Last week, I used an example to illustrate the impact the new tax accounting rules under ASU 2016-09 will have on companies’ P&L statements. If your company is profitable, this is something you can do using your own financials. In this week’s blog entry, I explain how.
Finding the Numbers
I found all the numbers for my example in the company’s 10-K. I didn’t even have to pull up the full 10-K; I used the interactive data on EDGAR—it took me about 5 minutes. Here’s where to look:
You can find your company’s net earnings, tax expense, and basic EPS in your income statement (“income statement” is the less cool way to say “P&L,” which is shorthand for “profits & loss statement”).
You can usually find your excess tax benefit or shortfall in your cash flow statement or the statement of stockholders’ equity (or you may already know this amount, if you manage the database that this information is pulled from).
The number of shares used in your basic EPS calculation will be indicated in either your income statement or your EPS footnote.
What To Do With the Numbers
Once you have collected that data, you can do the following:
Post-Tax Earnings: The tax benefit represents how much post-tax earnings would be increased (or, if you have a shortfall, how much earnings would be decreased).
Effective Tax Rate: Subtract the tax benefit (or add the shortfall) to tax expense and divide by pre-tax earnings to determine the impact on your effective tax rate.
Earnings Per Share: Divide the tax benefit (or shortfall) by the shares used in the basic EPS calculation to figure out the impact on basic EPS.
Do these calculations for the past several years to see how much the impact on earnings varies from year to year.
Stuff You Should Be Aware Of
This exercise is intended to give you a general idea of the impact of the new tax accounting rules for your company. There are lots of complicated rules that govern how earnings and tax expense are calculated that have nothing to do with stock compensation, but that, when combined with the rules for stock compensation, could change the outcome for your company. This is especially true if your company isn’t profitable—if you are in this situation, it may be best to leave the estimates to your accounting team.
Also, I’ve suggested calculating the impact only on basic EPS because it’s a little harder to figure out the impact on diluted EPS. In diluted EPS, not only will the numerator change, but the number of shares in the denominator will change as well, because excess tax benefits no longer count as a source of proceeds that can be used to buy back stock. See my blog entry, “Update to ASC 718: Diluted EPS” for more information).
It’s Not Too Late!
Taught by the industry’s leading experts, the NASPP’s acclaimed online program, “Stock Plan Fundamentals,” is the definitive primer on stock compensation, covering both the regulatory framework and day-to-day administrative procedures key to overseeing stock plans. The course started last week but there’s still time to register! All program webcasts are archived for your listening convenience.
Before You Adopt the Update to ASC 718
Got 15 minutes and 42 seconds? Check out my podcast on five things to consider before you adopt the Accounting Standards Update to ASC 718!
If you have 14 more minutes (and 8 seconds), check out my other podcast on five things I learned about the ISS Equity Plan Scorecard. Maybe you’ll learn something too!
NASPP To Do List
Here’s your NASPP To Do List for the week:
Register for the NASPP’s acclaimed online course, “Stock Plan Fundamentals“—even though the course started last week, it’s not too late to get into the program.
If you’re feeling curious about how equity plan proposals are performing with shareholder votes, today’s blog has answers. Semler Brossy recently released their 2016 report on Trends in Equity Plan Proposals. Keep reading for some of the highlights.
Upward Trend in Failed Say-on-Pay Votes?
The number of companies each proxy cycle that have failed to obtain say-on-pay (“SOP”) approval from shareholders has remained fairly constant since SOP became mandatory 2011. This time last year, only two of the Russell 3,000 companies had failed their SOP vote. This year, that number has increased to five companies so far. Does this signify an uptick in SOP failures? It appears so, because the number of companies with failed votes so far in 2016 amounts to 3.5%, marking the first time more than 3% of Russell 3000 companies have failed at this time in the cycle to obtain an affirmative vote. Whether this is an anomaly year, or an indicator of a trend, time will tell.
Correlation Between Affirmative Say-on-Pay and Stock Plan Proposal Approvals
One correlation that appears to be rising is that companies who receive a pass Say-on-Pay vote also receive strong support for their equity plan proposals. Since SOP was adopted, the percentage of equity plan proposals that receive affirmative support relative to passing SOP votes has steadily increased (from 83% in 2011 to 90% in 2015). According to the Semler Brossy report,
Similarly, average vote support for equity plans at companies that receive an ISS ‘For’ recommendation has increased over time; this may suggest that ISS voting policies have become well-aligned with shareholder preferences
Companies that fail Say on Pay tend to have significantly lower support for their equity plan proposals, indicating that shareholders are assessing both proposals under similar lenses
A couple of final data points that seem to bring this all full circle are that ISS has recommended that shareholders vote “Against” Say-on-Pay at 10% of the companies it’s assessed so far in 2016, and, on top of that, shareholder support was 32% lower at companies with an ISS “Against” vote. This seems to suggest that companies looking for shareholder support in other areas, such as equity plan proposals, are more likely to gain shareholder support when ISS has recommended an affirmative Say-on-Pay vote. At minimum, there is an intertwining of all these factors and how they drive shareholder support.
