Think the rules for reporting employee stock options and restricted stock are too complicated? The Financial Accounting Standards Board (FASB) agrees — and it has simplified the rules starting in 2017 for public companies and 2018 for private companies. Here is how.
Under current U.S. Generally Accepted Accounting Principles (GAAP), for each share-based payment, employers must determine whether the difference between the deduction for tax purposes and the compensation cost recognized for financial reporting purposes results in either an excess tax benefit or a tax deficiency.
Currently, when the deduction for a share-based payment for income tax purposes exceeds the compensation cost for accounting purposes, the employer recognizes an excess tax benefit in additional paid-in capital, which is an equity account on the balance sheet. Conversely, tax deficiencies are recognized either as an offset to accumulated excess tax benefits, if any, or in the income statement. Excess tax benefits are not recognized until the deduction reduces taxes payable.
Accounting Standards Update (ASU) No. 2016-09, Compensation — Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting, moves all accounting for income tax consequences of share-based payments to the income statement. Under the simplified rules:
- All excess tax benefits and tax deficiencies will be recognized as income tax expense or benefit
- The tax effects of exercised or vested awards will be treated as discrete items in the reporting period in which they occur
- Employers will recognize excess tax benefits regardless of whether the benefit reduces taxes payable in the current period
The new standard also calls for excess tax benefits to be classified on the statement of cash flows as an operating activity with other income tax cash flows. Under current GAAP, employers are required to separate excess tax benefits from other income tax cash flows and classify them as financing activities.
Alternative for Private Companies
Many people forget that private companies also may award stock options and restricted shares to employees. However, it is more challenging to value share-based awards for private companies, because their shares do not trade in the public markets.
The updated guidance provides a simplified formula for estimating the expected term for nonpublic entities that issue share-based payments based on a service or performance condition. Under this optional practical expedient, the expected term of a share-based payment will generally be the midpoint between the requisite service period and the contractual term of the award, if vesting is dependent only on a service condition. That formula also applies if the award is dependent on satisfying a performance condition that is probable of being achieved.
Right for You?
Share-based payments can be an effective way for cash-strapped businesses to attract and retain executives. However, the existing accounting rules have discouraged some companies from trying out employee stock options and restricted stock in their compensation plans. With simplification efforts in effect, it is easier than ever to report these transactions. Contact us to discuss whether share-based payments could work for your company.