Stock Compensation and Profits Interest Awards
Date: March 2024
Who does it affect
Both public and private entities that issue profits interest or similar awards as part of compensation.
When does it come into effect
• Public Business Entities: Annual periods starting after December 15, 2024, and interim periods within those annual periods.
• Other Entities: Annual periods starting after December 15, 2025, and interim periods within those annual periods.
Early adoption is permitted.
The change
This update clarifies the scope of ASC 718 by adding examples to help determine whether profits interest or similar awards should be accounted for as share-based payments under ASC 718. The update aims to reduce diversity in practice regarding the treatment of profits interest awards by providing clearer guidance.
How were things before
Companies offering profits interest awards used various approaches, sometimes treating them as share-based compensation under ASC 718 or as cash bonus/profit-sharing arrangements under ASC 710, leading to inconsistent reporting.
How are things now
With the added illustrative examples, companies will have clear guidance on whether to account for profits interest awards as share-based payments under ASC 718, reducing the need for interpretation and ensuring more consistent financial reporting.
Read more ...
The classification of profits interest awards as either stock-based compensation or cash-based compensation depends on specific conditions outlined in the guidance (ASC 718-10-15-3). The update adds examples to clarify these conditions.
Cash-Based Compensation (Not Subject to ASC 718):
A profits interest award is treated as cash-based compensation if:
- No equity instruments are issued to the recipient, and the award does not grant rights to equity-like participation.
- The award is settled in cash based on a metric not tied to the entity’s share price or equity (e.g., a percentage of operating income or EBITDA).
- The award is based on performance metrics unrelated to stock price or equity appreciation and does not involve issuing or offering to issue equity instruments (e.g., “phantom” units settled in cash, linked to performance or profits).
Example:
A profits interest award gives an employee the right to receive a percentage of the company’s annual net income after three years of service. It is settled in cash, and the amount is based on the company’s operating performance, not linked to the value of any equity or stock. This would fall under cash-based compensation and be accounted for under ASC 710.
Stock-Based Compensation (Subject to ASC 718):
A profits interest award falls under stock-based compensation (ASC 718) if:
- The award grants the right to equity participation or is settled with the company’s shares or equity instruments.
- The value of the award is tied to the company’s stock price or equity value, or it offers a right to participate in equity appreciation.
- The award is subject to equity vesting and settled by issuing the entity’s shares or other equity instruments.
Example:
A profits interest award grants an employee Class B units that give them the right to share in the company’s future profits after a certain vesting period. The units entitle the employee to equity-based payouts, such as receiving shares or cash based on the company’s share price at the time of settlement. This would be treated as stock-based compensation under ASC 718.
In summary:
• Cash-based awards: No equity rights and settled in cash based on non-equity metrics.
• Stock-based awards: Tied to equity participation or share price, and settled in equity or equity-related instruments.
Disclaimer
The content provided on this blog is for informational purposes only and reflects the personal views and opinions of the authors. It is not intended to serve as professional accounting, financial, or legal advice. While we strive to ensure the accuracy of the information presented, we make no guarantees regarding its completeness or relevance to specific situations. Always consult with a certified accountant, financial advisor, or legal professional before making decisions based on the information provided. For authoritative guidance, refer to official sources, such as the IRS, FASB, or your local regulatory bodies.
