Accounting industry sets stock option standards

Stock options have long been a part of blue-chip firms’ compensation packages. But not until the dot-com boom were stock options supplementing salaries and payments to non-employees so extensively.

Now, the Canadian Institute of Chartered Accountants and the Accounting Standards Board are establishing guidelines for the reporting of stock-based compensation. These new regulations, which take effect Jan. 1, 2002 for public companies and private companies on Jan. 1, 2003, will affect a company’s bottom line, experts say. The changes only apply to awards granted before fiscal periods beginning on or after Jan. 1, 2002.

Under the new standard, if there is a possibility that cash will be paid out under a company’s plan, the company will have to measure its liabilities at every reporting period. “A lot of companies that have those kinds of plans are looking to change them because they don’t want to have that earnings volatility,” said Kerry Danyluk, senior manager in the professional practice for Ernst & Young LLP.

For example, some plans allow employees to decide whether they want to pay the exercise right away and get the share or when they exercise the option, receive the difference between the exercise price and the current trading price of the share.

“The reason why companies use those kinds of plans is because then they can get a tax deduction for any amounts of cash that they pay. If it’s just an option, the company doesn’t get any kind of tax relief — if they just exercise and get the share, there’s no tax relief,” said Danyluk.

However, under the new regulations, companies are re-thinking their stock-based compensation plans, Danyluk added.

“They’re saying ‘Sure, the tax deduction was great, while it lasted. But we don’t want the earnings volatility.’ I guess that’s telling in itself that they think it’s going to be a big deal,” she said.

Danyluk said many high-tech companies do not fall into this group because they do not want to have the cash liability to employees. But changes to options granted to non-employees will affect them.

Companies that pay for services with cash and options — to lawyers and consultants, for example — will now have to come up with a fair value of either the services they receive or the options granted. The value for the options will be based on the company’s past stock performance.

“What’s going to happen is when they are giving out options like that, they will always end up having an expense where maybe they have not in the past because we generally really didn’t account for options in Canada before,” said Danyluk.

The purpose of these new accounting rules is to provide better market comparability between the American and Canadian companies.

“I would suggest that it’s a good thing,” said Peter Doyle, national industry director, software and electronics for KPMG LLP. “It won’t be that noticeable a difference between the Canadian environment and the U.S. environment.”

Added Doyle: “With respect to the options that were being issued, there were really no guidelines in Canada to require companies to value those options and expense them. And this is what the new rules are going to do. If you’re a public company and you’re using options as currency, you’re going to be required to value them, account for them (and) take a charge to your income statement.”

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