Financial Reporting

Stock Option Rules Simplify Reporting, FASB Says

Putting all stock option tax reporting on the income statement is a big change, a standard setter says.
David KatzApril 8, 2016

If the Financial Accounting Standards Board is right, CFOs of companies that pay their employees and executives in stock options and restricted shares will find it simpler to report the related tax deductions starting at the end of this year.

Moreover, finance chiefs at private companies, in particular, will have an easier time reporting on share-based compensation under an accounting standards update issued last week, the standard setters feel.

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The effective dates for the new guidance are coming up fast. The update will go live for public companies for yearly periods starting after December 15 and for interim periods within those annual periods.

Private companies must start complying for annual periods beginning after December 15, 2017, and for interim periods within annual periods beginning after December 15, 2018. Senior managements of private companies who want to start adopting the measure early may do so for any interim or annual period they want.

Russell G. Golden, FASB chair

Russell G. Golden, FASB chair

The guidance will simplify the accounting for the income tax consequences of share-based-payment award transactions, according to FASB. “The accounting for the income tax consequences is probably the most significant change,” Mark Barton, a FASB practice fellow involved in preparing the update, told CFO.

Currently, companies account for excess tax benefits and excess tax deficiencies linked to employee stock options “with the hope that share prices will increase over time to benefit the employee,” according to Barton.

Such increases can create accounting burdens for employers, however. “Because many companies issue shares to their employees that appreciate in value over time and create excess tax benefits for those companies, the tax effects related to those shares are not reflected in the income statement,” he says.

That’s because under current GAAP, excess tax benefits are recognized as what’s called additional paid-in-capital, or APIC, which is on the balance sheet, rather than the income statement.

Adding to the complexity, tax deficiencies related to stock awards may be recognized in one of two ways. One way is as an offset to the excess tax benefits. Another way is on the income statement.

The new standard will erase all but one way of reporting of tax benefits and deficiencies. “All tax benefits and tax deficiencies will be recognized through the income statement. So that’s a pretty big simplification,” the FASB official says.

On the other hand, there are some corporate finance and accounting executives who have argued that the board’s way of reporting income tax will make its new employee stock award regime more complex rather than simpler. “We disagree with the proposed approach of recognizing tax benefits and tax efficiencies in the income statement,” wrote Michael J. Wood, Raytheon’s controller and chief accounting officer in a July 25, 2015, letter to FASB commenting on the exposure draft preceding the accounting standards update.

Raytheon’s leadership believes that FASB “should pursue a model wherein all excess tax benefits and tax deficiencies are reflected in equity as additional paid-in capital,” Wood wrote last year, “because the exercise of a stock option by the option holder represents an equity transaction. We think the proposed approach results in a financial reporting that is not reflective of the nature of the transaction and introduces other complexities.”

On August 7, 2015, Monty Garrett, Verizon’s senior vice president of accounting, wrote the board that the telecommunications giant opposes FASB’s approach of reporting everything on the income statement because it “will result in volatility in income tax expense based solely on changes in a company’s share price from grant date to the payment date of the awards.”

Hard to Value

FASB expects the update will simplify the accounting for private companies that provide share-based payments to employees. “People often tend to think of things like stock options and other kinds of share-based awards as being specific to public companies. But it’s actually quite common for private companies to issue share-based awards as well,” Barton said in an interview.

But unlike public companies, whose shares trade in public markets, private companies don’t have “observable market prices” enabling them to easily gauge the fair value of the employee share options, according to the update.

Under current GAAP, however, private companies as well as public ones must use a valuation technique that takes into account the expected term of the share option. (The expected term is the period during which the award is expected to be outstanding, assuming that it vests.)

To make reporting easier for nonpublic entities, FASB’s update provides a “practical expedient” —  a formula enabling the companies to estimate the expected term of all awards that meet certain conditions. Currently, private companies must estimate the period of time that each share-based award will be outstanding.

In another break for private companies, they’ll be able to make a one-time election to switch from measuring all awards classified as debt (rather than equity) at fair value. Instead, they can measure them at intrinsic valuePreviously, public companies could measure all such liability-classified awards at intrinsic value, but some private companies were unaware of that option.

Discussing the update overall, FASB chair Russell G. Golden said in a press release accompanying it that “[b]oth public and private company stakeholders identified a few aspects of accounting for employee share-based awards that are unnecessarily complex.”

The board “has issued a standard that we believe will simplify the accounting while maintaining the usefulness of information provided to investors,” he added.