Effective date and transition considerations
Statement 123(R) proposes different effective dates and transition methods for private and public companies. This summary identifies the general provisions that are relevant for most companies. A private company that already applies the fair value method under Statement 123 or a company that has grants that change from equity under Statement 123 to liability under Statement 123(R), or vice versa, faces additional issues.
Statement 123(R) requires that private companies that utilized the minimum value method under Statement 123 adopt the new fair value accounting prospectively for new or modified grants for fiscal years beginning after December 15, 2005. Prospective adoption means that awards granted in earlier fiscal years continue to be accounted for using the existing accounting, typically Opinion 25. Private companies that elected to use the fair value method under Statement 123 will follow the same guidance as public companies outlined below.
Public companies should adopt the new fair value accounting under the modified prospective method in fiscal years beginning after June 15, 2005. For small business (S-B) filers, the effective date is fiscal years beginning after December 15, 2005. Modified prospective means that for fiscal years beginning after June 15, 2005 (December 15, 2005 for S-B filers), (1) new grants and modified grants are accounted for in accordance with Statement 123(R) and (2) awards granted in earlier fiscal years that are not yet vested are accounted for in accordance with the fair value model of Statement 123. For companies that currently apply Opinion 25, this transition method effectively brings into the income statement for fiscal years after the effective date the compensation expense that previously would have been reported in the pro forma disclosures.
Public companies may elect to apply a modified retrospective application to periods prior to the effective date (e.g., either for (a) all periods for which Statement 123 was effective or (b) only prior interim periods in the year of initial adoption). Modified retrospective application requires compensation cost and related income tax effects to be accounted for under Statement 123(R), regardless of whether awards were treated as fixed or variable under Option 25. As a reminder, a company electing to apply a modified retrospective application to all prior periods will need to adjust the beginning balances of paid-in capital, deferred taxes and retained earnings and disclose such adjustments in the notes to the financial statements. Those companies applying the modified retrospective method only to interim periods in the year of adoption would not need to adjust beginning balances but should disclose the method utilized.
Practical Note: Under both the modified prospective and modified retrospective applications, no change to assumptions for previous grants would be appropriate, unless it is to correct an error. Companies are required to cease the previous policy of recognizing forfeitures as incurred and instead need to estimate forfeitures and true-up to actual. If a company previously recorded compensation expense in the income statement (either because it issued awards with compensation expense under Opinion 25, such as restricted stock or discounted options, or because it previously adopted the fair value method in its income statements [not just in the notes]), Statement 123(R) requires a charge-off of any remaining balance sheet amounts related to the old forfeiture policy (net of tax effects and exclusive of nonrefundable dividend payments) to be treated as a cumulative effect of a change in accounting.
We expect that most public companies will choose the modified prospective method and choose to handle noncomparability through discussion within MD&A, rather than choosing retrospective application. In transitioning to the requirements of Statement 123(R) under the modified prospective application, some additional considerations include computing cumulative catch-up adjustments for the following items:
- Estimation of forfeitures for awards not yet fully vested, if the company previously recorded forfeitures only as they happened;
- Elimination of any contra-equity accounts relating to unearned or deferred compensation for awards issued prior to adoption of Statement 123(R);
- Determination of fair value for liability awards previously recorded under intrinsic value method; and
- Awards that are liabilities under Statement 123(R) but were treated as equity previously.
If in applying Statement 123(R) a company concludes that its pro forma disclosures reported under Statement 123 contained material errors, they will need to correct those disclosures. Detection of such errors raises a question about the adequacy of internal controls and requires the company to assess the significance of the deficiency.
If a company voluntarily adopted the fair value method in accordance with Statement 123 and FASB Statement No. 148 (As Amended), Accounting for Stock-Based Compensation - Transition and Disclosure -- An Amendment of FASB Statement No. 123, it had three choices in transition-prospective, modified prospective, and retrospective. If the company chose retrospective or modified prospective at that time, it continues to apply the same accounting to past awards and to awards granted in 2004 and 2005 and applies the accounting requirements of Statement 123(R) to new awards. If the company previously chose the prospective transition method, Statement 123(R) effectively overrides that decision by requiring the modified prospective method now.
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