KPM

Non-GAAP Metrics Reduce Billing Bottlenecks Auditor Independence Accounting Methods Year-End Financials Auditing Revenue Recognition Inventory Management System Access To Capital M&A Due Diligence What Is Materiality Job-Costing Systems Technology Bank Reconciliation Cybersecurity New Segment Expense Disclosure Rules QuickBooks To Prepare 2024 Budgets Safeguard Organization Assets Offsetting Rules Inventory Count negotiation M&A Accounting Monthly Financial Close Shareholder advance Payroll challenges Prepare for audit QuickBooks income tax Crypto Accounting Percentage-Of-Completion Financial Statement PCAOB Overhead Mileage in QuickBooks UTPs Cross-Train Employee Benefit Plan Audits Accounts Receivable

Valuing Profits Interests In LLCs

The use of so-called ‘profits interest’ awards as a tool to attract and retain skilled workers has increased as more companies are being structured as LLCs rather than as corporations. But accounting complexity has caused some private companies to shy away from these arrangements. Fortunately, relief from the Financial Accounting Standards Board (FASB) may be coming soon.

New twist on equity compensation

Corporations tend to award traditional stock options. But profits interests are used exclusively by LLCs. As the name suggests, these arrangements provide recipients with a share of the company’s future profits. Under existing U.S. Generally Accepted Accounting Principles (GAAP), these transactions may be classified as:

  • Share-based payments
  • Profit sharing
  • Bonus arrangements
  • Deferred compensation

The classification is determined by the specific terms and features of the profits interest. In most cases, the fair value of the award must be recorded as an income statement expense. Profits interest also can result in the recognition of a liability on the balance sheet and require footnote disclosures.

Need for simplification

Profits interest arrangements can accomplish a variety of business objectives. Though they are most often awarded to employees, profits interests also can be given to investors, third-party service providers, and other individuals.

These awards are usually issued in exchange for future services, without direct payment or financial investment. Various terms and features can be incorporated into a profits interest. For example, these awards often have contingency features, such as vesting requirements, participation thresholds, the occurrence of certain events, limited time periods, expiration dates, and forfeiture provisions. In turn, this variability can cause additional complexity compared to other forms of equity compensation and require special valuation techniques.

“Profits interest continues to come up as an area private companies are struggling with,” said Candace Wright, Chair of the Private Company Council PCC during a meeting with the FASB earlier this year. Private companies have been clamoring for practical expedients and additional guidance from the FASB on such issues as acceptable valuation methods, audit techniques, and disclosure requirements.

Work in progress

Simplification of the financial reporting guidance would be welcome news for employers, employees, and other stakeholders. Contact us for help reporting these transactions under existing U.S. GAAP or for an update on the latest developments from the FASB.

Related Articles

Talk with the pros

Our CPAs and advisors are a great resource if you’re ready to learn even more.