Articles

Current Status of the International Financial Reporting Standards (IFRS)

United States
Most companies in the U.S. are adopting a wait and see approach with respects to IFRS. Their concerns (as per a survey conducted by Deloitte Development LLC in 2008) appear to be principally:

1. Cost (education, training and systems),
2. Lack of consistency in applying IFRS globally (it is more of a principles-based standards than is GAAP, which is more rule-based), and;
3. Reservations on how the reported information will be received by analysts and investors.

Related to the third concern, information presented in CFO.com in 2007 suggested an improvement in 2006 earnings across most EU companies in moving from GAAP to IFRS, but without a discernable relationship.

The future direction for the US should become clearer on June 16, 2008 when in a public forum held in New York, the FASB and the FAF will discuss how the US will move forward with respect to IFRS. FASB chairman Robert Herz said the intent is to devise a progressive plan to "identify the most orderly, least disruptive, and least costly approach" to transition U.S. public companies to IFRS. The forum's main intent is to determine whether a dual accounting system will be adopted allowing companies to determine whether to use GAAP or IFRS or to have the FASB set a specific deadline for which all companies must switch to only IFRS standards.

Canada
In Canada, the Accounting Standards Board (AcSB) confirmed in February that it has established an adoption date for IFRS of January 1, 2011, i.e. reporting on a full year basis in 2012.

On April 7th 2008, the AcSB released its omnibus Exposure Draft for conversion to IFRS and the replacement of Canadian GAAP. Comments to the draft (available via the link below) must be made by July 31, 2008.
Adopting IFRSs in Canada

Implications for Accounting for Stock-Based Awards

Two objectives of releasing FAS 123(R) in the US in 2004 were to simplify and standardizing GAAP reporting (by eliminating APB 25's intrinsic value method) and to achieve greater convergence with international accounting standards, however, there remain some wide GAAPs between FAS 123(R) and IFRS 2.

When IFRS 2, "Share-based Payment", was issued in February 2004, it required, for the first time, that share-based payments to be recognized as an expense and that, "an entity [must] reflect in its profit or loss and financial position the effects of share-based payment transactions, including expenses associated with transactions in which share options are granted to employees." (Technical Summary of IFRS 2, prepared by the IASC Foundation).

Keeping with its principles-based approach, IFRS 2, including appendices, is roughly 130 pages. By comparison, FAS 123(R) runs close to 300 pages, and interpretations and applications put forth by the major accounting firms can exceed 500 pages. In terms of scope, FAS 123(R) deals little with awards to non-employees, since these are largely treated under EITF Issue No. 96-18, "Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services" and now 00-18 (same topic).

Both FAS 123(R) and IFRS 2 make distinctions of when costs are measured and how they are recognized based on whether an award is treated as an equity or liability instrument at grant (or subsequently). Both statements require reporting companies to base the expense recognition on the best available estimate of the number of shares expected to vest and to revise those estimates in the presence of better, more accurate data.

The more significant areas of divergence between FAS 123(R) and IFRS 2 are listed in A Roadmap to Fair Value Measurements under FAS 123 Share-Based Payment - Second Edition, Deloitte & Touche (USA). They are described below.

• IFRS 2 requires the use of the modified grant-date method for share-based payment arrangements with nonemployees. In contrast, Issue 96-18 requires that grants of share options and other equity instruments to nonemployees be measured at the earlier of (1) the date at which a commitment for performance by the counterparty to earn the equity instruments is reached or (2) the date at which the counterparty's performance is complete.
• IFRS 2 contains more stringent criteria for determining whether an employee share purchase plan is compensatory or not. As a result, some employee share purchase plans for which IFRS 2 requires recognition of compensation cost will not be considered to give rise to compensation cost under FAS 123(R).
• IFRS 2 applies the same measurement requirements to employee share options regardless of whether the issuer is a public or a nonpublic entity. FAS 123(R) requires that a nonpublic entity account for its options and similar equity instruments based on their fair value unless it is not practicable to estimate the expected volatility of the entity's share price. In that situation, the entity is required to measure its equity share options and similar instruments at a value using the historical volatility of an appropriate industry sector index.
• In tax jurisdictions such as the United States, where the time value of share options generally is not deductible for tax purposes, IFRS 2 requires that no deferred tax asset be recognized for the compensation cost related to the time value component of the fair value of an award. A deferred tax asset is recognized only if and when the share options have intrinsic value that could be deductible for tax purposes. Therefore, an entity that grants an at-the-money share option to an employee in exchange for services will not recognize tax effects until that award is in-the-money. In contrast, FAS 123(R) requires recognition of a deferred tax asset based on the grant-date fair value of the award. The effects of subsequent decreases in the share price (or lack of an increase) are not reflected in accounting for the deferred tax asset until the related compensation cost is recognized for tax purposes. The effects of subsequent increases that generate excess tax benefits are recognized when they affect taxes payable.
• FAS 123(R) requires a portfolio approach in determining excess tax benefits of equity awards in paid-in capital available to offset write-offs of deferred tax assets, whereas IFRS 2 requires an individual instrument approach. Thus, some write-offs of deferred tax assets that will be recognized in paid-in capital under FAS 123(R) will be recognized in determining net income under IFRS 2.