For more interesting Say-on-Pay and equity plan proposal trends, view the full Semler Brossy report.
Here’s what’s happening at your local NASPP chapter this week:
DC/VA/MD: Erin Bass-Goldberg and Jarret Sues of Frederic W. Cook present “CEO Pay Ratio: Now What?” (Wednesday, April 28, 3:30 PM)
Boston: Equity Methods presents a webinar on “2016 State of the Union in Equity Compensation.” (Thursday, April 28, 4:00 PM)
Ohio: Barbara Baksa of the NASPP and Sean Waters of Fidelity Stock Plan Services present a webinar on the amendments to ASC 718. (Thursday, April 28, 2:00 PM)
For today’s blog entry, I use an example to illustrate the impact the new tax accounting procedures required under the recently issued ASU 2016-09 will have on companies’ P&L statements.
A Refresher
Under the old ASC 718, all excess tax benefits and most tax shortfalls for equity awards were recorded to paid-in-capital. An excess tax benefit occurs when the company’s tax deduction for an award exceeds the expense recognized for it; a tax shortfall is the opposite situation—when the company’s tax deduction is less than the expense recognized for the award. The nice thing about old ASC 718 is that paid-in-capital is a balance sheet account, so these tax effects didn’t impact the company’s profitability. Under the amended ASC 718, all excess tax benefits and shortfalls are recorded to tax expense, which ultimately impacts how profitable a company is.
Effective Tax Rates
Not only do changes to tax expense impact a company’s profitability, they also impact the company’s effective tax rate. This rate is calculated by dividing the tax expense in a company’s P&L by its pre-tax earnings. A company’s effective tax rate is generally different from the company’s statutory tax rate because there are all sorts of credits that reduce the tax a corporation pays without reducing income and there are items that can increase a company’s tax expense that don’t increase income.
An effective tax rate that is lower than the statutory tax rate is good; it shows that the company is tax efficient and is keeping its earnings for itself—to use to operate and grow the company or to pay out to shareholders—rather than paying the earnings over to Uncle Sam. Just like you want to minimize the taxes you pay, shareholders want the company to minimize the taxes it pays.
An Example
This example is based on a real-life company that grants stock compensation widely. I’ve rounded the numbers a bit to make it easier to do the math, but my example isn’t that far off from the real-life scenario.
The company reported pre-tax income of $900 million for their most recent fiscal year and tax expense of $250 million. That’s an effective tax rate of 28%, which is probably less than their statutory tax rate.
The company reported (in their cash flow statement) an excess tax benefit for their stock plans of $70 million. Under the old ASC 718, that tax benefit didn’t impact the company’s earnings. But if it had been recorded to tax expense as is required under the amended ASC 718, it would have reduced the company’s tax expense to just $180 million. That reduces the company’s effective tax rate from 28% to just 20%.
In addition, the company’s basic earnings-per-share is $1.30, with 500 million shares outstanding. The tax benefit would have increased basic earnings per share by 14 cents, which is an increase of just over 10%.
Next week, I’ll explain how you can apply this example to your own company.
Online Fundamentals Starts Today!
Taught by the industry’s leading experts, the NASPP’s acclaimed online program, “Stock Plan Fundamentals,” is the definitive primer on stock compensation, covering both the regulatory framework and day-to-day administrative procedures key to overseeing stock plans. The course starts today but there’s still time to register! If you have to miss the first webcast, a recording is archived for your listening convenience.
Last week, guest author Corey Rosen of the NCEO started a two-part series on how companies can share equity and stay private. This week, he concludes the series.
Yes, You Can Share Equity and Stay Private: Part Two
By Corey Rosen, National Center for Employee Ownership
In Part One of this article, we looked at general issues for staying private, including plan design and redemptions. Below are four more liquidity options.
Sales to Employees
Employees can buy shares from sellers. The purchase is with after-tax dollars; the proceeds are taxed as a capital gain. Some companies pay employees a bonus to use to buy the shares or loan the money at a reasonable rate, which right now could be very low without incurring a tax problem. It is also possible to set up an internal stock market. The details are beyond the scope of this article. Suffice it to say here that the SEC has made it possible to do this is a way that avoids most significant regulatory burdens.
Outside Investors
We have seen a growing trend in recent years for investors in private companies, whether angel investors or private equity firms, to be willing to invest in closely held companied with the intention of selling to another investor group in 5-7 years instead of forcing a sale to another company. This lets the company stay private, but be aware that these investors may want some level of control even for a minority interest, preferred stock, and/or a relatively high rate of return on their money.
Secondary Markets
If your company is a high-flyer with real prospects to go public at some point, there are now secondary markets such as NASDAQ’s SecondMarket and SharesPost,that allow investors to buy equity (usually equity held by employees in the form of options or restricted shares). These rights are then traded on the market until a liquidity event. Only the most promising companies can do this, however.
