 Earnings (PDF 486k).

Report from the IFRIC meeting 1 April 2005

02 Apr 2005

The International Financial Reporting Interpretations Committee (IFRIC) met at the IASB's offices in London on Thursday 31 March and Friday 1 April 2005. Presented below are the preliminary and unofficial notes taken by Deloitte observers at the second day of the meeting.Notes from the IFRIC Meeting1 April 2005 IAS 39: Impairment of an Equity Instrument One of the impairment triggers in paragraph 61 of IAS 39 is 'a significant or prolonged decline in the fair value of an investment in an equity instrument below its cost'. The submission before the IFRIC is for guidance regarding whether 'significant' in paragraph 61 should be measured against the original cost or the original cost less any prior impairment losses, and whether 'prolonged' in paragraph 61 should be evaluated against the entire period for which the investment has been held, or against the time period since the last recognised impairment loss.

In addition, guidance is being sought as to whether IAS 39 allows an entity to, in some way, segregate different loss events impacting an investment in a single equity instrument and evaluate the significance and duration of each event separately.

The IFRIC debated this issue at length, with some noting that by its nature, the requirements of paragraph 61 as regards the words 'significant' and 'prolonged' would result in different application in practice. There was general agreement that a loss event leading to an impairment loss on an available-for-sale financial asset should not have the effect of setting a new 'cost', instead any further losses should also be recognised as impairment losses ('keep the meter running'). This results in the need to maintain a record of impairment losses recognised throughout the period for which such instrument is held.

It was noted that practise in the USA would result in a new cost being set up after the first loss event. Members indicated that this issue does not require the development of an Interpretation and that any suggestion to the IASB to amend IAS 39 would significantly change the accounting for available-for-sale instruments (that is, potentially requiring all gains and losses to be recognised in the income statement). A rejection note will be drafted and presented at the next meeting setting out why the IFRIC believe the issue is clear together with an expanded note clarifying that the word 'prolonged' refers to the period that the instrument has a value below cost.

IFRIC D12, D13, D14 Service Concessions Arrangements

The staff indicated to IFRIC members that there was general concern that the 61-day comment period ending 3 May 2005 was too brief. IFRIC agreed to extend the comment period to 31 May 2005 but would encourage those respondents able to meet the original deadline to submit their comments on that earlier date in order to allow IFRIC to start processing responses. It was also noted that those constituents that had advocated for this issue to be dealt with swiftly, should be notified of the possible delay on the overall timetable resulting from this extension.

Convertible Instruments Denominated in a Foreign Currency (Cross-Currency Bonds)

The issue before the IFRIC concerns the classification of a convertible bond denominated in a foreign currency (ie a currency other than the functional currency of the entity issuing the bond). Such a bond allows the holder to convert the bond into a fixed number of the entity's equity instruments in exchange for a fixed amount of foreign currency. For example an entity whose functional currency is the Euro issues a US dollar-denominated convertible bond that can be converted into a fixed number of the entity's equity instruments (ie it contains an option to exchange a fixed number of the entity's shares for a fixed amount of US dollars).

IAS 32 states that a contract that will be settled by the entity by delivering a fixed number of its own equity instruments in exchange for a fixed amount of cash or another financial asset is an equity instrument. Consequently, the question determining classification of the written option in the convertible bond is whether a fixed amount of a foreign currency represents a fixed amount of cash or other financial asset. Ie, in the example above, is a fixed amount of US dollars 'a fixed amount of cash or another financial asset' for an entity whose functional currency is Euro?

If a fixed amount of a foreign currency represents a fixed amount of cash or another financial asset the convertible is separated into a liability and an equity component in the usual way. If however a fixed amount of a foreign currency represents a variable amount of cash then some have asserted that the written option component in the convertible

  • is a liability;
  • is equity; or
  • is a hybrid instrument with equity and foreign exchange components that require separate accounting under IAS 39 Financial Instruments: Recognition and Measurement.