One can debate how substantive these differences are, and in any case their relevance is limited to instances where companies are presently reporting under both standards or will be converting from FAS 123(R) to IFRS 2, as part of a wholesale conversion from GAAP to IFRS. In that case, the differences between FAS 123(R) and IFRS 2 will be minimal in the context of the overall conversion issues.

Supreme Court rules on lawsuit against corporate plan administrator

In a unanimous decision by the US Supreme Court on February 26, 2008 equity plan administrators can now be sued by their participants if their accounts are mishandled, overturning a ruling made by the U.S. 4th Circuit Court of Appeals in Richmond, VA. The initial ruling was based on a 1985 precedent that rejected lawsuits of this nature, permitting only legal actions to be taken in cases where the mismanagement of the entire plan was involved, rather than the case of a single participant account. "That landscape has changed" stated Justice John Paul Stevens. Modern plans allow for much more personal selection and fund management than those of 20 years ago.

In September 2000, James LaRue had instructed the administrators of his 401(K) plan at DeWolff Boberg & Associates, a Dallas-based consulting firm, to make certain changes to the allocation of his investments and move his assets from equity funds into low risk bond funds. His instructions were not followed and the subsequent downturn in the market resulted in personal losses of approximately $150,000. On June 2, 2004, LaRue filed a civil action to acquire reimbursement for the funds lost due to the administrator's misconduct.

Citing this as a breach of fiduciary duties and stipulating that individual participants are protected under section 502(a)(2) of the Employee Retirement Income Security Act of 1974 (ERISA), the Supreme Court ruled that LaRue was able to sue for those losses but must prove negligence on the part of the administrator. The ruling effects not just 401(K)s but all defined contribution plans which includes 70 million working American participants with around $3.3 trillion in total investments. The average US worker who has been in a plan since 1999 has $66,650 invested in their 401(K) plan.

Some experts feel this ruling may lead to lower popularity of these types of retirement plans by smaller companies and that it may result in raised administrative fees for the management of such plans in order to cover the potential costs and risks of litigation. Outsourcing plan administration is becoming a more viable option where corporations can effectively shift the bulk of the management duties and risk to a third party.

It will focus plan sponsors on using people who get it right and get it right the first time.

states Martha Priddy Patterson, director Human Capital Practice - Deloitte Consulting.

35 years of stock options and Black-Scholes

The use of stock options for employee compensation is now commonplace for many industries but it was relatively recently that they were first introduced to the trading community. This quarter marks the 35th Anniversary of the introduction of stock option trading, making it the perfect opportunity to have a look back at how they came to be and how they made it into the compensation packages of around 10 million employees.

April 26th, 1973 marked the beginning of a revolutionary change in the financial community when the first exchange-listed stock option in the world was made available and publicly traded on the Chicago Board Options Exchange (CBOE). Thirty-five years later the CBOE now trades over 806 million (2006) contracts annually.

The spread in popularity of options soon led to the need to ensure stability and integrity in the market so the government establishing the Commodity Future Trading Commission and the Options Clearing Corporation. It also drove Fischer Black and Myron Scholes to create a quantitative model in order to accurately estimate the value of options. The Black-Scholes model is still used widely today despite some inherent errors due to assumptions of prices following a stationary log-normal process, a constant interest rate, constant market volatility and continuous dividend payments, however, the model is quite valuable for approximations.

The availability of call and put options and their accessibility to the general public in the 70's helped open the door for the advent of employees receiving stock options as part of their compensation plans. The popularity of stock options saw a steady rise throughout the 90's. The number of employees that receive stock options broke the 1 million mark in 1992 and as their availability spread outside of the executive offices to the rest of the employees, the numbers have risen to around 9 million employees today.

Part 1 of 2 : Look for Part 2 in the next issue of KnowledgeWorks in August

Plan managers across North America are coping with more and more complexity as compliance requirements evolve and plan designs shift to suit immediate and future goals. Companies are seeking a means to effectively execute, manage and administer multiple plan types while achieving the core purpose of aligning company and employee aspirations.

Multiple stakeholders, different plan designs and evolving compliance issues require administrators to provide accurate, timely information to a diverse group of individuals that require customized information at different times for specialized requirements. Compounding this challenge with keeping plan participants educated and up-to-date with benefits of the plan, changes to the plan, and transaction functionality, presents administrators with huge mandates to satisfy and effectively manage their employee equity initiatives.