ESOPs
Employee Stock Ownership Plans (ESOPs) are highly tax-favored ways for companies to redeem their own shares by setting up an employee benefit trust similar to profit sharing or 401(k) trusts that are designed to hold company stock. Companies can use pretax money to redeem the shares through the ESOP, which then allocates them to employees. All full-time employees with a year or more of service are included and allocations are based on relative pay or a more level formula. Sellers can defer capital gains tax on the sale, and S corporation ESOPs can reduce their tax obligation by the percentage of shares the ESOP owns.
Corey Rosen, Ph.D., is the cofounder and senior staff member of the NCEO. He co-authored, along with John Case and Martin Staubus, Equity: Why Employee Ownership Is Good for Business (Harvard Business School Press, May 2005). Over the years, he has written, edited, or contributed to dozens of books, articles and research papers on employee ownership. He is generally regarded as the leading expert on employee ownership in the world.
Here’s what’s happening at your local NASPP chapter this week:
Boston: Raenelle James and Josh Schaeffer of Equity Methods present “Innovative Compensation ‘Next Practices’ for 2017.” (Tuesday, April 19, 8:30 AM)
Connecticut: Kelly Geerts and Michelle O’Connor of E*TRADE, Nancy Clark of Wealth Delivery Solutions, and Ed Sala of The Priceline Group present “Building a Partnership: Plan Administration & Payroll.” The presentation will be followed by a cocktail reception. (Tuesday, April 19, 2:30 PM)
I was planning to blog more about ASU 2016-09 this week, but the FASB’s Private Company Council discussed accounting for awards granted to nonemployees at their meeting on Tuesday, so I’ve decided to blog about that instead. While the changes the FASB is considering in this area may have their genesis in simplifying things for private companies, they ultimately would apply to both private and public companies, so it’s worth reading about the meeting even for public companies.
What the Heck is the PCC?
The Private Company Council is the primary advisory body to the FASB on private company matters.
Good News
There were two bits of good news. The first is that the FASB staff recommends aligning the treatment of awards granted to nonemployees with the treatment of employee awards. Moreover, their recommendation is for awards to all nonemployees, not just nonemployees providing similar services as employees (which the staff seemed to recognize would be a bit of a rat’s nest to figure out).
Secondly, overall, the PCC generally seemed to agree with the staff’s recommendation. That’s certainly the official position. From the “Media Meeting Recap“:
The PCC generally supported aligning the models for nonemployee and employee share-based payments under GAAP.
Stuff I Found Surprising/Concerning
When I listen to FASB meetings, I often end up shouting at my computer like I am watching a televised sporting event. Here are a few things that got a reaction from me.
I was a little surprised at how unfamiliar the PCC seemed to be with how start-ups use equity awards for nonemployees. One Council member suggested that it seemed to him that accounting for employee awards is harder than accounting for nonemployee awards. For a minute there, I thought he was going to suggest that the treatment of employee awards be aligned with that of nonemployees. Luckily, most of the other Council members did not seem to agree with him.
The Council also was very concerned about companies buying goods (the example tossed about was buildings) with stock. Does this actually happen? Enough that the PCC needs to be so worried about it? I will admit that buying a building with stock is far outside my wheelhouse, so maybe it does happen all the time and maybe there are all sorts of valid concerns over how the transaction is accounted for that justify keeping this situation outside the scope of ASC 718.
Another thing I didn’t know is that the current guidance on accounting for nonemployee awards stipulates that if vesting is contingent on performance conditions, the interim estimates of expense are based on the lowest possible aggregate fair value, which is $0 if the award will be forfeited in full if the performance conditions aren’t met. 1) Who knew? 2) Are companies actually granting performance awards to nonemployees?
The Most Surprising Thing
Only one member of the PCC is located west of the Mississippi, which explains A LOT. (And, in general, all of the FASB advisory groups seem to be heavily weighted towards the east coast, which explains even more.) The one Council member from the west coast is from Portland. Nothing against Portland, but given the proliferation of start-ups here in Silicon Valley, it seems like maybe the FASB ought to find an accounting practitioner from this area who works with starts-up to be on the Council. Equity compensation can’t be the only area where technology start-ups do things differently.
Online Fundamentals Starts Next Week
Taught by the industry’s leading experts, the NASPP’s acclaimed online program, “Stock Plan Fundamentals,” is the definitive primer on stock compensation, covering both the regulatory framework and day-to-day administrative procedures key to overseeing stock plans. Register today to avoid the last-minute rush—the course starts next Wednesday, April 20.
Trends in Equity Plan Proposals
A study by Semler Brossy finds that companies whose Say-on-Pay votes fail also tend to have significantly lower support for their stock plan proposals than companies whose Say-on-Pay votes pass.
NASPP To Do List
Here’s your NASPP To Do List for the week:
