Financial Reporting Alert 07-10: SEC Extends the Use of the Simplified Method in SAB 107 Under Certain Circumstances
December 27, 2007
Under Financial Accounting Standards Board (FASB) Statement No. 123(R), Share-Based Payment, the term that an option is expected to be outstanding is a key factor in measuring its fair value and the related compensation cost. Question 6 of Section D.2 of SAB Topic 141 sets forth the “simplified” method of estimating the expected term of "plain vanilla" share options, but is due to expire on December 31, 2007. Last week, the Securities and Exchange Commission (SEC) staff issued SAB 110, which permits entities, under certain circumstances, to continue to use the simplified method. SAB 110 amends and replaces Question 6 of Section D.2 of SAB Topic 14.
|Editor's Note: To meet the definition of "plain vanilla," and therefore allow an entity to use the simplified method, the entity's share options must have only the basic characteristics of a share-based payment award detailed in Section D.2 of SAB Topic 14.|
There are no hard-and-fast rules in SAB 110’s revisions to SAB Topic 14; a company may use the simplified method if it concludes that it is not reasonable to base its estimate of expected term on its historical share option exercise experience. Previously, under SAB Topic 14, a company could avail itself of the simplified method’s safe harbor regardless of whether the company had enough information to make a more refined estimate of expected term.
Further, in SAB 110, the SEC staff gives the following examples of situations in which it may be appropriate to use the simplified method:
- “A company does not have sufficient historical exercise data to provide a reasonable basis upon which to estimate expected term due to the limited period of time its equity shares have been publicly traded.
- A company significantly changes the terms of its share option grants or the types of employees that receive share option grants such that its historical exercise data may no longer provide a reasonable basis upon which to estimate expected term.
- A company has or expects to have significant structural changes in its business such that its historical exercise data may no longer provide a reasonable basis upon which to estimate expected term.”
The staff also acknowledged that a company may use the simplified method for some, but not all, of its employee share option grants. That is, the staff will accept the use of the simplified method for grants for which a company does not have sufficient historical exercise data. The staff also indicated that it will not object to the use of the simplified method in the periods before a company becomes public.
Finally, a company that uses the simplified method should disclose the following information in the notes to its financial statements:
- The fact that the simplified method was used
- The reason why this method was used
- The types of share option grants for which the simplified method was used, if it was not used for all share option grants
- The period(s) for which the simplified method was used, if it was not used in all periods presented.
While SAB 110 does not include an expiration date for the use of the simplified method, companies should be aware that the staff believes that more detailed external information about exercise behavior will, over time, become readily available. Therefore, the staff does not expect the simplified method to be used for share option grants when more relevant detailed information becomes widely available.
1 SAB Topic 14, “Share-Based Payment,” added by SEC Staff Accounting Bulletin No. 107.