During its tenure in the employee equity plan services industry, Solium Capital Inc. has developed this "Top Ten Best Practices in Employee Equity Plan Administration" as a tool to assist companies who are currently evaluating new plan implementations or considering changes to existing plans.

1. Motivate a diverse employee set through multiple plan types
   Many organizations are evolving their employee plans to utilize multiple incentive plan types and create value for their employees while directly connecting their performance to the company bottom line. As a result, companies are using multiple plan types to achieve various goals. Stock options, share units, share appreciation rights (SARS), tandem SARs, RRSPs, savings plans, share purchase plans, and stock settled SARs are all effective ways to motivate employees.
2. Provide employee self service
   Equity-based incentive and savings plans can be effective tools to align company and employee objectives. However, employees need to understand what benefits the plans offer, how to access the plans, how to transact and how to monitor their holdings to make educated decisions about their assets. Organizations that place control in the hands of the employee, quickly realize the benefits of employee self-service and enhanced plan transparency. Shifting control to employees with tools such as online account access, real-time transactions, ability to view holdings online and on demand statements are all tools and best practices that leading companies are implementing to increase the effectiveness of their plans. Participants become empowered to manage their holdings, choose when and how to transact and become more closely linked with company performance.
3. Support real-time market transactions
   With the emergence of the Internet economy and online banking, timelines for execution are shrinking and employee expectations are increasing. Providing real-time transaction capabilities enable employees with self-service functionality and direct links to the market allowing for immediate processing of trades. Employees can monitor their portfolios from anywhere at anytime and feel empowered to make decisions that suite their timeframes. Organizations who are leading these new initiatives in employee equity plans can now provide online execution with direct deposits to employee personal bank accounts in as little as 4 days.
4. Standardize and automate plan administration
   Increasingly companies are opting to automate processes to lower total cost of ownership and reduce the risk of data and transaction errors. Utilizing technology can ensure consistency and accuracy in ongoing processes such as reporting, black out automation, generating online plan statements, processing share sales, option exercises, automating employee communications, suspensions and terminations.
5. Centralize your data source to create a singular view
   As discussed, companies utilizing different plans for different purposes are becoming commonplace. As such, the integration of data associated with these plans is not only a best practice but also a necessity. Accurate data becomes paramount when administrating employees that may participate in multiple plans. One source for all employee demographics and plan details ensures minimal maintenance of data changes due to employee turnover, overlap between multiple plans, activations, and contribution changes and ensures that all stakeholders have accurate information on an ongoing basis.

Best practices 6-10 will be published in the next issue of Knowledgeworks.

Regular Features

The Shrinking Board
On February 26th, the Financial Accounting Foundation Board of Trustees approved a change to restructure and streamline the Financial Accounting Standards Board by reducing the number of people who serve on the board from seven to five. According to Terri Polley, the interim COO of the FAF, the move is intended to make the board more efficient, nimble and better able to respond quickly to changes in the global marketplace.

The change comes into effect on July 1, 2008. Board members are appointed for five-year terms and are eligible to serve two consecutive terms and have a staff of approximately 68 other professionals.

The SEC Hit List

Individual(s)	Title	Company	Charge	Status	Penalty
Sharlene Abrams	CFO	Mercury Interactive Corp.	Tax evasion related to stock option backdating for non-qualified stock options	Indicted	MIC/HP - $145 million
		Broadcom Corp.	Fraud - Stock option backdating	Fined	$12 million
James Treacy Anthony Bonica	President and COO Controller	Monster.com	Fraud - stock option backdating	Charged	potentially $13.5 million and up to 25 years
Weili Dai	COO	Marvell Technology Group	Stock option backdating	Agreed to fines	Dai- $500,000 Marvell - $10mil

Recently (May 7, 2008) the Chairman of the SEC addressed the US Senate Committee on Appropriations and gave a review of the SEC's activities in 2007. He reported that the SEC had been very active in cases regarding stock option backdating in order "to stamp out that notorious abuse" and that, in all, the SEC's investigations had led to the surrender of more than $1 billion in illegal profits and payments of more than $500 million in financial penalties.

CFO's top concerns look towards HR

In a recent survey (Feb. 2008) conducted by Duke University and CFO.com, CFOs were polled to determine what their top concerns for conducting business in 2008 were. Three of the top ten fall into the radar of HR. With the cost of labor claiming the number two spot and cost of health care and the shortage of skilled workers falling closely behind, HR professionals can expect some executive attention to be directed their way in 2008.

Scores are based on the weighted average importance score of the respondents top three ranked concerns.
http://www.cfo.com/article.cfm/10596933/c_10711055?f=TodayInFinance_Inside

Random Statistic: Over 10% of valuable options expire unexercised every year. Effective communication can help engage and educate participants, increasing the inherent value of a plan.