The FASB’s gift to us all – ASU 2018-07 (almost) no more consultant stock option revaluations!

With all of the tax reform changes, stock market volatility and political noise going on these days, it would have been easy to miss the FASB Accounting Standard Update 2018-07.   But it’s one you definitely want to know about!

If you’re issuing stock options or any equity compensation awards to consultants, advisors, or other non-employees (other than Directors), then you’re currently going through the hassle of revaluing those equity awards for stock compensation expense reporting purposes.

Enter ASU 2018-07, part of the FASB’s Simplification Initiative and largely the end of mark-to-market valuations for equity-classified non-employee awards!

What did it do?

Technically, the amendment expands the scope of Topic 718 (which governs valuation of employee awards) to include share based payment transactions for acquiring goods and services from nonemployees.   This does not impact all non-employee awards however; the amendment clarifies that Topic 718 does not apply to share-based payments used to effectively provide (1) financing to the issuer or (2) awards granted in conjunction with selling goods or services to customers as part of a contract accounted for under Topic 606, Revenue from Contracts with Customers.

What does it mean?

  • Fair Value Measurement from Grant Date:

The measurement of equity-classified non-employee awards will be fixed at the grant date (rather than as previously at either the “performance commitment” date or date at which the non-employee completed their contracted work).  This may mean a lower expense, certainly means lower volatility in the income statement, and most importantly means less work for you!

  • Performance Awards measurement based on probable outcomes:

During the vesting period, non-employee awards that contain performance conditions that affect the quantity or other award terms (e.g., exercise price) are measured based on the outcome that is probable.  This is a change from the previous guidance in ASC 505-50 that requires these types of awards to be measured at the lowest aggregate fair value within a range of possible outcomes.

  • Use of either Expected Term or Contractual Remaining Life for non-employee awards:

Previously, companies were required to use Remaining Contractual Life for non-employee award term.  In order to switch to Expected Term, companies must have historical data on award and exercise behavior for a reasonably similar population.

  • Additional non-public company simplifications

The standards update also allows for non-public entities to apply some of the simplifications used for employee award accounting to non-employee award accounting, as long as the same methods are used for both populations:

  • Use of the mid-point Simplified Method for calculating expected term for non-employee awards with service or performance vesting conditions
  • Use of an appropriate peer group to calculate volatility, rather than use company stock history
  • Use of intrinsic value for non-public entity liability awards

Non-public entities that measure their liability-classified employee awards using intrinsic value must also measure liability-classified nonemployee awards using intrinsic value, instead of the previously required fair value.

 What does the transition to ASU 2018-07 look like?

If you weren’t an early adopter, the guidance is effective for public business entities (PBEs) in annual periods beginning after 15 December 2018, and interim periods within those annual periods.  For all other entities, it is effective in annual periods beginning after 15 December 2019, and interim periods within annual periods beginning after 15 December 2020.

Early adoption is permitted, including in an interim period for which financial statements have not been issued (PBEs) or made available for issuance (non-PBEs), but not before an entity adopts ASC 606.

When transitioning – an entity should only re-measure liability-classified awards that are outstanding on the date of adoption and equity-classified awards that are still vesting.  Upon transition, you’ll need to measure these non-employee awards at fair value as of the start of the year of the adoption date, or the start of the fiscal period if using an interim period adoption.  For awards that have already been amortizing expense, you’ll need to make a cumulative-effect adjustment to retained earnings as of the beginning of the fiscal year of adoption.

When the change is adopted, disclosures should include the nature of and reason for the change in accounting principle and, if applicable, detailed information about the cumulative effect of the change on retained earnings or other components of equity.

Have questions?

The OptionTrax team of Certified Equity Professionals is here to help!  Contact us at [email protected] to get help with understanding or implementing the transition to ASU 2018-07, or with any other aspect of your equity compensation plan!