As you’ve likely heard, in March of 2016, the FASB board released an Accounting Standards Update (Update 2016-09) with several changes that impact accounting standards for stock option and equity compensation plans. The intent of these changes was to simplify the accounting processes related to equity compensation plans.
Though FASB updates are generally considered fairly droll occurrences, these updates have already made headlines as some issuers with high-value plans make the switch. On February 3rd, the Wall Street Journal reported that Facebook Inc.’s earnings in 2016 included a more than $900 million boost from accounting changes, primarily related to the change that calls for running excess tax benefits from stock option exercises directly through the income statement, which reduces the provision for taxes and therefore increases net income.
As a quick recap, the main updates included in ASU 2016-09 were as follows
• Forfeiture Accounting – When recording the amortization of stock compensation cost, the accrual values are currently based on the number of awards that are expected to vest, requiring the issuer to estimate a forfeiture rate. This update allows an entity to make an entity-wide accounting policy election to either use a forfeiture hedging estimate to estimate the number of awards that are expected to vest, or to account for forfeitures real-time in the financial reporting period in which they occur. This shift is made much easier to implement by the fact that equity compensation systems such as OptionTrax® can automatically track forfeitures and adjust stock comp expense accordingly in the period in which the forfeiture occurs.
• Statutory Withholding on Exercises & Vests – In the past, employers were allowed to withhold only up to the minimum statutory tax rate for awards without causing the award to be classified as a liability award (requiring variable accounting over the lifetime of the award). The revised standard now allows employer share-based withholding up to the maximum statutory tax rates applicable in the issuer’s jurisdiction. It is important to note, however, that despite the updated FASB rules regarding tax withholdings for financial accounting purposes, there haven’t been changes in Treasury regulations (i.e., the methods to determining the withholding rate for supplemental wages still include the choice of only (1) mandatory flat rate withholding; (2) optional flat rate withholding; and (3) aggregate method withholding). As a result, before making changes to the withholding method for plan participants, it is important to understand and consider the IRS guideline implications.
• Statement of Cash Flows Classification of Employee Taxes Paid When an Employer Withholds Shares for Tax-Withholding Purposes – Until now, there has been no clear guidance on how cash payments made by a company to tax authorities for taxes on exercise or vest when an employee withholds shares, should be classified on the Statement of Cash Flows. This is now clarified, and should be classified as a financing activity.
• Private Entity Intrinsic Value Accounting – As per this update, nonpublic entities will be permitted to make a one-time accounting policy election to switch from measuring all liability-classified awards at fair value to intrinsic value. Since the initial adoption of ASC 718 private entities have had this option, however, FASB acknowledged that many private entities were not aware of the option, and has therefore authorized this one-time switch over of methodologies.
Facebook is not alone. Google parent, Alphabet Inc., and Microsoft Corp. have also seen an increase in earnings due to early adoption of the change. And it is likely that there will be more announcements of significant earnings impact, as other major tech companies and industries adopt the changes in the coming year.
Along with simplifying the rules, such results may boost the popularity of equity compensation plans even further. It also shows that while change is never easy, dragging your feet on this particular set of updates carries a real opportunity cost!
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