In late February, the FASB met to review the comments received on the exposure draft of the proposed update to modification accounting under ASC 718 (see “ASC 718 Gets Even Simpler“) and voted to go ahead with the changes.
What’s Changing
The update clarifies that when the terms of an award are amended, modification accounting is required only if the amendment causes one of the following things to change:
The current fair value of the award
The vesting provisions
The equity/liability status of the award
The Comment Letters
The FASB received only 15 comment letters on the exposure draft and 12 of those were in support or it. The three letters that opposed the proposal did so at least in part because they felt that the above conclusion can already be drawn from the current standard. (Although, board member James Kroeker noted that one of the firms that opposed the proposal had previously contacted the FASB with technical inquiries as to what types of amendments require modification and had suggested that the FASB issue the update because they felt that there is diversity in practice. Go figure—perhaps the people writing the letters don’t communicate with the people actually doing the work.)
The FASB’s Decision
The FASB voted to go ahead with the proposed update, with only a few clarifications:
The determination of whether the fair value has changed should be consistent with the approach used to determine incremental cost for modifications. In general, this is determined on an award basis (rather than a per-share basis or an aggregate basis for all awards modified at one time).
The disclosures related to material modifications are required even if the amendment doesn’t trigger modification accounting.
Not So Fast; This Isn’t Final Yet
The FASB staff still has to draft the final language of the update and the FASB has to approve it. The staff anticipates issuing the final update in April 2017. Public companies will have to adopt it by the start of their first fiscal year beginning after December 15, 2017. Early adoption is permitted, but not before the official ASU is issued.
Could I Possibly Use the Word Modification More in One Blog Entry?
I doubt it. Here is this blog entry in a nutshell: As a result of technical questions that arose in the context of the prior modification to ASC 718, the FASB voted to go forward with a proposed modification to ASC 718 to stipulate that award modifications are subject to modification accounting only when the fair value, vesting conditions, or status of awards are modified, but the FASB had a few modifications to the proposed modification. The next time the FASB decides to update ASC 718, I hope the change doesn’t have anything to do with award modifications.
Many companies are very excited about the expanded exception to liability treatment that is available under ASU 2019-06 (see my blog entry, “Update to ASC 718: The FASB’s Decisions,” December 1). In the NASPP’s quick survey on the ASU, about 30% of respondents so far have said that this is the amendment they are most excited about (to the extent that anyone can be excited about accounting).
Many plans (possibly even most plans, by a wide margin), include language prohibiting employees from tendering award shares to cover tax payments in excess of the minimum statutory required withholding. This language is included in the plan to make it abundantly clear that the company doesn’t allow share withholding in excess of the minimum required tax payment; liability treatment could be required if it appears that the company would allow this, even if it isn’t ever actually done. I’m sure the language is also included to protect companies from themselves—if anyone had ever gotten the bright idea to allow share withholding for a tax payment in excess of the minimum required, hopefully someone would have realized the plan prohibited this.
If this language exists in your plan, the plan has to be amended to change the limitation from the minimum required payment to the maximum payment before you can change your share withholding procedures.
Shareholder Approval May Be Required
At a minimum, the Board of Directors would need to approve the amendment to the plan. But for some companies, shareholder approval may be required as well. The NYSE and NASDAQ require shareholder approval of any material amendments to stock plans. As Mike notes:
From the perspective of the NYSE and NASDAQ, if the Stock Plan allows the recycling of shares surrendered or withheld to pay tax withholding (that is, puts those shares back in the authorized share pool and allows those shares to be re-used for future awards), then an amendment of that Plan that allows for tax withholding at the maximum rate, instead of the minimum rate, would be material because it will increase the number of shares available for issuance under the Plan!
According to the NASPP’s 2013 Domestic Stock Plan Design Survey (co-sponsored by Deloitte Consulting), close to 60% of respondents allow shares withheld for taxes to be recycled. These companies would need to obtain shareholder approval of this amendment.
Companies May Need to Wait Until After Adopting the ASU
Once you amend your plan, your auditors make take this as an indication that you plan to allow share withholding in excess of the minimum required tax payment. If so, and the amendment is approved before you adopt ASU 2016-09, that’s going to trigger liability treatment for all of the awards under the plan. This liability treatment will go away once you adopt the ASU, but until then, it could be a problem.
It might be possible to structure the amendment so that it is effective only after your company adopts ASU 2016-09, but it’s a good idea to consult with your legal and accounting advisors before rushing headlong into amending your plan.
