The Financial Accounting Standards Board (FASB) has issued Accounting Standards Update (ASU) 2016-09, Improvements to Employee Share-Based Payment Accounting, which amends ASC Topic 718,Compensation – Stock Compensation.
FASB adopted the ASU on March 30, 2016 to improve the accounting for employee share-based payments and simplify how such payments are accounted for as well as presented in financial statements. The ASU includes certain non-public company-only simplifications. However, the amendments affect all organizations, public or private, that issue share-based payment awards to their employees.
Specifically, the ASU simplifies several aspects of the accounting for share-based payment award transactions, including:
- Accounting for income taxes of share-based payments
- Statutory tax withholding requirements with respect to share-based equity grants
- Accounting for Forfeitures
- Simplification of rules applicable to private companies
Accounting for income taxes
Currently, accumulated excess tax benefits (i.e., tax benefits in excess of compensation cost commonly referred to as “windfalls”) are available to offset current period and subsequent period tax deficiencies and are factored into determining the annual estimated effective tax rate. The update characterizes excess tax benefits as discrete income tax expenses or benefits in the current income statement (including tax benefits of dividends on share-based payment awards) and thus eliminates the need to track a “windfall pool.” In addition, an organization may recognize excess tax benefits whether the benefit reduces taxes payable in the current period or not, and, thus, recognition of such a benefit will be recorded when it arises. Finally, the ASU provides that excess tax benefits should be classified along with other income tax cash flows as an operating activity on the statement of cash flows.
Statutory tax withholding requirements
Under current accounting rules, in order to avoid liability accounting, an employer may only withhold the minimum statutory amount of taxes upon a settlement of an equity award. The ASU provides that an employer may increase the withholding rates used from the minimum statutory tax rates up to the maximum statutory tax rates in the applicable jurisdictions without resulting in liability classification of the award. In addition, cash payments made to applicable taxing authorities when an employer directly withholds shares for tax withholding purposes should be presented as a financing activity on the statement of cash flows.
Accounting for forfeitures
Companies are also permitted to make an entity-wide accounting policy election for the impact of forfeitures on expense reporting. The election allows a company to either estimate the number of awards that are expected to be forfeited or such forfeitures can be accounted for when they occur.
Certain private company rules
The update also provides simplification of accounting for private company share-based compensation by allowing such companies to (1) apply a practical expedient to estimate the expected term for certain share-based awards in lieu of estimating the period of time that a share-based award will be outstanding, which would be adopted prospectively; and (2) make a one-time election to switch from measuring all liability-classified awards at fair value to measuring them at intrinsic value upon adoption of the ASU.
For public companies, the amendments are effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. For all other entities, the amendments are effective for annual periods beginning after December 15, 2017, and interim periods within annual periods beginning after December 15, 2018. Companies may want to adopt the update earlier than required to take advantage of certain amendments. Although early adoption is permissible, a company is required to adopt the entire update at one time so it is imperative to review your current accounting practices and equity granting practices to ensure an early adoption is prudent.
Companies, whether public or private, should review their equity plans and award agreements with counsel to determine whether any necessary amendments should be adopted. There may be certain administrative and other challenges (such as possible changes to processes and controls may be necessary) that require consultation and coordination between the company’s finance and legal departments. Companies may also want to consider how to address or otherwise account for the new statutory tax withholding rules in any equity plan that will take effect before the ASU rules become effective.