FAS 123R Reporting: Recodified and Explained

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As if the changes from FAS 123 to FAS 123R back in 2004 were not complicated enough, under FASB's Accounting Standards Codification project, as of Sept. 2009, FAS 123R has been recodified and will now be known as FASB ASC Topic 718 - Stock Compensation. Luckily, the recodification does not change GAAP accounting, but merely introduces "one level of authoritative GAAP" and "introduces a new structure—one that is organized into an easily accessible, user-friendly online research system." As a mere re-arrangement, these changes do not affect equity compensation reporting for privately-held companies. Despite that, whenever there is a change, even just in organization or name, we know this will encourage many people to once again try to understand equity compensation reporting (which we are still referring to using the more popular term FAS 123R for now).

Therefore, it seemed like a good time to revisit equity compensation reporting under FAS 123R (ASC Topic 718) and try to explain the most important requirements in a "nutshell" that could greatly increase a CFO's understanding of these complex reporting requirements ... but in just an hour or so. This has been done in an excellent three part blog series by Jeremy Wright of Two Step Software at Two Step's Private Company Equity Management Blog. It divides up the explanation into Part 1: How to value an option using the Black-Scholes formula, Part 2: How to expense stock options, and Part 3: What are the required financial statement disclosures.

At an introductory level, this series nicely collects the definitions, formulas, calculations, and disclosures.

Part 1: Valuation explains the fair value calculation and the six inputs used in the Black-Scholes formula:

  1. Fair Market Value
  2. Exercise Price
  3. Expected Term
  4. Interest Rate
  5. Volatility
  6. Dividend Rate

Two Step Software also provides a free set of Black-Scholes calculators, for those who are not ready to use an online system for equity administration and FAS 123R reporting, which automates the calculation of fair value, as well as the the three inputs: volatility based on a set of peer companies; interest rate; and expected term (including the weighted average vesting calculation).

Part 2: Expensing Stock Options explains the eight terms you need to know to amortize the fair value of a stock option grant over the service period and the three expensing methods:

  1. Fair Value Per Share
  2. Actual Fair Value
  3. Requisite Service Period
  4. Forfeiture Rate
  5. Reporting Period
  6. Expensing Method
  7. Project fair Value
  8. True-Up

Part 3: FAS 123R Disclosures explains the minimum disclosure requirements for financial statement reporting based on FAS 123R Paragraph A240. These disclosures can be divided up into three sections:

  1. Valuation Summary: In this section, you need to report the range and weighted-average value for five values: fair value, volatility, interest rate, expected term and dividend rate.
  2. Option Activity: In this section, you need to report nine items that disclose the number of options outstanding at the beginning of the period, the option activity during the period, and several numbers related to the end of the period.
  3. Expense Recognition: In this section, you need to report eight items that disclose the amount of expense recognized in the past, the amount to be recognized in the current period, and the expense that is projected to be recognized after the current period.

While the information contained in this blog series is quite complex, it remains focused on summarizing the basic definitions, inputs, variables, and formulas. It tries to explain as succinctly as possible what a CFO would want to be familiar with at a minimum when reporting equity compensation expense or reviewing it with an auditor. I hope that this series on valuation, expensing and disclosures under FAS 123R (now ASC Topic 718) will help you understand the basic steps related to this complicated task.

When you are ready to consider moving away from spreadsheets and see how an online equity management system can make stock and option administration and equity compensation reporting much easier, take a look at the 4-minute video Introduction to Equity Focus. It may help you think about whether an online system could make your work much easier, more accurate and less time consuming.

Gary D. Levine, President and CEO
Two Step Software, Inc.


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