While many of us in the accounting world are busy thinking about the Big 3 new standards, the Financial Accounting Standards Board (FASB), masters of all things U.S. GAAP, have been busy too…helping preparers of financial statements to reduce the burden of preparing their financial statements. The FASB has recently undertaken a simplification initiative. The objective of this initiative is to reduce the cost and complexity in financial reporting while maintaining or improving the usefulness of information provided to the users of financial statements.
As part of this process, the FASB has issued ASU 2018-07, Improvements to Nonemployee Share-Based Payment Accounting. This amendment expands the scope of ASC 718, Stock Compensation, to include share-based payment transactions for acquiring goods and services from nonemployees. These types of arrangements had previously been accounted for under ASC 505-50 and numerous differences existed between the two sets of guidance. Some of those differences include:
- The determination of the measurement date
- Accounting for awards with performance conditions
- Certain measurement elections available to nonpublic entities
- And more!
This new ASU aligns many of these accounting requirements for share-based payments granted to employees with those granted to nonemployees. Taking two standards (ASC 718 for employees and ASC 505 for nonemployees) down to just one…how’s that for simplification?!
Scope of the revised standard
This revised standard expands the scope of ASC 718 to include all share-based payment arrangements entered into as a result of the acquisition of goods or services by either employees or nonemployees and applies to all entities that enter into these types of transactions.
Previously, ASC 505-50 provided guidance on accounting for nonemployee share-based payment arrangements and ASC 718 provided guidance on the accounting for share-based payment arrangements with employees. Additionally, ASC 505-50 provided guidance on the accounting for both the grantor and the grantee. This included guidance on the grantor’s accounting for share-based payments issued as sales incentives to customers.
Under the new guidance, an entity will apply ASC 606, Revenue from Contracts with Customers, to any share-based payments received by a grantee from a customer (grantor) because the entity must include any non-cash consideration (including share-based payments!) at its estimated fair value in determining the estimated transaction price at contract inception.
In order to illustrate the changes made by this amendment, let’s take a minute to remind ourselves of the accounting for share-based payment awards and the differences between accounting for those granted to employees and those granted to nonemployees.
So, how should we account for these share-based payment awards? Well, it depends on whether GAAP Dynamics is applying the old guidance or the new! Let’s take a look.
Under current guidance, nonemployee share-based payment awards are measured at the fair value of the consideration received or the fair value of the equity instruments issued, whichever can be most reliably measured.
In our example, I’m willing to bet this is likely the consideration received!
Under the new guidance, and consistent with the accounting for share-based payment awards, nonemployee share-based payment awards will be measured at the grant-date fair value of the equity instruments that the entity is obligated to issue when the good or service has been delivered or rendered.
Therefore, GAAP Dynamics will need to determine the grant-date fair value of these equity instruments.
So, what is the measurement date under U.S. GAAP? Currently, for equity classified awards, the measurement date is the earlier of the date at which a commitment for performance by the counterparty is reached or the date at which the counterparty’s performance is complete.
In our scenario, it is likely the date at which a commitment for performance is reached with Thought Industries.
Under the revised GAAP (and ASC 718), the measurement date is the grant date, which is the date at which a grantor and a grantee reach a mutual understanding of the key terms and conditions of a share-based payment award.
In our scenario, this is likely the date a contract is signed by both parties.
Measurement alternatives for nonpublic entities:
So how should GAAP Dynamics measure the awards? While this would generally be a fair value-based measurement, ASC 505-50 does give one alternative for nonpublic entities:
If GAAP Dynamics were applying the revised standard under ASC 718, it would have a few more options to value its instruments as a nonpublic entity.
There are a few other changes worth noting as well. Under the current guidance, entities are not allowed to consider the probability that a performance condition will be met. Instead, the entity measures the awards at the lowest aggregate fair value until the outcome of the performance conditions is known or achieved.
In practice, this could mean that the lowest aggregate fair value is zero and no cost is recognized until the performance condition is achieved!
Under the revised standard, an entity will consider the probability of satisfying performance conditions when recognizing any cost, similar to the current guidance for employee share-based payment awards.
Is there anything that didn’t change? YES! While the new guidance may result in the total cost recognized for nonemployee awards being different than that under the old guidance, the manner and period for cost recognition will not change. Under ASC 718, compensation cost is generally recognized ratably over the requisite service period. This type of ratable recognition may not make sense to certain types of nonemployee awards. Therefore, the ASU retains the guidance in ASC 505-50 that any asset or expense should be recognized in the same period and in the same manner as though the grantor had paid cash.
When are these amendments effective?
According to the ASU, the amendments are effective for public business entities for fiscal years beginning after December 15, 2018. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2019 with an extra year for interim period compliance. Early adoption is permitted, but no earlier than an entity’s adoption date of ASC 606, Revenue from Contracts with Customers.
Generally speaking, as of the beginning of the fiscal year of adoption, an entity will remeasure liability-classified awards that have not been settled and equity-classified awards for which the measurement date has not been established through a cumulative-effect adjustment to retained earnings.
And don’t forget about disclosures! Entities should disclose the nature and reason for the change in accounting principle and, if applicable, any quantitative information about the cumulative effect of the change on retained earnings or other components of equity.
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