After some debate, there was general consensus within IFRIC that contracts that will be settled by an entity by delivering a fixed number of its own equity instruments in exchange for a fixed amount of foreign currency should be classified as liabilities. IFRIC agreed to undertake a research project on possible amendments to the literature that could be passed on to the IASB for consideration. This course of action was taken as the IASB is currently considering a project dealing with liability / equity issues.

IFRS 2: Treasury Share Transactions and Group Transactions

The IFRIC continued its discussions of various issues relating to accounting for share-based payment arrangements in which:

  • An entity grants options to its employees and chooses to or is required to purchase its own shares upon exercise of the options by its employees
  • A subsidiary's employees are granted rights to shares of the parent.

The staff presented a revised draft Interpretation setting out the changes suggested at the previous meeting and there was general agreement with the revised document. Subject to minor editorial amendments, no objections were noted to the issuance of the draft Interpretation.

Scope of IFRS 2

The staff indicated that they had prepared the latest draft Interpretation to deal mainly with the issue of whether there is a requirement to demonstrate that goods or services would be received in order to IFRS 2 to apply. There was general support for the document. Subject to minor editorial amendments, no objections were noted to the issuance of the draft Interpretation.

IFRIC D11 Changes in Contributions to Employee Share Purchase Plans (ESPPs)

To date, 34 comment letters on D11 have been received. The staff presented a summary of comments on:

  • the proposed treatment of a cessation of contributions
  • the proposed treatment of a change from one ESPP to another
  • other issues.

Cessation of contributions

Most respondents focused on this issue. Many disagreed with the proposed treatment in D11. Of those who disagreed, many argued that a requirement to contribute to the plan is a vesting condition; therefore, a cessation of contributions should be accounted for as a forfeiture (ie reversal of the expense recognised to date and no further charges).

Of the remainder of respondents who disagreed with the proposal in D11, some supported the alternative treatment outlined in paragraph BC10 of the Basis for Conclusions to D11, ie the cessation of contributions has no accounting effect; instead, the entity should continue to recognise an expense for services received from that employee over the remainder of the vesting period. In addition to the above, a few respondents who disagreed with the proposal in D11 argued that instead of treating the cessation of contributions as a cancellation, the entity should cease recognising an expense for that employee, with no reversal of the previous expense. One respondent suggested that IFRS 2 be amended to permit this treatment.

Changes from one ESPP to another

Some respondents did not comment on the proposed treatment of a change from one ESPP to another. Of those respondents who did express a view, most agreed with the proposal in D11. IFRIC discussed the comments and some members made the point that it was not clear whether US GAAP is consistent with IFRS on the issue of cancellation. The point was made that US GAAP deals explicitly with 'reductions' in contributions but not cancellations.

Other Issues

IFRIC discussed other conceptual issues including when a 'shared understanding' of the arrangement is reached, for example, where a letter of employment states that employees are free to join the ESPP scheme as part of their employment contract. Does the signing of the contract by all employees represent grant date? Or is grant date when the employees that decide to join the scheme, indicate their willingness to join (possibly by making the contributions)? Following this thinking, some IFRIC members questioned the reason (at a conceptual level) why no charge for share-based payments had been proposed for employees that remained in employ but did not join the scheme. This thinking would have wide ramifications on various types of employee benefit schemes in existence.

After much debate, IFRIC seemed to agree that 'forfeiture' is not a possible solution, and neither is accounting for the SAYE schemes as those presenting the employees with a choice of settlement in cash or equity. Some suggested that D11 as currently drafted is the only correct interpretation of IFRS 2 as drafted, but 5 IFRIC members indicated that they would vote against D11 as currently drafted.

Others indicated they would prefer to reach a consensus that would allow entities to cease expensing or even continue with the expensing they had been doing, but would not accept accelerated expensing (as per D11) as it is counter intuitive. The opportunities to abuse such provisions were noted with indications that the Board would probably not sanction such amendments.

IFRIC concluded that the issue should be elevated to the Board with a proposal that the cancellation provisions in IFRS 2 be revisited.

IFRIC D10 Liabilities Arising from Participating in a Specific Market - Waste Electrical and Electronic Equipment

The most striking fact with regard to descriptive statistics is that no individual preparer and only one preparer representative body has commented on IFRIC D10. 7 responses came from accountancy bodies and standard setters and 5 from accounting firms. Finally, EFRAG and FEE have sent a comment letter to IFRIC.

