In March 2016, the FASB issued Accounting Standards Update (ASU) No. 2016-09, Improvements to Employee Share-Based Payment Accounting, which includes significant changes to ASC 718 – Compensation – Stock Compensation. This ASU applies to both public and private companies. Public companies were required to adopt this standard in annual reporting periods beginning after December 15, 2016. For private companies, the standard becomes effective for annual reporting periods after December 15, 2017, and for interim periods beginning after December 15, 2018. However, early adoption is permitted.
The new ASU simplifies several aspects of the accounting and presentation for stock compensation and could significantly impact your company’s income tax provision, earnings per share, and Statement of Cash Flows.
Income Tax Impact
Typically, the amount of stock compensation expensed on a company’s financials is much different from the amount it can deduct on its tax return, which generally must match the amount of income reported on the recipients' W-2s and 1099s. These differences can make up a substantial portion of a company’s deferred tax assets (DTAs) and significantly impact its effective tax rate (ETR). Under the previous accounting standard, tax deductions in excess of stock compensation expense ("windfalls") are recognized in APIC and tax deficiencies ("shortfalls") are recognized either as an offset to accumulated windfalls, if any, or in income tax expense. Additionally, windfalls may not be recognized in APIC until they can reduce income taxes payable and until then, must be tracked off balance sheet in an “APIC pool.” So, while a company maintains taxable loss positions, the process of calculating and tracking the windfalls each year is typically complex and dreadfully tedious.
The new ASU eliminates the need to track the APIC pool, and instead, windfalls and shortfalls will be recognized in income tax expense as they occur, subject to normal valuation allowance considerations.
So, What Does That Really Mean?
- No more “with” and “without” income tax provisions and simplified recordkeeping for companies who had an APIC pool. APIC pools will no longer be required for tracking purposes.
- Increased volatility of income tax expense, net income and ETR due to the recognition of windfalls and shortfalls as they occur.
- An increase to the company’s DTAs in the period it adopts in the amount of its previously unrealized windfalls that were tracked off balance sheet.
- Diluted earnings per share (EPS) will no longer include windfalls and shortfalls in a company’s assumed proceeds; therefore, equity awards will have a more dilutive effect on EPS.
Presentation on the Statement of Cash Flows
The new ASU also changes the presentation of income tax cash flows on the Statement of Cash Flows: Windfalls are currently classified as inflows from financing activities and outflows from operating activities and must be separated from other income tax cash flows. However, the new ASU will require all tax-related cash flows resulting from stock compensation to be included in the operating section. The FASB hopes this will improve consistency through the cash flow statement.
Other Prominent Changes
- An entity can now make an accounting policy election to either account for award forfeitures as they arise or continue to estimate forfeitures under the current guidance. For companies without ample historical data, the election to account for the awards as they occur may ease the burden of preparing estimates. The company would also recognize an increase to their DTA for the elimination of the forfeiture estimate.
- Employer-paid withholding taxes will now be classified as a financing activity on the Statement of Cash Flows.
- The minimum statutory withholding requirements will be simplified to allow business entities to withhold the employees’ maximum individual tax rate without subjecting the award to liability classification.
Companies should consider the following before they adopt:
- What is the impact to the income tax provision calculation?
- Have adequate disclosures been made?
If you have any questions about the standard, or how it will impact your company, please contact us or consult your BPM advisor.
This article was authored by Sarah Miller, Corporate Tax Senior of BPM.
BPM for Life Science
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