As part of their simplification initiative, the FASB has issued new accounting guidance for stock comp (ASC 718). This is great news for us hard working accountants, right? FASB definitely simplified some of the complexities in accounting for share-based payment awards when they issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting in March of 2016. If your reading this and saying to yourself “finally FASB has issued some guidance that will make my life easier” – you are at least partially correct! Don't start planning extended lunches to absorb all the time savings just yet. You’ll likely by using that time to explain volatility in earnings that will be created by the simplified accounting.
The big headline associated with ASU 2016-09 is the elimination of the APIC pool. Not sure what an APIC pool is? No worries, read on I’ll explain below. In fact, we’ll also explore the changes to the tax withholding requirements and the accounting policy election related to forfeited awards that is introduced in the new guidance.
Accounting for Excess Tax Benefits and Deficiencies – Elimination of the APIC Pool
Before we talk about the elimination of the APIC pool – let’s make sure everyone understands how excess tax benefits and deficiencies related to share-based payment awards are created. I’m sure you remember but just in case, a deferred tax asset is created when stock compensation expense is recorded because the expense is only deductible for tax purposes once the award is exercised. The differences between the deferred tax asset recognized (based on fair value under ASC 718) and the deduction taken on the entities tax return (based on actual appreciation) create these excess tax benefits and deficiencies.
Under current guidance, excess tax benefits are recognized in additional paid in capital (APIC) on the balance sheet and the accumulation of these benefits is referred to as the APIC pool. Excess tax benefits are only recognized to the extent they can reduce current income taxes payable; otherwise, recognition is deferred until they can be realized. Tax deficiencies are offset to the APIC pool until all accumulated benefits are exhausted. Tax deficiencies in excess of accumulated tax benefits are recorded as an expense in the current period’s earnings.
Under ASU 2016-09 the APIC pool is eliminated. All excess tax benefits and deficiencies are recorded in the income statement in the period they are created. This change will be applied prospectively in the period of adoption. Although companies will celebrate the demise of the APIC pool, inevitably this change will result in additional volatility in earnings.
Companies will no longer be required to delay the recognition of excess tax benefits until they can be realized under the new guidance. At the time of adoption, a cumulative-effect adjustment will be recorded in retained earnings for any excess tax benefits not previously recognized due to realizability.
Finally, all tax-related cash flows related to share-based payments will be presented as an operating activity within the statement of cash flows – this is a change from current guidance. This change can either be applied prospectively or retrospectively
Tax Withholding Requirements
Under ASC 718, cash settlement of awards results in liability classification. Employers are permitted to withhold shares to satisfy the employers withholding requirement. Because this practice is essentially cash settling a portion of the award, the amount is strictly limited to the employer’s minimum statutory tax withholding requirement under the current guidance. If shares in excess of the statutory minimum are withheld, it results in the entire award being classified as a liability award. The guidance contained in ASU 2016-09 will permit withholding shares up to the maximum individual statutory tax rate in the applicable jurisdiction and still allow the award to be classified as an equity award. This will simplify the withholding process by allowing a company to determine a single maximum rate for all employees in a jurisdiction.
Accounting for Forfeited Awards
Current guidance requires a company to estimate the number of forfeitures that will occur when recognizing compensation cost related to share-based payment awards. Under the new guidance in ASU 2016-09, companies can continue to estimate forfeitures or they can elect to account for forfeitures as they occur by reversing compensation cost when the award is forfeited. If a company elects to account for forfeitures as they occur, they will still be required to estimate forfeitures when issuing replacement awards in a business combination or when awards are modified. Companies making an accounting policy election to account for forfeitures as they occur will do so by recording a cumulative-effect adjustment in retained earnings as of the beginning of the year of adoption.
Other Changes and Effective Date
ASU 2016-09 also includes simplifications specific to nonpublic entities not covered by this blog post. ASU 2016-09 is effective for public entities for annual reporting periods beginning after December 15, 2016 and interim reporting periods with the year of adoption. The new guidance is effective for all other entities for fiscal years beginning after December 31, 2017. Early adoption of the entire ASU is permitted.