Page 162 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

148 The Complete Guide to Executive Compensation

the newly authorized restricted stock options under the 1950 Revenue Act. This bulletin
stated that such stock would not require a charge to the income statement. This principle
for nondiscounted stock options would be challenged in the 1990s and later reversed with
FAS 123.
Accounting Principles Board. The Accounting Principles Board (APB) succeeded the
AICPA in 1959 and, through it, accounting firms established generally accepted accounting
principles (GAAP), which form the basis for consistency in accounting matters. The basic
rule is that compensation is an expense charged to earnings, and all stock issued is a dilution.
A landmark ruling affecting executive pay was Opinion No. 25 in 1972, “Accounting for
Stock Issued to Employees.” It was prompted by the establishment of restricted stock plans
(which will be discussed in Chapter 8, “Long-Term Incentives”).
APB 25 stated that in accounting for stock issued to employees, one either had a compensa-
tory stock option or a noncompensatory stock option. Noncompensatory plans were considered those
intended to raise capital and/or diversify ownership among its employees. The requirements
included the following:
• Substantially all full-time employees must be eligible.
• The stock must be distributed equally per formula to all eligible persons.
• A reasonable time period must be provided to exercise the rights.
• Discount from market price can be no greater than a reasonable offer to shareholders
or others.

A compensatory plan is one that does not meet all four of these requirements. Broad-based
stock option plans may meet the definition of a noncompensatory plan, but executive stock
option plans clearly would be compensatory. There are no compensation expenses under the
former, but under the latter, an expense equal to the difference between the option price and
the market price at time of grant must be charged over the vesting period. This would be zero
if there were no discount—a continuation of AICPA Bulletin No. 43.
Under APB 25, plans are categorized as either fixed or variable. As the term suggests,
with a fixed plan the expense is fixed or determined at time of grant (and therefore sometimes
called grant date accounting). Under a variable plan, the expense is determined at the date
following grant when both the number of shares and the price per share are known. The
former would include traditional, nondiscounted stock options (as well as those with a
discount at time of grant). It also covers restricted stock awards when the number of shares
and latest possible payment date are known. Variable plans essentially cover all other type of
stock options and stock awards.
The key principle of APB 25 is the measurement date principle, which states that compen-
sation expense should be measured when the number of shares and price per share is first
known. More specifically, “Compensation for services that a corporation receives as consid-
eration for stock issued through employee stock option, purchase, and award plans should be
measured by the quoted market price of the stock at the measurement date less the amount,
if any, that the employee is required to pay … if a quoted market price is unavailable, the best
estimate of the market value of the stock should be used to measure compensation. The
measurement date for determining compensation cost in stock option, purchase, and award
plans is the first date on which are known both (1) the number of shares an individual
employee is entitled to receive and (2) the option or purchase price, if any.” The net result is
that there is no requirement for a charge to earnings for stock options that are issued at or