Over the past couple of months, the FASB has been busy. I wanted to point out one recent change and my thoughts on its impact.
FASB has “simplified” share-based compensation accounting. I will always have a special place in my heart for old FAS123 since it was on my CPA exam a couple of decades ago. Nevertheless, much has changed since then (APB No. 25 anyone?), including most recently:
- No more APIC pools. Currently, tax benefits in excess of compensation cost are recorded in equity (specifically, Additional Paid In Capital or APIC). The accumulation of excess benefits has been known as an APIC pool. Tax deficiencies decrease the APIC pool. Under the new accounting rules, excess benefits and deficiencies are recognized in the period in which they occur.
My Take – Expect more income tax expense volatility from period to period. If the changes impact tax expense significantly, we could see more non-GAAP financial measures develop. Just be careful of the renewed focus on non-GAAP financial measures from the SEC.
- No longer need to estimate forfeitures. GAAP currently requires you to estimate the number of awards that will be forfeited to calculate a more accurate amount of compensation cost each period. Under the new rules, you can continue to estimate or you can just reverse the compensation previously expensed when the forfeiture occurs. If you choose the new route, then you will have to hit retained earnings for the cumulative-effect adjustment incurred as a result of the change as of the beginning of the year the change is applied.
My Take – Again, there could be potentially more volatility if you elect to apply the new “actual” forfeiture approach. A good example of volatility would be if a company had a significant layoff of employees. The increase in forfeitures during the layoff period would significantly decrease stock compensation expense. On the other hand, there would be so much other noise with the layoff (including severance payments that would increase compensation expense) that the potential for increased volatility may not really be that big a deal. Reversing the expense as forfeitures occur may just be simpler.
- Cashless exercises are simplified under the new rules. Awards with a cashless exercise feature can be viewed as a potential obligation of the company (i.e., a company may be required to essentially repurchase shares of stock from an employee and remit the purchase price to the government to satisfy the employee’s tax withholding obligations). Under current GAAP, you do not need to classify the award as a liability because of that potential “repurchase” obligation, but only if the value of the shares to be withheld does not exceed the employer’s minimum statutory tax withholding requirement. The new guidance simplifies the approach and allows withholding up to the employee’s maximum statutory withholding rate. This may make holders of stock options happy, because under current rules they often have to shell out cash – sometimes significant amounts of cash – to pay the difference between the minimum rate and their actual rate.
My Take: You may want to consider revising your plan documents to allow for the increase in the net-settlement feature. The increase in size of the net share settlement can reduce the number of shares that must be issued (and thus slightly reduce dilution to existing shareholders).