FAS 123R is the 2006 financial accounting standard introduced by the Financial Accounting Standards Board (FASB) that requires companies to deduct the amount of share-based (equity) payment granted to their employees on an annual basis. Share-based payment is a transaction in which a company acquires or receives goods or services for equity-based payment, such as stock options, restricted stock, or performance shares.
FAS 123R applies to all share-based payment transactions, whether they are settled in cash, equity instruments, or a choice of either. The basic idea behind It is that the costs associated with equity payment for employee services are to be expensed on financial statements in order to reflect the economic transaction taking place between a company and its employees.
In this article, we will provide some background on how FAS 123R came into being, explain its main requirements and methods, and discuss its impact and implications for various stakeholders. We will also compare It with other accounting standards and practices around the world.
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FAS 123R: An Overview
- It is a financial accounting standard that requires companies to expense the cost of share-based (equity) compensation to their employees on their financial statements.
- It was introduced by the Financial Accounting Standards Board (FASB) in 2006 and applies to all forms of equity compensation, such as stock options, restricted stock, stock appreciation rights, etc.
- It aims to reflect the economic transaction between a company and its employees and to align the interests of shareholders and managers.
Why FAS 123R Matters
- Before FAS 123R, companies did not have to expense the cost of equity compensation because it was not a real cash outflow to the company.
- However, equity compensation is a direct expense to the shareholders, who bear the dilution of their ownership stake when new shares are issued or convertible securities are converted.
- Expensing equity compensation helps to improve the transparency and comparability of financial reporting and to reduce earnings manipulation by managers.
How FAS 123R Works
- It requires companies to estimate the fair value of equity awards at the grant date and recognize the compensation expense over the vesting period.
- The fair value of equity awards is determined by using valuation models, such as the Black-Scholes model or the binomial model, that take into account various factors, such as the stock price, the exercise price, the expected volatility, the expected dividend yield, the risk-free interest rate, and the expected term.
- The compensation expense recognized for equity awards with performance conditions is based on the probable outcome of that performance condition, with adjustments made to reflect the actual outcome at the end of the vesting period.
The Impact of FAS 123R
- FAS 123R has changed the landscape of executive compensation and corporate governance in several ways:
- It has reduced the use of stock options and increased the use of other forms of equity compensation, such as restricted stock or performance shares, that have more motivational power and fewer risk-taking incentives.
- It has increased the sensitivity of executive pay to stock price performance and reduced the sensitivity to accounting earnings performance, which may affect managers’ investment and financing decisions.
- It has increased the disclosure and communication of equity compensation plans and policies to shareholders and regulators, which may enhance shareholder activism and oversight.
Conclusion
- FAS 123R is a significant accounting standard that affects how companies measure and report the cost of equity compensation to their employees.
- FAS 123R aims to provide a more accurate and consistent representation of the economic transaction between a company and its employees and to align the interests of shareholders and managers.
- FAS 123R has implications for executive compensation design, corporate governance practices, and financial decision-making.
Frequently Asked Questions (F&Qs)
What is FAS 123R expense?
The FAS 123R expense is a non-cash expense, meaning that it does not have a direct impact on the company’s cash flow. However, the expense does reduce the company’s net income, which can impact its earnings per share.
What is the difference between FASB and GAAP?
- FASB stands for Financial Accounting Standards Board. It is an independent, non-profit organization that sets accounting standards for public companies in the United States.
- GAAP stands for Generally Accepted Accounting Principles. It is a set of accounting standards that companies must follow when preparing their financial statements. GAAP is set by the FASB.
Here is a table that summarizes the key differences between FASB and GAAP:
| Feature | FASB | GAAP |
|---|---|---|
| Name | Financial Accounting Standards Board | Generally Accepted Accounting Principles |
| Organization | Independent, non-profit organization | Set of accounting standards |
| Purpose | Sets accounting standards for public companies in the United States | Provides a set of rules and guidelines for companies to follow when preparing their financial statements |
| Authority | The FASB is the only organization that can issue new GAAP standards | GAAP is not legally binding, but it is widely accepted by accountants and regulators |
When was SFAS 123 effective?
