SEC views on accounting for stock options

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20 Sep 2006

The Office of the Chief Accountant (OCA) of the US SEC has stated its views on the appropriate application of the stock option accounting literature in the historical financial statements of public companies in the following circumstances: dating an option award to predate the actual award date, option grants with administrative delays, uncertainty as to the validity of prior grants, and other related circumstances. The OCA's views are set out in a letter to the Committee on Corporate Reporting of Financial Executives International and the Center for Public Company Audit Firms of the American Institute of Certified Public Accountants.

Prior to the adoption of the Financial Accounting Standards Board's Statement No. 123 (revised 2004) Share-Based Payment, many US public companies accounted for stock options under Accounting Principles Board Opinion No. 25 Accounting for Stock Issued to Employees. The OCA's letter discusses the accounting consequences under Opinion 25 of the circumstances cited above. One of the key conclusions in the letter is as follows:

In many cases, when options were awarded before (or in the absence of) completion of required granting actions, the terms cannot be considered to have been determined with finality until (and unless) such actions were completed. Indeed, as evidenced by some of the option granting practices and patterns of conduct that the staff has become aware of, awarding options in a manner that did not comply with the required granting actions does suggest that the terms and recipients of the options may have been subject to change. For example, in the event that the company's stock price declined prior to finalizing the required granting actions, the company may have retracted awards (e.g., failed to follow through with the initially determined awards) or lowered the exercise price of options. This type of practice indicates that, for all awards (including those awards for which the terms were not changed), the terms and recipients were not determined with finality (and therefore were not "known") prior to the completion of all required granting actions. Similarly, any evidence indicating that the preparation of documentation was done in a manner calculated to disguise the true nature of the option granting actions would preclude a company from concluding that a measurement date occurred prior to the completion of all required granting actions. If a company operated as if the terms of its awards were not final prior to the completion of all required granting actions (such as by retracting awards or changing their terms), the staff believes the company should conclude that the measurement date for all of its awards (including those awards that were not changed) would be delayed until the completion of all required granting actions.

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