EITF ABSTRACTS Issue No. 88-6 Title: Book Value Stock Plans in an Initial Public Offering [Nullified by FAS 123(R) except for entities within the scope of paragraph 83 of FAS 123(R)] Dates Discussed: March 10, 1988; April 21, 1988; June 2, 1988 References: ISSUE FASB Statement No. 123, Accounting for Stock-Based Compensation FASB Statement No. 5, Accounting for Contingencies FASB Statement No. 123 (revised 2004), Share-Based Payment FASB Interpretation No. 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans FASB Interpretation No. 44, Accounting for Certain Transactions involving Stock Compensation APB Opinion No. 25, Accounting for Stock Issued to Employees SEC Accounting Series Release No. 268, Presentation in Financial Statements of "Redeemable Preferred Stocks" In Issue No. 87-23, "Book Value Stock Purchase Plans," the Task Force reached a consensus concerning the accounting for book value stock purchase plans of privately held companies and for book value stock option plans of both privately held and publicly held companies. For a book value stock purchase plan of a privately held company, the consensus provides that no compensation expense should be recognized for the increase in book value during the employment period if (1) the employee makes a substantive investment that will be at risk for a reasonable period of time and (2) the formula that determines the price at which the employee sells the stock back to the company is the same as the formula that determines the purchase price. For book value stock option plans of privately held and publicly held companies, the consensus provides that compensation expense should be recognized for any increase in book value from date of grant to date of exercise. During the discussion of Issue 87-23, a question was raised concerning the recognition and measurement of compensation expense for private Page 1
company book value stock purchase and stock option plans in connection with an initial public offering (IPO). The issues are: 1. Whether the accounting by a publicly held company for a book value stock purchase plan differs from that of a privately held company 2. For book value stock option plans, what the appropriate accounting is at the time of the IPO if the option (a) converts to an option to purchase unrestricted stock (market value stock option) or (b) remains a book value stock option 3. For book value stock purchase plans, what the appropriate accounting is at the time of the IPO if the book value stock (a) converts to market value stock or (b) remains book value stock 4. If modification to the accounting followed by a privately held company is required when the company has an IPO, whether the modification should occur only at the time of a successful public offering or at some earlier time. EITF DISCUSSION The Task Force reached a consensus on Issue 1 that a book value stock purchase plan of a publicly held company should be considered a performance plan and should be accounted for like a stock appreciation right (SAR). [Note: This consensus has been nullified by Statement 123(R). See STATUS section.] The SEC Observer noted that for existing book value stock purchase or stock option plans, issuances or grants under those plans made prior to January 28, 1988 need not be accounted for like an SAR if such accounting treatment was not being followed prior to that date and the terms of the book value plan had been adequately disclosed. The Task Force discussed book value stock options that convert to market value stock options (Issue 2(a)) and reached a consensus that, in addition to compensation expense previously recognized for actual changes in book value, compensation expense should be recognized upon successful completion of the IPO for the difference between market value and book value at the date of the IPO because the conversion of the book value option to a market value option results Page 2
in a new measurement date. Subsequent to the IPO, no further compensation expense would be recognized under Opinion 25 assuming the plan otherwise remains a fixed plan under that Opinion. [Note: This consensus has been nullified by Statement 123(R). See STATUS section.] For book value stock options that remain book value stock options (Issue 2(b)), the Task Force reached a consensus that any change in book value resulting from successful completion of the IPO should be recognized as compensation expense at the time of the IPO in accordance with variable-plan (SAR) accounting. Subsequent to the IPO, the plan should continue to be accounted for like an SAR based on the consensus reached in conjunction with Issue 87-23. [Note: This consensus has been nullified by Statement 123(R). See STATUS section.] The SEC Observer stated that for book value stock options that either convert to market value options or remain book value options (Issues 2(a) and 2(b)), the registration statement filed in conjunction with the IPO should include prominent pro forma disclosure of the additional compensation expense that will be recognized upon successful completion of the IPO. The Task Force reached a consensus that for book value stock purchase plans in which the book value stock converts to market value stock (Issue 3(a)), no compensation expense should be recognized at the time of the IPO for the difference between market value and book value. However, book value shares issued under the purchase plan within one year of the IPO are presumed to have been issued in contemplation of the IPO and would result in compensation expense for the difference between the book value price of those shares and the estimated fair value at the date of issuance (considering the IPO price and other evidence of fair value). Subsequent to the IPO, no further compensation expense would be recognized under Opinion 25 assuming the plan otherwise remains a fixed plan under that Opinion. [Note: This consensus has been nullified by Statement 123(R). See STATUS section.] Page 3
