The Financial Accounting Standards Board (FASB) recently released Accounting Standards Update (ASU) 2016-09, Compensation (Topic 718): Improvements to Employee Share-Based Accounting. The ASU, which is a result, in part, of the post-implementation review of FASB Statement No. 123(R) Share Based Payment, is also part of the FASB's continuing simplification project. The amendments are intended to simplify certain aspects of the accounting for share-based payments, including:
- Accounting for income taxes upon settlement of the award;
- Presentation of excess tax benefits;
- Accounting for forfeitures; and
- Withholding requirements and presentation of income taxes.
Additionally, the amendments provide for certain practical expedients for non-public entities.
Changes from the Proposed ASU
Changes to share-based accounting became part of the Simplification Initiative project list in 2014, and the FASB released a proposed ASU in June of 2015. The final ASU is similar in most respects to the Exposure Draft, however, after receiving comment letters and other feedback, the FASB decided not to include its proposed changes to the classification of awards with repurchase features. The June 2015 Exposure Draft included suggested amendments providing that entities should include an assessment of whether contingent repurchase features, such as an embedded put or call feature, have a probable occurrence when evaluating the impact of the contingent feature on the classification of the awards as equity or as a liability. The Exposure Draft included amendments that would have allowed equity classification if the contingent event is not probable. This would have changed the current guidance, which requires the reporting entity to assess the award classification based on whether the contingent event is within the employee's control.
Accounting for Income Taxes Upon Vesting or Settlement of Awards
The amount of compensation expense recognized for financial reporting purposes and the amount reported for income tax reporting purposes often differ for share-based payment awards. As a result, a temporary tax difference is recognized as the compensation expense is recognized for financial reporting purposes, which is ultimately settled once the award itself is settled. If the actual tax benefit exceeds the deferred tax asset recorded in the financial statements (Excess Tax Benefit), the excess is recorded directly to equity. However, if the actual tax benefit is less than the deferred tax asset recorded in the financial statements (Tax Shortfall), the accounting can be more complex. A Tax Shortfall is recorded directly to equity only to the extent that a Tax Windfall Pool exists. A Tax Windfall Pool represents the cumulative total of previously recognized Tax Benefits in excess of previously recognized Tax Shortfalls. If a Tax Windfall Pool has not been established (previously recognized Tax Shortfalls exceed Tax Benefits), the Tax Shortfall should be recorded as a component of income tax expense rather than directly to equity. These accounting requirements require an entity to separately track all previously recognized Tax Benefits and Shortfalls to determine the cumulative amounts.
The amendments to ASC 718 will require all Tax Benefits and Tax Shortfalls to be recognized directly to income, as a component of the income tax expense, regardless of whether tax benefits affect payable taxes in the reporting period. This will result in less reporting complexity as entities will no longer be required to track the Tax Windfall Pool, but the amendment will also result in more volatility to the reported income tax expense.
Additionally, existing guidance requires an entity to delay the recognition of a Tax Shortfall until the date it reduces the taxes payable on the respective tax return, including, reduction of taxable income or carryback to prior tax returns in a period without taxable income. The amendments change the recognition requirements such that all Tax Shortfalls should be recognized on the date the award is settled. If the settlement results in an additional deferred tax asset, the deferred tax asset should be evaluated in a similar fashion with all existing deferred tax assets.
The amendments will also have an impact on the calculation of diluted shares when determining earnings per share (EPS). As the Excess Tax Benefit will no longer be recorded directly to equity, the tax benefit will no longer affect the assumed proceeds when calculating EPS under the treasury stock method. This will result in a more dilutive impact from existing share based payment awards.
Presentation of Excess Tax Benefits on the Statement of Cash Flows
In the statement of cash flows, entities will account for Excess Tax Benefits that result from the vesting or settlement of awards as an operating activity. ASC 718 currently requires entities to classify Excess Tax Benefits as a financing activity as well as an outflow from operating activities.
The amendments allow entities to make an enterprise-wide accounting policy election to estimate the number of service condition-based awards expected to forfeit (which is the requirement in current practice) or they can choose to account for forfeitures as they occur.
Minimum Statutory Tax Withholding Requirements & Presentation of Taxes
The withholding of income taxes from awards upon exercise has traditionally been viewed as a method of cash settlement if the amount withheld by the entity on the employee's behalf is greater than the minimum statutory requirement. For example, a stock option plan may allow for the tax liability to the employee to be withheld in the form of shares that would have been issued to the employee. The fair value of those shares withheld is then remitted to the taxing authority in cash to meet the tax liability of the employee. As a result, if a reporting entity had established a policy of withholding amounts in excess of the statutory minimum amounts, the outstanding awards were classified as liability awards. The amendments retain the concept of cash settlement of the award when the employer withholds income taxes, however, the threshold for triggering liability accounting has been raised from the statutory minimum for the employee to the statutory maximum for the employee or employee group.
The amendments to the ASU also require entities to classify cash paid from the withholding of shares to meet minimum statutory withholding requirements as financing activities.
Private Company Practical Expedients
The amendments also provided two practical expedients for non-public entities (as determined by the definition of a non-public entity in ASC 718). Qualifying entities can elect to estimate the expected term of option (or similar) service- or performance-based awards, using a convention that represents the midway point between the service period and the contractual expiration of the award (as stated in the contract). The expected life is a significant input when determining the estimated fair value of an award. If the non-public entity determines a performance condition is not likely to occur, then the expected life of the asset is equal to its contractual term.
Upon adoption, non-public entities can also make a one-time election to measure all awards classified as liabilities at intrinsic value rather than fair value.
Transition Method and Effective Date
Public business entities will be required to adopt the amendments for annual and interim periods beginning after December 15, 2016. All other entities will be required to adopt the amendments for annual periods beginning after December 15, 2017, and interim periods beginning after December 15, 2018. Early adoption is permitted as of the beginning of the year of adoption, however, all provisions of the ASU must be adopted at the same date.
The amendments requiring the recognition of income tax benefits and shortfalls in the tax provision should be applied prospectively. Non-public entities electing to account for awards at intrinsic value should also be applied prospectively.
Entities should use the modified retrospective transition method for adopting the amendments related to timing of the recording of income tax benefits at settlement of an award (i.e. those deferred and not recognized until they impact the taxes payable), statutory withholding requirements and forfeiture estimates.
Modifications to the presentation of employee taxes paid in the statement of cash flow when shares are withheld to meet statutory tax withholding requirements will require a retrospective transition. Entities will be able to elect either a prospective or a retrospective transition to presenting excess tax benefits in the statement of cash flows.
Disclosures will be required during the period of adoption, but entities will not have to quantify the effect of the change during the period of adoption.
For More Information
If you have specific comments, questions or concerns, please share them with Mike Loritz of MHM's Professional Standards Group. Mike can be reached at firstname.lastname@example.org or 816.945.5611.
Published on April 26, 2016