For my last installment (at least for the moment—expect another blog when the FASB officially adopts the new standard) in my series on the FASB’s ASC 718 simplification project, I answer a few questions relating to early adoption of the new standard.
Can companies adopt it early?
Yes, companies can adopt the amended standard in any interim or annual period after the FASB approves the official amendment. If the FASB approves the amendment as expected in this quarter, companies could adopt it in this quarter.
Can companies adopt it now?
No, not quite yet. Companies have to wait until the final amendment is approved by the FASB to adopt it.
Can companies adopt just the parts of the update they like early and wait to adopt the rest of it?
Heck no! This isn’t a salad bar; it’s all or nothing. You have to take the bad with the good.
If we start allowing employees to use shares to cover tax payments in excess of the minimum required withholding now, are my auditors really going to make me use liability accounting, given that we all know the rules are changing soon?
Well, I can’t really speak for your auditors, so you’d have to ask them—accounting-types do tend to be sticklers for the rules, however. If the FASB approves the amendment on time, you could adopt it this quarter and there’d be no question about liability treatment. But you’d have to adopt the whole standard, including the tax accounting provisions, so you would want to make sure you are prepared to do that.
If you don’t want to adopt the entire update as soon as the FASB approves it, liability treatment applies if shares are withheld for more than the minimum tax payment. For awards that are still outstanding when you adopt the update, this liability treatment will go away. You’ll record a cumulative adjustment at the time of adoption (see my blog last week on the transition) to switch over to equity treatment. But for the awards that are settled prior to when you adopt the standard, you won’t reverse the expense you recognize as a result of the liability treatment.
If the awards that will settle between now and when you expect to adopt the standard are few enough, the expense resulting from the liability treatment might be immaterial. Likewise, if your stock price is at or below the FMV back when the awards were granted, you might not be concerned about liability treatment because it likely wouldn’t result in any additional expense.
Note, however, that if you establish a pattern of allowing share withholding for excess tax payments, liability treatment applies to all awards, not just those for which you allow excess withholding. You could have liability treatment for all award settlements that occur before you adopt the amended standard.
For today’s installment in my series on the FASB’s ASC 718 simplification project, I explain what the next steps are in this process.
Is the update final now?
Not quite yet. For the most part, we know what the final update is going to look like because the FASB’s decisions with respect to each issue in the exposure draft are public. But the FASB staff still has to draft the actual amendment to ASC 718 and the FASB has to vote to adopt the amendment.
In addition, there are a few technical details in the exposure draft that were commented on and that we expect the staff to clean up, but we won’t know for sure until the amendment is issued. The FASB didn’t vote on these details because they don’t change the board’s overall position; it is merely a matter of clarifying what the board’s decision means with respect to some aspects of practical implementation. For example, the language of the proposed amendment relating to share withholding seemed to imply something different than the FASB’s explanation of what this change would be. I am assuming the staff will modify this language but we won’t know for sure until the final amendment is issued.
When will the FASB adopt the amendment?
According to the FASB’s Technical Agenda, this project is expected to be finalized in Q1 2016. Anyone who’s been in the industry for a more than a couple years knows, however, that these things tend to slip a bit. In my 20 years in this industry, I can’t think of a single regulation, rule, amendment, etc. that, when targeted for issuance during a specific time frame, came out earlier than the very last week or so in that time frame. (10 pts to anyone who can prove me wrong on this—I started in the industry in 1994, so stuff before that doesn’t count.) The FASB is no exception, so I’m guessing that we are looking at the end of March or maybe even Q2 2016.
When will companies be required to comply with the new guidance?
Public companies will have to adopt the update by their first fiscal year beginning after December 15, 2016 (and in the interim periods for that year). Private companies have a year longer to adopt for their annual period and two years longer for interim periods.
Will the standard now be called ASC 718(R)?
No. For people like me who write about accounting, that would be handy because it would make it easy to distinguish when I’m talking about the pre-amendment vs. the post-amendment ASC 718. Now I’ll have to use some sort of unwieldy clarification, like “ASC 718, as amended in 2016.” But under the FASB’s codification system, the existing standard is simply updated to incorporate the amendments. The name of the standard will stay the same.
If the Codification system didn’t exist, maybe we would call it FAS 123(R)(R). Or would it be FAS 123(R)2?
