In the continuing project on stock compensation, the Financial Accounting Standards Board decided Feb. 24 that if companies retain shares in excess of the required withholding amount for tax purposes, they get stuck with a stripe of accounting that leaves them open to the vagaries of the stock market when it comes to compensation costs.

A company usually accounts for an employee’s exercised stock option as fixed if it can be recognized the day the option is granted. The companies will often make the exercise price of the option equal to the stock price on the day the option is granted, which means no compensation cost to the company, because there is no difference between the two. Fixed-award accounting is the typically desired approach.

If this is not possible, the award is called variable and the compensation cost is the amount of intrinsic value at a later measurement date, which could vary depending on the price of the stock.

The board decided that if a company has a stock compensation plan that allows for withholding of more shares than the minimum number required for tax withholding, the plan should be accounted for as a variable award. FASB allowed one loophole if the employee makes an irrevocable election at the date of the grant not to withhold more than the minimum number of shares–then the company can retain the fixed-award accounting.

If the plan does not specify that additional shares are withheld, but that is the company’s regular practice, then the company would have to use variable accounting.

"It’s clear now if you’ve got a plan that specifies this and you do it–withhold an excess of the minimum required amount–that the shares have to be accounted for as variable options," said Lailani Moody, senior manager, assurance services in Grant Thornton’s national office. She said that the area had long been gray, but that she did not think many companies used the excess withholding practice.

FASB’s interpretation of Opinion 25 is due out for comment by the end of March, and it is expected to be out in final form by September.