Accounting for stock compensation
Changes made relating to accounting for share-based transactions
TAX ALERT |
On March 30, 2016, the Financial Accounting Standards Board (the Board) released Accounting Standards Update (ASU) 2016-09, Compensation – Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting, to reduce the complexity of certain aspects of the accounting for employee share-based payment transactions. This update involves significant changes in the several aspects of the accounting for share-based payment transactions, including the accounting for the income tax consequences of share-based awards. The update significantly changes many of the current accounting principles related to share-based compensation. For public companies, the ASU is effective for annual periods beginning after Dec. 15, 2016, and interim periods within those annual periods. For private companies, the ASU is effective for annual periods beginning after Dec. 15, 2017, and interim periods within annual periods beginning after Dec. 15, 2018. Early adoption is permitted for any organization in any interim or annual period.
Under the new standard, all excess tax benefits and tax deficiencies (including tax benefits of dividends on share-based awards) will be recognized as income tax expense or benefit in the income statement. Currently, such excess tax benefits are recognized as an adjustment to paid-in capital. Further, each award must be evaluated to determine if there is a deficiency or an excess. Although this change will certainly reduce the complexity surrounding the accounting for excess tax benefits and deficiencies, it will create significant volatility in a company’s tax rate. The standard provides that the tax effects of exercised or vested awards will be treated as a discrete item in the reporting period in which they occur. Thus, the tax effect of excess benefits and deficiencies on a company’s tax rate will not be part of the overall effective tax rate.
Under current accounting rules, excess tax benefits may only be recognized when they reduce tax liability. This results in significant complexity in determining when such benefits are realized. The new standard permits an entity to recognize excess tax benefits regardless of whether the benefit reduces taxes payable in the current period. Therefore, to the extent that excess benefits result in a net operating loss carryforward, or result in greater credit carryforwards, the benefits will still be recognized, subject to normal assessment of the realization of deferred tax assets.
The standard also requires that excess tax benefits not be separated from other income tax cash flows, and thus would be classified with other cash flows as operating activity.
The standard also changes the minimum withholding requirements related to share-based payments. One of the previous requirements for an award to qualify for equity classification is that an entity cannot partially settle the award in cash in excess of the employer’s minimum statutory withholding requirements. The determination of employees’ minimum statuary withholding amount has been difficult for some entities. Under the ASU, the threshold to qualify for equity classification would permit withholding up to the maximum individual statutory tax rate in the applicable jurisdictions. Also, the ASU provides that cash paid by an employer when directly withholding shares for tax-withholding purposes would be classified as a financing activity on the statement of cash flows.
The changes related to the timing of when excess benefits are recognized, minimum statutory withholding requirements, certain accounting changes dealing with forfeitures and intrinsic value, should be applied using a modified retrospective transition method by means of a cumulative–effect adjustment to equity as of the beginning of the period in which the guidance is adopted. For example, if an entity has excess tax benefits that have not been recognized (but that could be under normal deferred tax asset realization standards), would record a credit to equity for the amount at the beginning of the period of adoption.
Amendments requiring recognition of excess tax benefits and tax deficiencies in the income statement should be applied prospectively. An entity may elect to apply the amendments related to presentation of excess tax benefits on the statement of cash flows using either a prospective transition method or retrospective transition method.
This ASU makes significant changes in the tax accounting for stock compensation. Although the ASU can be adopted in the first quarter of 2016, entities should carefully consider the impacts of the standard. Further, company’s should ensure that they have accurately accounted for prior exercised and vesting of awards, and that deferred tax assets for equity awards are accurately stated prior to adoption of the new standard.