The Task Force also reached a consensus that for book value stock that remains book value stock (Issue 3(b)), no compensation expense should be recognized upon successful completion of the IPO for any impact that the IPO may have on the book value. However, book value shares issued under the purchase plan within one year of the IPO are presumed to have been issued in contemplation of the IPO and would result in compensation expense under variable-plan (SAR) accounting for actual changes in book value of those shares since the date of issuance. Subsequent to the IPO, compensation expense would be recognized for increases in book value after the IPO under the consensus reached on Issue 1. [Note: This consensus has been nullified by Statement 123(R). See STATUS section.] The SEC Observer stated that the registration statement filed in conjunction with the IPO should include prominent pro forma disclosure of the additional compensation expense related to book value shares issued within one year of the IPO that will be recognized upon successful completion of the IPO. The Task Force noted that, with respect to Issue 4, the combination of the Task Force consensuses for the preceding Issues and the SEC guidance defines the timing of compensation expense recognition as well as pro forma disclosure. [Note: This Issue has been nullified by Statement 123(R). See STATUS section.] The Task Force Chairman noted that the Task Force consensuses do not apply to market value plans, which should be accounted for under Opinion 25. The Task Force agreed that the plans covered by those consensuses and accounted for as SARs should not result in cumulative compensation expense of less than zero, consistent with Interpretation 28. The examples in Exhibit 88-6A are presented to summarize those consensuses and illustrate their application. [Note: This Issue has been nullified by Statement 123(R). See STATUS section.] With respect to book value stock purchase plans (Issues 3(a) and 3(b)), the SEC Observer stated that, for issuances or purchases prior to the one-year period, the SEC staff generally will not Page 4
challenge the accounting for book value stock unless there is evidence that (1) the stock was issued in contemplation of a public offering or (2) the book value is materially different from the market value at the date of issuance. For publicly held companies with existing book value stock plans and for privately held companies with book value stock plans that will remain in existence after an IPO, the SEC Observer noted that the SEC staff will require that the redemption amount of the book value stock be classified in the balance sheet outside stockholders' equity, consistent with the requirements of ASR 268, if the plan includes any conditions under which the company must redeem the stock with the payment of cash. STATUS In October 1995, the FASB completed its reconsideration of Opinion 25 and issued Statement 123. Statement 123 defines a fair value based method of accounting for stock-based compensation plans and encourages all entities to adopt that method of accounting. However, it also allows an entity to continue to measure compensation cost for employee plans using the intrinsic value based method of accounting prescribed in Opinion 25. Statement 123 does not address issues related to the application of Opinion 25. Interpretation 44 was issued by the FASB in March 2000. It clarifies application of Opinion 25 to certain issues. It supports the consensus reached in Issue 1. For public entities if a repurchase feature is not based upon the fair value of the shares at the date of the repurchase, variable accounting is required. Interpretation 44 does not specifically address the other issues in Issue 88-6. Statement 123(R) was issued in December 2004. This Issue addresses the accounting for book value stock plans under Opinion 25. Statement 123(R) replaces Statement 123, supersedes Interpretation 44, and supersedes Opinion 25, thereby nullifying this Issue. However, this Issue Page 5
would still apply to those entities that continue to account for awards under Opinion 25 and its related interpretive guidance pursuant to paragraph 83 of Statement 123(R). No further EITF discussion is planned. Page 6
Exhibit 88-6A EXAMPLES OF THE APPLICATION OF OPINION 25 AND THE EITF CONSENSUSES ON ISSUES 87-23 AND 88-6 IN AN IPO The following examples describe the application of Opinion 25 and the consensuses from Issues 87-23 and 88-6 to book value stock option and stock purchase plans in an IPO. Assumptions Book Value per Share Market (Fair) Value per Share 1 year prior to IPO $10 $15 Immediately prior to IPO $12 $19 Immediately after IPO $15 $19 1 year after IPO $16 $21 Compensation Expense Recognition Shown below is the amount of compensation expense to be recognized in the case of an IPO for both book value stock option plans and book value stock purchase plans that (a) convert to market value plans or (b) remain book value plans for the following three periods: Period 1 One year before the IPO until immediately prior to the IPO Period 2 Immediately prior to the IPO until immediately after the IPO Period 3 Immediately after the IPO until one year after the IPO Book Value Stock Option Plans (a) Book value stock option converts to market value stock option Compensation Basis for Period Expense Conclusion 1 $2 ($12 $10) Issue 87-23 consensus 2 a $7 ($19 $12) Issue 88-6 consensus 3 None Opinion 25 (fixed plan) a The registration statement filed in conjunction with the IPO should include prominent pro forma disclosure of the additional compensation expense that will be recognized upon successful completion of the IPO. Page 7
(b) Book value stock option remains book value stock option Compensation Basis for Period Expense Conclusion 1 $2 ($12 $10) Issue 87-23 consensus 2 a $3 ($15 $12) Issue 88-6 consensus 3 $1 ($16 $15) Issue 87-23 consensus Book Value Stock Purchase Plans (a) Book value stock converts to market value stock Compensation Basis for Period Expense Conclusion 1 None b Issue 87-23 consensus 2 None Issue 88-6 consensus 3 None Opinion 25 (fixed plan) (b) Book value stock remains book value stock Compensation Basis for Period Expense Conclusion 1 None c Issue 87-23 consensus 2 a None c Issue 88-6 consensus 3 $1 ($16 $15) Issue 88-6 consensus a The registration statement filed in conjunction with the IPO should include prominent pro forma disclosure of the additional compensation expense that will be recognized upon successful completion of the IPO. b For shares issued within one year of the IPO, compensation expense should be recognized for the difference between the book value price and the estimated fair value at the date of issuance. In that example, a share issued one year prior to the IPO would require recognition of $5 of compensation expense ($15 fair value $10 book value). Subsequent changes in fair value or book value would not result in compensation expense. c For shares issued within one year of the IPO, compensation expense should be recognized under variable-plan (SAR) accounting for actual changes in book value since the date of issuance. In that example, a share issued one year prior to the IPO would require recognition of $2 of compensation expense in Period 1 ($12 $10). Compensation expense for Period 2 of $3 ($15 $12) would require prominent pro forma disclosure in the registration statement filed in conjunction with the IPO as well as recognition upon successful completion of the IPO. Page 8