SFAS 123, or Statement of Financial Accounting Standards No. 123, was effective for financial statements for fiscal years beginning after December 15, 1995. However, companies could choose to adopt the standard earlier.
What is a FAS in accounting?
FAS can refer to two things in accounting:
- Financial Accounting Standards (FAS) are a set of accounting standards that are issued by the Financial Accounting Standards Board (FASB). FAS are designed to provide a consistent framework for reporting financial information, and they are used by companies all over the world.
- FAS 123R is a specific accounting standard that requires companies to expense the fair value of all share-based payments to employees. FAS 123R was issued in 2004, and it is now a widely accepted accounting practice.
What is the full form of FAS in accounting?
The full form of FAS in accounting is Financial Accounting Standards. It refers to a set of accounting standards that are issued by the Financial Accounting Standards Board (FASB). FAS are designed to provide a consistent framework for reporting financial information, and they are used by companies all over the world.
Is IFRS the same as FASB?
No, IFRS and FASB are not the same. IFRS stands for International Financial Reporting Standards, while FASB stands for Financial Accounting Standards Board. IFRS is a set of accounting standards that are used by companies all over the world, while FASB is a US organization that sets accounting standards for public companies in the United States.
Here is a table that summarizes the key differences between IFRS and FASB:
| Feature | IFRS | FASB |
|---|---|---|
| Name | International Financial Reporting Standards | Financial Accounting Standards Board |
| Scope | Used by companies all over the world | Used by public companies in the United States |
| Organization | International Accounting Standards Board (IASB) | Financial Accounting Standards Board (FASB) |
| Authority | IFRS is not legally binding, but it is widely accepted by accountants and regulators | FASB standards are legally binding in the United States |
Does FASB determine GAAP?
Yes, the Financial Accounting Standards Board (FASB) determines GAAP. GAAP stands for Generally Accepted Accounting Principles, and it is a set of accounting standards that companies must follow when preparing their financial statements. The FASB is an independent, non-profit organization that is responsible for setting GAAP.
What replaced FASB?
Nothing replaced FASB. The Financial Accounting Standards Board (FASB) is still the organization responsible for setting accounting standards for public companies in the United States. However, in 2009, the FASB adopted the Accounting Standards Codification (ASC), which replaced the previous system of Statements of Financial Accounting Standards (SFAS). The ASC is a comprehensive set of accounting standards that is organized by topic.
What is FAS 113 accounting?
FAS 113, or Statement of Financial Accounting Standards No. 113, is an accounting standard that governs the accounting for reinsurance transactions. Reinsurance is a contract between two insurance companies, where one company (the ceding company) transfers some or all of its insurance risk to another company (the reinsurer).
What is FAS 91 accounting?
FAS 91, or Statement of Financial Accounting Standards No. 91, is an accounting standard that governs the accounting for nonrefundable fees and costs associated with lending and acquiring loans and initial direct costs of leases.
What is CAS 15 in cost accounting?
CAS 15, or Cost Accounting Standard 15, is an Indian accounting standard that deals with the principles and methods of classification, measurement, and assignment of selling and distribution overheads, for determination of the cost of sales of product or service, and the presentation and disclosure in cost statements.
What is FAS 91 amortization?
FAS 91 amortization is the process of spreading the cost of nonrefundable fees and costs associated with lending and acquiring loans over the life of the loan as an adjustment of yield. This means that the fees and costs are not recognized as income or expense when they are incurred, but rather they are spread over the life of the loan.
What is FAS 133 Accounting for Derivative Instruments and Hedging Activities?
FAS 133, or Statement of Financial Accounting Standards No. 133, is an accounting standard that governs the accounting for derivative instruments and hedging activities. Derivative instruments are financial instruments that derive their value from an underlying asset, such as a security, commodity, or currency. Hedging activities are those that are undertaken to reduce the risk of changes in fair value or cash flows.