31 March 2016

FASB makes targeted amendments to the accounting for employee share-based payments

The Financial Accounting Standards Board (FASB) issued an Accounting Standards Update (ASU)1 that will change certain aspects of accounting for share-based payments to employees.

The new guidance will require all income tax effects of awards to be recognized in the income statement when the awards vest or are settled. It also will allow an employer to repurchase more of an employee's shares than it can today for tax withholding purposes without triggering liability accounting and to make a policy election to account for forfeitures as they occur.

The ASU also amended Accounting Standards Codification (ASC) 7182 to provide two practical expedients for nonpublic entities.3 One will allow them to use a simplified method to estimate the expected term for certain awards. The other will allow those that currently measure liability-classified awards at fair value to make a one-time change in accounting principle to measure them at intrinsic value.

The guidance was developed as part of the FASB's simplification initiative to address narrow topics relatively quickly to reduce the cost and complexity of financial reporting while improving or maintaining the usefulness of information provided to users of financial statements. The guidance is largely consistent with what the FASB proposed last year, except the FASB decided not to change the classification guidance for awards with contingent repurchase features.

Accounting for income taxes when awards vest or are settled

Under the new guidance, companies will no longer record excess tax benefits4 and certain tax deficiencies5 in additional paid-in capital (APIC).6 Instead, they will record all excess tax benefits and tax deficiencies as income tax expense or benefit in the income statement, and APIC pools will be eliminated. For interim reporting purposes, companies will account for excess tax benefits and tax deficiencies as discrete items in the period in which they occur (i.e., they will be excluded from a company's estimated annual effective tax rate). The new guidance also makes similar changes to the accounting for employee stock ownership plans. Companies will apply all of this guidance prospectively.

In addition, the guidance eliminates the requirement that excess tax benefits be realized (i.e., through a reduction in income taxes payable) before companies can recognize them. Under current guidance, companies cannot recognize excess tax benefits when an option is exercised or a share vests if the related tax deduction increases a net operating loss carryforward rather than reduces income taxes payable. Companies will apply this part of the guidance using a modified retrospective transition method and will record a cumulative-effect adjustment in retained earnings for excess tax benefits they have not previously recognized. A company must assess the realizability of any deferred tax assets it records upon adoption as a result of recognizing excess tax benefits. If a valuation allowance on those deferred tax assets is necessary on the date of adoption, the company will record the valuation allowance in retained earnings.

Presentation of excess tax benefits on the statement of cash flows

The guidance requires companies to present excess tax benefits as an operating activity on the statement of cash flows rather than as a financing activity. Companies can elect to apply this guidance retrospectively or prospectively.

Statutory withholding

The guidance will increase the amount an employer can withhold to cover income taxes on awards and still qualify for the exception to liability classification for shares used to satisfy the employer's statutory income tax withholding obligation (i.e., the employer repurchases some of the employee's shares and uses the employee's cash proceeds from the repurchase to pay income taxes it is obligated to withhold on the employee's behalf). An employer with a statutory income tax withholding obligation will be allowed to withhold shares with a fair value up to the amount of tax owed using the maximum statutory tax rate in the employee's applicable jurisdiction(s). The guidance allows an entity to determine only one maximum rate for all employees in each jurisdiction, rather than a rate for each employee in the jurisdiction.

Under current guidance, an entire award must be classified as a liability if the fair value of the shares withheld, or the shares that could be withheld at the employee's election, exceeds the employer's minimum statutory withholding obligation. Liability accounting requires a company to remeasure an award at fair value each reporting period until it is settled. Companies will apply the guidance to outstanding liability awards at the date of adoption using a modified retrospective transition method, with a cumulative-effect adjustment to retained earnings.

Presentation of employee taxes paid on the statement of cash flows

The new guidance will require an employer to classify the cash paid to a tax authority when shares are withheld to satisfy its statutory income tax withholding obligation as a financing activity on its statement of cash flows. Until now, US GAAP has not specified how these cash flows should be classified. Companies will apply this guidance retrospectively.

Implications

— The exception to liability accounting can be applied only by employers that have a statutory income tax withholding obligation and only to supplemental wages subject to withholding tax.