For my first blog entry of 2016, I look at the transition methods that will apply under the FASB’s Accounting Standards Update (ASU) to ASC 718. (If you’ve forgotten what this is all about, read Part I and Part II of my update on the FASB’s decisions on the ASC 718 simplification project.) Also, see my handy chart showing how FASB voted on each issue in the exposure draft and the required transition method for it.
Prospective
The prospective transition method is perhaps the easiest to understand. Under this method, the company just changes its accounting procedures on a go-forward basis, with no restatement of prior periods or cumulative adjustments.
The prospective transition method will be used for the tax accounting provisions. For transactions that occur after a company adopts the ASU, the amounts that would have been recorded to additional paid-in capital will now simply be recorded to tax expense. It’s that easy: no adjustments to paid-in capital or tax expense for past transactions and the ASC 718 APIC pool calculation is no more.
Retrospective
Retrospective transition is also fairly straightforward. With this method, the company changes its accounting procedures going forward, but also adjusts any prior periods reported in its current financials. For example, most companies show three fiscal years in their annual financial statements. Where retrospective transition is required, a company that adopts the ASU in 2016 would not only change their accounting procedures for 2016, but would go back and adjust the 2015 and 2014 periods as if the new rules had applied in those periods.
The adjustment is presented only in the current financials; the company does not reissue any previously issued financial statements or re-file them with the SEC.
The only provisions in the ASU that are subject to retrospective transition are the provisions related to classification of amounts reported in the cash flow statement (and for the classification of excess tax benefits, the company can choose between prospective and retrospective).
Modified Retrospective
This transition method is used when a cumulative adjustment is necessary. Accounting for forfeitures is a good example. A company can’t just switch from applying an estimated forfeiture rate to accounting for forfeitures as they occur on a prospective basis: since previously recorded expense was adjusted based on estimated forfeitures, companies would end up double-counting forfeitures when they occur. Retrospective restatement wouldn’t fix this problem because some of the prior expense may have been recorded outside of the periods presented in the company’s current financials.
It also doesn’t make sense to make companies record a big change in expense in their current period; this would be confusing (and possibly alarming) to investors and isn’t reflective of what is happening. So instead, the transition is handled with a cumulative adjustment that is recorded as of the start of the fiscal period. This adjustment is recorded in retained earnings (which is the balance sheet account where net earnings end up) with an offsetting entry to paid-in capital.
In the case of forfeitures, the company calculates the total expense it would have recognized as of the start of the period if it had been accounting for forfeitures as they occur all along and compares this to the actual amount of expense recorded to date (which should generally be lower). The difference is then deducted from retained earnings, with a commensurate increase to paid-in capital.
In addition to the forfeitures provision, modified retrospective is used for private companies that take advantage of the opportunity to change how they account for liability awards. It is also used theoretically for the share withholding provisions if companies have been allowing employees to tender shares in payment of taxes in excess the minimum statutorily required withholding and has outstanding awards that are subject to liability treatment as a result. But I doubt anyone has been doing that, so in practice, I don’t think a transition will be necessary for the share withholding provisions.
This week I provide additional coverage of the decisions the FASB made on the ASC 718 simplification project (see my blog from last week for Part 1).
Cash Flow Statement
The Board affirmed both of the proposals related to the cash flow statement: cash flows related to excess tax benefits will be reported as an operating activity and cash outflow as a result of share withholding will be reported as a financing activity. Nothing particularly exciting about either of these decisions but, hey, now you know.
Repurchase Features
The board decided not to go forward with the proposal on repurchases that are contingent on an event within the employee’s control. The proposal would have allowed equity treatment until the event becomes probable of occurring (which would align with the treatment of repurchases where the event is outside the employee’s control). The Board decided to reconsider this as part of a future project. The Board noted that this would have required the company to assess whether or not employees are likely to take whatever action would trigger the repurchase obligation, which might not be so simple to figure out (we all know how hard it is to predict/explain employee behavior).
Practical Expedient for Private Companies
The Board affirmed the decision to provide a simplified approach to determining expected term for private companies, but modified it to allow the approach to be used for performance awards with an explicitly stated performance period. I’m not sure that many private companies are granting performance-based stock options, but the few who are will be relieved about this, I’m sure.
Options Exercisable for an Extended Period After Termination
Companies that provide an extended period to exercise stock options after retirement, disability, death, etc., will be relieved to know that the FASB affirmed its decision to eliminate the requirement that these options should be subject to other applicable GAAP. This requirement was indefinitely deferred, but now we don’t have to worry about it at all.