As noted last week, the FASB has issued the final Accounting Standards Update to ASC 718. Here are a few more tidbits about it.
The ASU Has a Name
Handily, the ASU now has a name that we can use to refer to it: ASU 2016-09. Now I can stop calling it “the ASU to ASC 718,” which was awkward—too many acronyms.
Transition Wrinkle
One surprise to me is how the transition works if the ASU is adopted in an interim period other than the company’s first fiscal quarter. When the ASU is adopted in Q2, Q3, or Q4, the update requires that any adjustments required for the transition be calculated as of the beginning of the fiscal year. Consequently, where companies adopt the ASU in these periods, they will end up having to recalculate the earlier periods in their fiscal year (and restate these periods wherever they appear in their financial statements), even if the transition method is prospective or modified retrospective, which normally would not require recalculation or restatement of prior periods.
For example, if a company adopts the ASU in its second fiscal quarter, the company will have to go back recalculate APIC and tax expense as required under tax accounting approach specified in the ASU for its first fiscal quarter. Likewise, if the company decides to account for forfeitures as they occur, the company will have to recalculate expense for the first fiscal quarter under the new approach and record a cumulative adjustment to retained earnings as of the beginning of the year, not the beginning of Q2.
While I can understand the rationale for this requirement, it is different than how I expected the transition to work for interim period adoptions.
No Other Surprises
The ASU 2016-09 seems to be an accurate reflection of the decisions made at the FASB’s meeting last November and documented ad nauseam here in this blog. I still haven’t read every last word of the amended language in the ASC 718, but I don’t think there are any other significant surprises.
For today’s blog, I have a few unrelated developments in stock compensation.
HSR Act Thresholds
Good news: now executives can acquire even more stock! Under the Hart-Scott-Rodino Act, executives that acquire company stock in excess of specified thresholds are required to file reports with the Federal Trade Commission and the Department of Justice. The FTC has increased the thresholds at which these reports are required for 2016 (the thresholds are adjusted every year). See the memo we posted from Morrison & Foerster for the new thresholds, which are effective as of February 25, 2016.
If you have no idea what I’m talking about, check out our handy HSR Act Portal.
Nonemployee Accounting
More good news! The FASB is still reconsidering the accounting treatment of awards issued to nonemployees. You may recall that, as second phase of the ASC 718 simplification project, the Board directed the FASB staff to research whether it would make sense to bring awards nonemployees under the scope of ASC 718, if not for all nonemployees, than at least for those who provide services that are similar to employee services. In December, the FASB staff presented its research to the Board and the Board directed the staff to continue its research. So the possibility of awards to nonemployees eventually being accounted for in the same manner as awards to employees is still on the table.
ASC 718 Update
And while we’re on the topic of ASC 718, no word yet on when the final update will be issued for phase 1 of the simplification project. As of 12:32 AM today, the FASB website still lists the estimated completion date for this project as Q1 2016, which means we could see it any day now. However, I have heard unsubstantiated rumors that it may push into Q2, so don’t start holding your breath just yet. Personally, I’m betting on the week of March 21, because I’m presenting on it twice that week: once at the 12 Annual CEP and Silicon Valley NASPP Symposium and later in the week for a Certent webinar.
Last Monday, the FASB met to review the comments submitted on the exposure draft of the proposed amendments to ASC 718. I have been watching the video of the meeting (and you can too) and have made it about half way through. After getting over my shock that no one on the Board has mentioned what a finely crafted comment letter I submitted, here’s what I’ve learned so far. (See the NASPP alert “FASB Issues Exposure Draft of ASC 718 Amendments” for a summary of the exposure draft).
Tax Accounting
The most controversial aspect of the exposure draft is the proposal to record all excess tax benefits and shortfalls in tax expense. Despite the fact that the overwhelming majority of letters submitted opposed this (see my Nov. 10 blog “Update to ASC 718: The Comments“)—including my own aforementioned finely crafted letter—and the FASB staff’s recommendation that the excess benefits and shortfalls be recognized in paid-in-capital instead, the Board voted to affirm the position in the exposure draft. I was a little surprised at how little time the Board spent considering the staff’s recommendation.
The Board decided that stock plan transactions could be treated as “discrete items” that do not need to be considered when determining the company’s annual effective tax rate. I don’t know a lot about effective tax rates, but I’m guessing that this is poor consolation for the impact this change will have on the P&L.