21 respondents (95%) fully agreed with the draft Consensus. While 8 respondents (36%) had no or just a few formal comments, 13 (59%) raised some concerns about the scope of IFRIC D10 and a certain lack of clarity in several paragraphs of the body of the draft Interpretation and the Basis for Conclusions.

Some scope issues were discussed, mainly that the interpretation should be drafted in a broader context and only making reference to the WE&EE directive. IFRIC indicated that they had already debated this issue and had arrived at the draft as currently drafted but would include a reference to the hierarchy in IAS 8 to deal with some of the scope issues.

Some respondents had requested that the requirements of the draft Interpretation be expanded by addressing disclosure requirements. IFRIC agreed to encourage this disclosure through the Basis for Conclusions but believe they could not require such disclosure without re-exposure and consulting the Board.

IFRIC decided to clarify that the recognition of the liability arising from applying D10 would take place 'during' the measurement period in order to avoid full recognition on the first day of participating in the market.

This summary is based on notes taken by observers at the IFRIC meeting and should not be regarded as an official or final summary.

Scroll down for Notes from 31 March 2005.

Proposal to replace Canadian GAAP with IFRSs

01 Apr 2005

The Canadian Institute of Chartered Accountants' Accounting Standards Board (AcSB) has issued an Invitation to Comment on its draft strategic plan, Accounting Standards in Canada: Future Directions.

The draft plan includes the AcSB's proposal to follow separate strategies for public companies, private businesses, and not-for-profit organisations. Highlights:
  • For public companies, the AcSB will direct its efforts primarily to participating in the movement toward the global convergence of accounting standards. "The best way to achieve the objective of a single set of globally accepted, high-quality accounting standards is to converge Canadian GAAP with International Financial Reporting Standards (IFRSs) over a transitional period, expected to be five years. At the end of that period, Canadian GAAP will cease to exist as a separate, distinct basis of financial reporting for public companies." The AcSB also acknowledges that US GAAP is an appropriate alternative when regulators and other competent authorities choose to permit its use.
  • For private businesses, the AcSB will clarify that GAAP applies only to entities that have significant external users of their financial statements. For those entities, the AcSB will undertake a comprehensive examination of their financial reporting needs and determine the most appropriate model for meeting those needs.
  • For not-for-profit organisations, the AcSB will continue to apply those elements of GAAP for profit-oriented enterprises that are applicable to their circumstances, and develop other standards dealing with the special circumstances of the not-for-profit sector.

The deadline for written comments on the proposed strategies is 31 July 2005. Click to download the Invitation to Comment (PDF 458k).

Deadline on IFRIC D12-13-14 extended to 31 May

01 Apr 2005

The IFRIC has agreed to extend the deadline for comments on its three Draft Interpretations D12, D13, and D14 Service Concession Agreements to 31 May 2005. Those proposals were issued on 3 March 2005 with an original comment deadline of 3 May 2005. .

The IFRIC has agreed to extend the deadline for comments on its three Draft Interpretations D12, D13, and D14 Service Concession Agreements to 31 May 2005. Those proposals were issued on 3 March 2005 with an original comment deadline of 3 May 2005.

PCAOB proposal on elimination of a material weakness

01 Apr 2005

The US Public Company Accounting Oversight Board has proposed for public comment a standard that would apply when auditors report on the elimination of a material weakness in a company's internal control over financial reporting.

The proposed standard would establish a voluntary, stand-alone engagement that would be performed at the election of the company. Comments are due 16 May 2005. If the PCAOB does adopt a final standard, it will be submitted to the Securities and Exchange Commission for approval. The proposed rule may be Downloaded from the PCAOB's Website (Docket No. 018).

Report from the IFRIC meeting 31 March 2005

01 Apr 2005

The International Financial Reporting Interpretations Committee (IFRIC) is meeting at the IASB's offices in London on Thursday 31 March and Friday 1 April 2005. Presented below are the preliminary and unofficial notes taken by Deloitte observers at the first day of the meeting.Notes from the IFRIC Meeting31 March 2005 Administrative Matters Gilbert Gelard, IASB member chaired the meeting.