— While the ASU does not address this point, we believe a change to an outstanding award to allow the use of the exception will be accounted for as a modification.

Accounting for forfeitures

Companies will have to elect whether to account for forfeitures of share-based payments by (1) recognizing forfeitures of awards as they occur (e.g., when an award does not vest because the employee leaves the company) or (2) estimating the number of awards expected to be forfeited and adjusting the estimate when it is likely to change, as is currently required. They will be required to make this election at the entity level (i.e., for all share-based payments an entity grants) using a modified retrospective transition method, with a cumulative-effect adjustment to retained earnings.

Nonpublic entity practical expedients

Expected term

The guidance will give nonpublic entities the option to use two practical expedients. The first will allow them to more easily estimate the expected term for awards with performance or service conditions instead of making a more precise estimate as described in ASC 718. If an award includes only a service condition for vesting, an entity can estimate the expected term as the midpoint between the vesting date and the contractual term.

If an award includes a performance condition, an entity will assess at the grant date whether it is probable that the performance condition will be met. If it is probable, the entity can estimate the expected term as the midpoint between the requisite service period (the longer of the service or performance period) and the contractual term. If it is not probable that the performance condition will be met, and the requisite service period is an implied service period (i.e., a service period that is inferred based on when a performance condition is expected to be achieved), the entity is required to estimate the expected term as the contractual term. However, If it is not probable that the performance condition will be met, and the service period is stated in the award, the entity can estimate the expected term as the midpoint between the requisite service period and the contractual term.

Entities can apply this practical expedient prospectively to all awards that are measured at fair value. The practical expedient can also be used to remeasure liability-classified awards.

Intrinsic value

The second practical expedient allows nonpublic entities that currently measure liability-classified awards at fair value to elect a one-time change in accounting principle to measure them at intrinsic value. Entities that apply this practical expedient will use a modified retrospective transition method, with a cumulative-effect adjustment to retained earnings.

Implications

The practical expedient for estimating an award's expected term will be especially useful for nonpublic entities that do not have their own historical data to determine the estimated term. Public companies can already apply a similar simplified method of estimating the expected term described in Securities and Exchange Commission Staff Accounting Bulletin Topic 14.

The one-time change in accounting principle to measure liability-classified awards at intrinsic value provides a second chance to companies that didn't elect this method when they adopted FASB Statement No. 123(R).

Disclosures and effective date

Companies will be required to make the disclosures about a change in accounting principle under ASC 250-10-50-1 through 50-3, but they will not have to quantify the income statement effect of the change in the period of adoption.

The guidance is effective for public business entities for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. For all other entities, it is effective for fiscal years beginning after December 15, 2017, and interim periods within fiscal years beginning after December 15, 2018. Early adoption is permitted in any annual or interim period for which financial statements haven't been issued or made available for issuance, but all of the guidance must be adopted in the same period. If an entity early adopts the guidance in an interim period, any adjustments must be reflected as of the beginning of the fiscal year that includes that interim period.

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RELATED RESOURCES

— For more information about EY's Tax Accounting services, visit us at www.ey.com/US/TaxAccounting
— For more information about EY's Tax Accounting University education program for clients, visit us at www.ey.com/TAU

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Contact Information
For additional information concerning this Alert, please contact:
 
Tax Accounting and Risk Advisory Services
Angela Evans(404) 817-5130
Joan Schumaker(212) 773-8569

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ENDNOTES

1 ASU 2016-09, Improvements to Employee Share-Based Payment Accounting.

2 ASC 718, Compensation — Stock Compensation.

3 The definition of a nonpublic entity in ASC 718 will be retained for determining which entities are eligible to apply the practical expedients.

4 Excess tax benefits occur when the amount deductible for an award of equity instruments on the employer's tax return is more than the cumulative compensation cost recognized for financial reporting purposes.

5 Tax deficiencies occur when the amount deductible for an award of equity instruments on the employer's tax return is less than the cumulative compensation cost recognized for financial reporting purposes.

6 Under today's guidance, tax deficiencies are recorded in the income statement if a company does not have a qualifying pool of excess tax benefits. If a qualifying pool of excess tax benefits exists, the tax deficiency is recorded to APIC.

Document ID: 2016-0596