The accounting for stock options and other share-based payments should be simpler going forward, under a new accounting standard meant to carve out unnecessary complexity.
The Financial Accounting Standards Board approved Accounting Standards Update No. 2016-09 in March to revise Topic 718 of the Accounting Standards Codification in a way that is intended to make the accounting easier on preparers while not complicating things for investors. “The impetus is to reduce the cost and complexity of existing GAAP while making sure the information investors are getting is not compromised,” says Sandie Kim, a partner in Deloitte’s national office and leader of the stock-based compensation team.
The changes are welcome to most companies, says Cynthia Scheuer, a partner with audit firm UHY. “This standard has been outrageously difficult for companies to manage,” she says. A public company CFO when FASB first required companies to expense stock options through income, she remembers well the complexity of the accounting. “I have a good feeling for what it is to administer this standard,” she says.
While experts agree the new accounting will be easier, transitioning to the new requirements will take some planning. “The transition requirements for the various provisions are not all the same,” says Kim. Some provisions, for example, must be adopted retrospectively, meaning companies must restate prior periods as if the provision had been in place all along. Other provisions must be adopted using a modified retrospective approach, so using cumulative-effect adjustments. Yet others will be adopted prospectively, or going forward. “It could be difficult to try to maneuver all the different transition provisions.”
But it’s an effort some companies seem eager to undertake sooner rather than later to shed the complexity of current accounting, says Ryan Brady, senior manager in accounting principles at Grant Thornton. “We’re getting inquiries in the national office about public companies that want to adopt this in the current quarter,” he says. “But if you do that, you have to adopt all the provisions together. Depending on the company, that could be a significant undertaking, or not.”
The standard contains provisions related to the income tax effects of share-based payment awards, the classification of tax items in the cash flow statement, statutory tax withholding requirements, and forfeitures. It also contains some practical expedients of interest to privately held companies. Perhaps most significant to public companies will be the relief from having to track tax benefits and tax deficiencies and to segregate them between equity and income, says Jeffrey Ellis, senior managing director at FTI Consulting.
“We’re getting inquiries in the national office about public companies that want to adopt this in the current quarter. But if you do that, you have to adopt all the provisions together. Depending on the company, that could be a significant undertaking, or not.”
Ryan Brady, Senior Manager, Grant Thornton
Companies must track the tax consequences of share-based payment awards separately for book and tax purposes because accounting rules are not the same as tax rules. And sometimes the vesting or exercising of shared-based payment awards leads to tax benefits rather than tax expenses or deficiencies.
Current accounting rules require companies to keep close track of all that activity and distinguish between tax consequences that are recorded through the income statement or through equity. The new standard tells companies to reflect all tax consequences through the income statement, ending the distinction between tax effects that go to equity versus income.
“There are so many complexities related to that,” says Yosef Barbut, a tax partner with BDO USA. “The big audit firms have many pages in their published guides on how to quantify this benefit to equity. The complexities are numerous.” In fact, it was a source of restatements when the accounting was still new and even in later years, he says. “If you just consider the tax accounting implications of this decision, this is a huge simplification.”
With all the tax consequences going to the income statement, experts say companies are expecting more volatility. Some companies are satisfied with the tradeoff, and some aren’t. “There’s going to be volatility, but you have a lot of volatility anyway,” says Scheuer. “It’s something that’s happening standard after standard. This is better accounting. It’s cleaner.”
But companies that have grown accustomed to the accounting and have processes in place may not prefer giving up their spreadsheets in exchange for volatility, says Ellis. “FASB got a lot of pushback on whether this was really a simplification or should have been handled as a normal agenda project,” he says. “I don’t think all companies are happy about this. It certainly wasn’t uniform.”
PROVISIONS OF ASU 2016-09 APPLICABLE TO PUBLIC COMPANIES:
Below FASB lists what provisions in the stock options standard apply to public companies.
Accounting for Income Taxes:
All excess tax benefits and tax deficiencies (including tax benefits of dividends on share-based payment awards) should be recognized as income tax expense or benefit in the income statement. The tax effects of exercised or vested awards should be treated as discrete items in the reporting period in which they occur. An entity also should recognize excess tax benefits regardless of whether the benefit reduces taxes payable in the current period.
Classification of Excess Tax Benefits on the Statement of Cash Flows:
Excess tax benefits should be classified along with other income tax cash flows as an operating activity.
An entity can make an entity-wide accounting policy election to either estimate the number of awards that are expected to vest (current GAAP) or account for forfeitures when they occur.
Minimum Statutory Tax Withholding Requirements:
The threshold to qualify for equity classification permits withholding up to the maximum statutory tax rates in the applicable jurisdictions.
Classification of Employee Taxes Paid on the Statement of Cash Flows When an Employer Withholds Shares for Tax-Withholding Purposes:
Cash paid by an employer when directly withholding shares for tax-withholding purposes should be classified as a financing activity.
Jeffrey Jones, a partner with KPMG, says he can’t speculate on what view companies might have on expected volatility, but he anticipates companies will prepare for it. “It will be a discrete item, so it will be called out separately in the income tax rate reconciliation,” he says. “I suspect it will be an item that for some companies will be material, so they will be calling it out as a component of their income tax effective rate. They will highlight to investors that now it is in my income statement.”
Barbut says he expects companies to adapt their communication to investors to assure they understand the change in the effective tax rate. “Show me a company that has statutory rates and effective tax rates that are the same,” he says. “It doesn’t exist. Large companies are concerned about this, but it is something that can be explained.”
Another significant simplification, says Ellis, is a change in withholding requirements related to share-based payments. For an award to qualify for equity classification, companies cannot partially settle the award in cash beyond the minimum statutory rate for each individual employee. The new standard allows withholding up to the maximum rate in each jurisdiction. “This has been difficult from an administrative standpoint,” he says.
Mike Loritz, a shareholder with audit firm Mayer Hoffman McCann, says he expects companies to appreciate the simplifications with respect to the statement of cash flows. In one provision of the new standard, companies are instructed to classify all income tax cash flows as operating activities. Under current GAAP, excess tax benefits are separated from other income tax cash flows and classified as a financing activity. “Elimination of the reporting of those within the financing section will produce more clarity for a lot of people in the statement of cash flows,” he says.
The new standard takes effect for public companies for annual periods beginning after Dec. 15, 2016, but early adoption is allowed.