The Chairman welcomed Shunichi Toyoda (Japan), who has replaced Junichi Akiyama on the IFRIC. Mr Toyoda is employed by the NEC Corporation. He is currently on secondment to the Accounting Standards Board of Japan, where he is a technical manager.

The IFRIC expressed its thanks and good wishes for the future to outgoing member Junichi Akiyama.

Mr Gelard also noted that this meeting would be the last for Robert Comerford (IOSCO-SEC) and for Kevin Stevenson (IASB). Mr Comerford will be leaving the SEC at the end of May. Mr Stevenson is returning to his native Australia at the end of April.

An IFRIC member expressed concern that the short comment letter period on the concessions exposure drafts (Draft Interpretations D12, D13 and D14) would lead to a 'lack of depth' in the comments. One of the international accounting firms had identified at least twelve points of principle in the exposure drafts and is concerned that there were several 'embedded interpretations' – especially of IAS 11 Construction Contracts – that might catch people unawares. The staff noted the concern and stated that the staff would investigate whether an extension of the comment period was possible given the desired completion date for the final interpretations.

IFRIC 3 Emission Rights

Intangible assets

The IFRIC considered a staff proposal to amend IAS 38 Intangible Assets to facilitate 'currency-like' intangible assets (eg emission allowances that can be used to settle emission obligations) to be measured at fair value through profit or loss. That amendment would be a further accounting policy choice in IAS 38.

The IFRIC had received strong representations from the European Financial Reporting Advisory Group (EFRAG) about IFRIC 3, especially with respect to a perceived accounting mismatch caused by the interaction of IAS 20 Government Grants, IAS 37 Provisions, Contingent Liabilities and Contingent Assets, and IAS 38.

The staff proposal would create a special category of intangible asset, which could be used if:

a. the intangible asset's value derives from the fact that it can be used to settle obligations; and b. the intangible asset has a fair value that can be determined by reference to an active market.

The IFRIC discussed the issue at length and explored the staff recommendations as well as other possible alternatives. There was enough support among IFRIC to direct the staff to develop its general proposal further. There was mixed support for a proposal that the accounting model should mandate a 'fair value through profit and loss' approach. One vote taken had enough support for a consensus view however, after further discussion, there was enough opposition to the mandatory requirement to block a consensus. Notwithstanding this vote, the IFRIC agreed that the staff should redraft the proposals assuming a mandatory requirement for fair value through profit or loss.

The staff was asked to refine the accounting model such that the class of intangible asset such that criterion (a) above would be something like 'the intangible asset ultimately derives its value from the fact that it can only be used to settle obligations'.

Hedge accounting

The IFRIC had also received a suggestion from the EFRAG that entities should be allowed to apply, by analogy, the hedge accounting provisions in IAS 39 Financial Instruments: Recognition and Measurement for a cash flow hedge of a foreign currency exposure.

IFRIC members stated that they wished to develop their views on the accounting for intangible assets before giving detailed consideration to this proposal. To that end, they directed the staff to ask EFRAG to prepare a more detailed proposal on hedge accounting and to submit this in good time before the next IFRIC meeting (2-3 June 2005).

IFRIC D9 Employee Benefit Plans with a Promised Return on Contributions or Notional Contributions

The IFIRC discussed a preliminary analysis of comments received on exposure, in particular the measurement of the defined benefit obligation in respect of a D9-type plan. The discussion was wide-ranging, and no conclusions were reached. Several concerns were expressed, especially that, if the tentative staff conclusions were pursued, the IFRIC would be undertaking a far more fundamental amendment of IAS 19 Employee Benefits. Such a move would necessitate re-exposure.

The IFRIC will resume its redeliberations in June.

IFRIC D6 Multi-employer Plans

IFRIC redeliberated IFRIC D6 Multi-employer Plans with respect to State Plans. IFRIC D6 contained a proposed amendment to IAS 19 that stated that entities should account for state plans as defined contribution plans. The results from exposure were inconclusive, and some commentators disagreed with the automatic exemption from defined benefit accounting for any type of plan.