Estimated Forfeitures
The Board affirmed the proposal to allow companies to make an entity-wide decision to account for forfeitures as they occur, rather than estimating them. At one point, the board was considering requiring companies to account for forfeitures as they occur (without even re-exposing this decision for comment), which was a little scary. I think most of us have supported this proposal primarily on the basis that companies can keep their current processes in place if they want; I’m not sure it would have received as much support if accounting for forfeitures as they occur had been mandatory (this wasn’t even mandatory under FAS 123). Thankfully, the Board backed off from that suggestion.
Share Withholding
The Board affirmed the decision to expand the share withholding exception to liability treatment, in spite of concerns that the potential cash outflow without a recorded liability could be misleading for users. For one nail-biting moment, eliminating the exception altogether was on the table (in my amateur opinion, this would seem to go well beyond the scope of what is supposed to be a “simplification” project, given the considerable impact this would have on practices with respect to full value awards). Luckily, this suggestion did not receive any votes (not even from the Board member who suggested it, oddly enough).
Stay Tuned
More on the rest of the FASB’s decisions in a future blog entry.
This is the most controversial aspect of the exposure draft. The volatility that this change introduces to the P&L is likely to be significant for companies that rely heavily on stock compensation. We performed a very quick analysis of a handful of companies and found that, for several of them, recognizing excess tax benefits in their P&L would have increased EPS by 10%. In one case, EPS increased by 60%. Ultimately, we think this will be incredibly confusing to investors and other financial statement users. We also feel that it is highly unintuitive for changes in a company’s stock price to generate significant profits and losses for the company. While eliminating the ASC 718 APIC pool is very attractive, ultimately, we felt that the impact on earnings and effective tax rates would offset the benefits of simplifying this area of the standard. Because of this, we recommended against this amendment.
We suggested that companies record all excess tax benefits and shortfalls to paid-in capital, rather than tax expense. This would eliminate the need to track the APIC pool without impacting the P&L.
Forfeitures
We supported the proposal to allow companies to make a policy election to account for forfeitures as they occur. Our only comment on this topic was to suggest that the FASB provide a mechanism for companies to change their election without treating it as a change in accounting principle (which requires a preferability assessment and retrospective restatement).
Share Withholding
We supported the proposal to amend the standard to provide that shares can be withheld to cover taxes up to the maximum individual tax rate without triggering liability treatment.
We asked the FASB to provide additional guidance on how this requirement applies to mobile employees and suggested that share withholding be allowed up to the combined maximum tax rate in all jurisdictions that the transaction is subject to.
We also asked the FASB to remove the requirement that the tax withholding be mandated by law.
Practical Expedient to Expected Term
We supported allowing private companies to treat the midpoint of the vesting period and contractual term of an option as the option’s expected term for valuation purposes. We asked the FASB to remove the condition that the option be exercisable for only a short period of time after termination of employment and also requested removal of the conditions applicable to performance-based options.
The Rest of It and Thanks
We supported the remaining proposals in the exposure draft without comment.
Thanks to everyone that completed the NASPP’s quick survey on the exposure draft—I hope to have the results posted by the end of this week.
Thanks also to individuals who agreed to serve on our task force for this project: Terry Adamson of Aon Hewitt, Dee Crosby of the CEP Institute, Elizabeth Dodge of SOS, Sean Kelly of Morgan Stanley, Ken Stoler of PwC, Sean Waters of Fidelity, Thomas Welk of Cooley, and Jason Zellmer of Bank of America Merrill Lynch. Their help was invaluable.
Last week, I blogged that the FASB has issued the exposure draft of the proposed amendments to ASC 718. In this week’s blog entry, I cover some of the additional issues addressed by the amendments.
Cash Flow Statement
The proposed amendments suggest changes to how a couple of items should be categorized in the cash flow statement. Most significantly, excess tax benefits realized from stock plan transactions would be presented as an operating activity. Currently, excess tax benefits are reported twice in the cash statement: as a cash inflow in the financing activities and a cash outflow in operating activities. In her “Meet the Speaker interview” last summer, Ellie Kehmeier highlighted the failure to do this as a very common error that companies make, so this change will clearly be helpful.
Private Companies
It is often very difficult for private companies to estimate the expected term of option grants. To assist with this, the proposed amendments would allow private companies to use a method similar to simplified method allowed under SABs 107 and 110. I think a lot of private companies are already doing this, so I’m not sure how revelatory this is. Also, the FASB imposes the same limitations that the SEC does, (i.e., the approach can only be used for options that are exercisable for only a short time after termination of employment), making this somewhat less than helpful.
