How to record a gain by adopting FAS 123 (R)
Two of the interesting items in Amazon's first quarter press release were that, one, it adopted FAS 123 (R) starting with the first quarter, and two, the adoption resulted in a cumulative effect gain of $26 million dollars. So how does adoption of FAS 123 (R) result in a gain? Well the specifics of Amazon's gain are not available but here is what might have happened. Most option plans start out as fixed plans, so that compensation expense is measured only once on the grant date. Amazon probably had a fixed plan and issued options at the market price, given that it was using the intrinsic method for calaculating compensation expense, the company recorded no comp[ensation expense.
However, Amazon after the market decline probably repriced its option which resulted in the fixed plan becoming a variable plan, now remember that this would result in compensation expense being measured at the end of each period (think of stock appreciation rights plans).
So imagine that in 2000 Amazon issued an option with a seven year vesting period when the market price was $50 to purchase a share at $50. Intrinsic value = $0, no expense.
2003 comes around the stock price is down to $10, amazon reprices the options to $10. The fixed plan becomes a variable plan and at the end of 2002 the market price of Amazon stock is $30, so intrinsic method total compensation expense would be $30 - $10 = $20 and this would have to be allocated over the remaining service period of 4 years. So, 2003 would get $5 of compensation expense.
However, assume that by the end of 2004 Amazon's stock price is now back down to$15, under the intrinsic method total compensation expense would be $15 - $10 = $5 and cumulative compensation expense to date would be $2.50 (2 years remaining on the vesting period from the repricing date), However, amazon has already recognized $5 last year, so the company would have recognized too much compensation expense to date and would get a cumulative effect type gain.
This is a great example for explaining the intricacies of variable vs. fixed option accounting and illustrates the major deficiency in FAS 123 (R) which is that compensation expense for fixed plans is only measured at the grant and is never updated.
However, Amazon after the market decline probably repriced its option which resulted in the fixed plan becoming a variable plan, now remember that this would result in compensation expense being measured at the end of each period (think of stock appreciation rights plans).
So imagine that in 2000 Amazon issued an option with a seven year vesting period when the market price was $50 to purchase a share at $50. Intrinsic value = $0, no expense.
2003 comes around the stock price is down to $10, amazon reprices the options to $10. The fixed plan becomes a variable plan and at the end of 2002 the market price of Amazon stock is $30, so intrinsic method total compensation expense would be $30 - $10 = $20 and this would have to be allocated over the remaining service period of 4 years. So, 2003 would get $5 of compensation expense.
However, assume that by the end of 2004 Amazon's stock price is now back down to$15, under the intrinsic method total compensation expense would be $15 - $10 = $5 and cumulative compensation expense to date would be $2.50 (2 years remaining on the vesting period from the repricing date), However, amazon has already recognized $5 last year, so the company would have recognized too much compensation expense to date and would get a cumulative effect type gain.
This is a great example for explaining the intricacies of variable vs. fixed option accounting and illustrates the major deficiency in FAS 123 (R) which is that compensation expense for fixed plans is only measured at the grant and is never updated.
posted by Don Pagach at 12:07 PM
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