After a brief discussion, the IFRIC agreed with a staff recommendation that the IFRIC should not proceed with the proposed amendments to IAS 19 in relation to state plans.

IFRIC D5 Applying IAS 29 Financial Reporting in Hyperinflationary Economies for the First Time

Disposition of comments received on the 'near-final draft' of proposed IFRIC 6 Applying the Restatement Approach under IAS 29 Financial Reporting in Hyperinflationary Economies.

The IFRIC did not provide Observer Notes for this session.

The IFRIC agreed a number of editorial amendments to the near-final draft of IFRIC 6 suggested by the staff. In addition, they agreed that the section on Transition (paragraph 7) was redundant and should be deleted.

The IFRIC agreed to redraft BC16, which contained a discussion of US generally accepted accounting principles and the reporting requirements of the US Securities and Exchange Commission, such that it is factual rather than discursive.

An IFRIC member raised a concern with the material in IE6, which addresses deferred tax accounting. The member was concerned that, while the example reflected appropriately the IFRIC's conclusions, the accounting result could be seen as being not meaningful. The concern was that the operation of the restatement approach magnifies the deferred tax effect by a greater amount than might be expected. The staff is to review the example. If it could be amended without major work and causing no changes in principle, the consensus would be issued under existing authorities granted by the IFRIC and IASB. However, if there were changes in principle as a result of the staff's review of the example, IFRIC 6 would have to be referred to the IFRIC (and the IASB) in June.

IAS 11 Combining and Segmenting Contracts

The IFRIC discussed a report to the IASB prepared by the staff, which summarised the IFRIC's work and conclusions on this topic. The staff's primary conclusions were (i) that there was no significant difference between IFRS and US GAAP with respect to combining and segmenting construction contracts and (ii) that the Board should assume responsibility for two revenue recognition issues identified during the course of IFRIC's discussions.

IFRIC members expressed concern that, while there might be no difference in net income between IFRS and US GAAP with respect to contract accounting, differences in the timing of revenue and expense recognition under the two regimes could lead to differences. These differences could lead to material differences in the measure of total revenue and total expense, even if net income was not affected.

The IFRIC also discussed two flowcharts comparing IFRS and US GAAP for the separation, allocation and recognition of multiple element arrangements. Some IFRIC members expressed some reservations about the staff analysis with respect to the accounting for multiple element arrangements under IFRS, but the discussion was not conclusive.

The IFRIC was asked to pass any comments to the staff off-line. In addition, they were asked to indicate which, if any, issues related to the topic they might want to pursue. Any such topics might be treated as supplemental topics for the service concessions team.

IFRIC D12, D13, D14 Service Concession Arrangements

The staff provided an oral report on the status of the comprehensive example designed to accompany D12, D13, and D14 on service concession arrangements. The example extends the example in the exposure draft to a 50-year arrangement and contains detailed computations, etc.

The staff had reviewed the example and had a number of comments and some major concerns, in particular with respect to potential conflicts with current requirements of IAS 38. The parties preparing the example (who are independent of the IASB) have yet to respond to the staff. However, from experience they have been very accommodating to staff concerns. The comprehensive example will be available on the IASB Website as soon as the staff is satisfied with its contents. The IFRIC will not review it.

This summary is based on notes taken by observers at the IFRIC meeting and should not be regarded as an official or final summary.

March 2005 edition of Accounting Roundup

01 Apr 2005

We have posted the (PDF 176k), prepared by the National Office Accounting Standards and Communications Group of Deloitte & Touche LLP (USA).

This edition has information about FASB developments (several final and proposed FSPs and summaries of recent FASB meetings); AICPA developments (exploring changes to GAAP for private companies); SEC developments (including SAB 107, an SEC Staff Alert on annual report reminders, and FAQs on the SEC's voluntary XBRL filing program); and international developments (including the IASB Staff Paper on the fair value option, IFRIC's proposed guidance on service concession arrangements, and a summary of the March 2005 IASB meeting). You will find past issues Here.

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