The FASB is also under the impression that there are a bunch of private companies with liability awards that did not know that they could have elected to value these awards using the intrinsic value method back when they adopted the standard and are now stuck with using the fair value method for them. The proposed amendments would give these companies a one-time opportunity to change the measurement of liability awards from fair value to intrinsic value without having to justify the change.
I don’t encounter a lot of liability awards at either public or private companies, so I am skeptical about how helpful this is, but maybe there are a bunch private companies that just cannot wait to change over to the intrinsic value method for their liability awards. Assuming they are paying attention and don’t miss this opportunity. Considering that they apparently already missed the opportunity once, I’m not optimistic. Are we going to have to go through this all again in another ten years? Maybe the FASB should just give private companies a free pass on changing the valuation method for liability awards once every ten years so we don’t have to discuss this again.
FSP FAS 123(R)-2
In somewhat more exciting news, the amendments would make permanent the guidance in FSP FAS 123(R)-2. This means that we no longer have to worry that, in the future, options that are exercisable for an extended period of time after termination of employment will be subject to liability treatment. I know you probably had forgotten that this was even a possibility, but it’s something I’ve been thinking about as I see FASB alerts that seem to indicate that the FASB is making progress on the other projects that would have impacted this. Now we all have one less thing to worry about. I also think this might be a sign that the FASB may eventually allow awards to non-employees to receive the same treatment as awards to employees—how awesome would that be!
I blogged back in October that the FASB has announced amendments to ASC 718 (Proposed Amendments to ASC 718 – Part I and Part II). Some of you may be wondering what happened with that project. The answer is that the FASB is still working on it. They have been meeting to discuss transitional issues and other projects related to the simplification of ASC 718.
The FASB met last Wednesday, February 4, to decide a number of transitional matters. I listened to the meeting; here are my observations. First, even though February 4 was my birthday, the FASB did not appear to be celebrating this in any way. In fact, it appeared that they did not even know it was my birthday. Go figure.
Share Withholding
The FASB debated whether the transition to the new share withholding guidance should be on a modified retrospective basis (essentially, companies switch over to the new method for all outstanding awards with an adjustment in the current period to account for the change) or a prospective basis only (the guidance would only apply to new awards) and decided on the modified retrospective approach. The discussion on this matter seems largely theoretical to me. The transitional guidance would only be a concern for companies that are currently subject to liability treatment due to their share withholding practices. In my experience however, there are very few, if any, companies that fall into that bucket. Most companies have carefully structured their share withholding procedures to avoid liability treatment so they don’t need to worry about any transition.
Estimated Forfeitures
The transition for changing from estimating forfeitures to accounting for forfeitures as they occur garnered even more discussion, with one FASB staffer recommending that companies be given a choice between the modified retrospective and prospective approaches. I guess there was a concern that companies wouldn’t be able to figure out the appropriate adjustment necessary to switch over to the new guidance using the modified retrospective method. But Board members were worried about confusion resulting from two different transition methods, so they decided to require the modified retrospective method.
I think that this whole area is so confusing as to be completely inscrutable to investors. Your auditors barely understand it. So while I appreciate the concern about confusion, personally I can’t see that a modicum more confusion is going to make any difference here.
But, having said that, I also can’t believe that companies would want to switch over to accounting for forfeitures as they occur on a prospective basis. That would leave companies applying an estimated forfeiture rate to awards granted prior to specified date but not after that date (or maybe to employees hired before a specified date—it was a little unclear from the Board’s discussion). That seems crazy complicated to me. My guess is that if companies can’t figure out the adjustment necessary to switch over to accounting for forfeitures as they occur, they’ll just continue to apply an estimated forfeiture rate.
Tax Accounting
For as controversial at it is, there was very little discussion among Board members of the transition to accounting for all excess benefits/shortfalls in the P&L. I guess the accounting is controversial but the transition is relatively simple. The Board decided on prospective approach. As I understand it, once the amendments are in effect, companies will just switch over to recognizing benefits/shortfalls in the P&L—the journal entries they were making to paid-in-capital to account for tax effects will now be made to tax expense.
A recent IASB proposal to amend IFRS 2 offers hope that life under IFRS, if it ever happens for US companies, may not be quite so bad after all.
Background: Share Withholding and the IASB
One area where IFRS 2 differs from ASC 718 is that the US standard incorporates a practical exception that allows share withholding to be used to cover taxes due upon settlement of awards without triggering liability treatment, whereas IFRS 2 has never provided this exception. Thus, awards that allow for share withholding are technically subject to liability treatment under IFRS 2 (although, I’ve heard that compliance with this requirement among US companies is spotty). This seems like such a small thing but it’s actually quite significant and vexing. According to the NASPP’s data(1), share withholding is, by far, the dominant approach to collecting taxes on awards, with around 80% of respondents reporting that this method is used for over 75% of all tax events.
This requirement makes share withholding fairly unattractive under IFRS 2. If US accounting standards are ever brought into convergence with IFRS, this could have been a death knell for share withholding. The amount of variability it would introduce to the P&L could be untenable for many companies.
IASB Backs Off
I’m excited to report, however, that the IASB has issued an exposure draft of an amendment to except share withholding from liability treatment under IFRS 2, similar to the exception that currently exists in ASC 718.
For companies that use share withholding for awards issued to employees in foreign subsidiaries for which they must prepare financial statements in accordance with IFRS, this is one less item to reconcile between the IFRS and US GAAP financials. And, should the SEC ever adopt IFRS here in the US, there will be many things to worry about, but this won’t be one of them. To paraphrase Iggy Azalea (with Ariana Grande in a song that is played way too often my gym): “I got 99 problems but share withholding won’t be one!” (You had no idea they were even singing about IFRS, did you?)
Some People Are Never Happy
But wait, you say—didn’t FASB just announce an amendment to ASC 718 related to share withholding? The IASB’s amendment will align with the current ASC 718, which provides an exception for share withholding for the statutorily required tax withholding. By the time the IASB finalizes their amendment, the FASB may have amended ASC 718 to allow share withholding up to the maximum individual tax rate (even if this exceeds the statutorily required withholding). If so, IFRS 2 and ASC 718 still wouldn’t align on this point. But at least it’s a step in the right direction and maybe someone will point this little nit out to the IASB before they finalize their amendment.
More Information
For more info on the IASB’s proposed amendment and a link to their exposure draft, see the NASPP alert “IASB Proposes Amendments to IFRS 2.” Thanks to Bill Dunn at PwC for alerting me to the IASB proposal.
Last week, I blogged about the proposed amendments to ASC 718. This week, I have some more information about them.
Is This a Done Deal?
Pretty much. The FASB has already considered—and rejected—a number of different alternatives on most of these issues. My understanding is that there was consensus among Board members as to each of the amendments and most of the changes aren’t really controversial, so we don’t expect there to be much debate about them.
Tax accounting is an exception, of course. This change is very controversial; in fact, the FASB considered this approach back when they originally drafted FAS 123(R) and ultimately rejected it is because of the volatility it introduces to the income statement. So perhaps there will be some opposition to this change.
What’s the Next Step?
The FASB will issue an exposure draft with the text of the changes, then will solicit comments, make changes as necessary, and issue the final amendments. I have hopes that we’ll see an exposure draft by the end of the year, with possibly the final amendments issued in the first half of next year.
ASC 718(R)?
No, the new standard will not be called “ASC 718(R),” nor will the amendments be a separate document. That’s the advantage of Codification. The amendments will be incorporated into existing ASC 718, just as if they had been there all along. In a few years, you may forget that we ever did things differently.
What’s the Next Project?
This isn’t the FASB’s last word on ASC 718. They have a number of additional research projects that could result in further amendments to the standard:
Non-Employees: In my opinion, the most exciting research project relates to the treatment of non-employees. As I’m sure you know, it is a big pain to grant awards to consultants, et. al., because the awards are subject to liability treatment until vested. The FASB is considering whether consultants should be included within the scope of ASC 718, with awards to them accounted for in the same manner as employee awards. If not for all consultants, than at least for those that perform services similar to that of employees.
Private Companies: Another research project covers a number of issues that impact private companies, such as 1) practical expedients related to intrinsic value, expected term, and formula value plans and 2) the impact of certain features, such as repurchase features, on the classification of awards as a liability or equity.
Unresolved Performance Conditions: Another project relates to awards with unresolved performance conditions. I’ll admit that I’m not entirely sure what this is.
That’s All, For Now
That’s all I have on this topic for now. You can expect more updates when we hear more news on this from the FASB.
A big thank-you to Ken Stoler and Nicole Berman of PwC for helping me sort through the FASB’s announcement. If you haven’t already, be sure to check out their Equity Expert Podcast on the amendments.