Share-based payments: FASB simplification initiative and common challenges. American Gas Association Accounting Principles Committee August 15, 2016

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1 Share-based payments: FASB simplification initiative and common challenges American Gas Association Accounting Principles Committee August 15, 2016

2 Agenda ASU changes to current GAAP Practical expedients for non-public entities Effective date and transition

3 ASU summary Improve and simplify FASB issued ASU , Improvements to Employee Share-Based Payment Accounting on March 31, Intended to reduce the ongoing cost and complexity of accounting for share-based payments. Transition provisions for each issue is different. Some changes will increase volatility in reported earnings. 3

4 Excess tax benefits and deficiencies What s changing? APIC pool is eliminated. Eliminate delay in recording excess tax benefits to when realized. Observations Volatility in reported earnings. Changes to diluted EPS under the treasury stock method. Valuation allowances may negate impact. Difficult judgments if need partial valuation allowance. Similar changes for tax benefits for ESOPs. Transition - - Prospective for tax benefits and deficiencies & EPS. - Cumm Catch to BOY retained earnings for Prior unrecognized benefits. 4

5 Excess tax benefits example Grant Date 1/1/20x1 Exercise price: $40 (equal to market price) Fair value per share option: $25 Vesting: 1 year cliff Exercise Activity 20x2 Fair value of shares: $100 Tax benefit realized - $24 ($100 - $40) * 40% Tax rate: 40% 5

6 Journal entries Recording excess tax benefits 20X1 Current GAAP ASU Dr. Compensation expense Cr. APIC Dr. DTA Cr. Deferred tax benefit

7 Journal entries - continued Recording excess tax benefits 20X2 Current GAAP ASU Dr. Cash Cr. APIC Dr. Deferred tax expense Cr. DTA Dr. Current taxes payable Cr. APIC Cr. Current tax expense Net P&L Impact - $14 7

8 Diluted EPS example Grant Date 1/1/20x1 Share options: 100,000 Exercise price: $40 (equal to market price) Fair value per share option: $10 Vesting: 4 year cliff Options expected to vest: 80,000 shares Tax rate: 40% Compensation cost: $800,000 over 4 years ($10 x 80,000 shares) 20x1 Activity Forfeitures: 2,000 shares (Expected to be the same for next 2 years) Average market price per share: $100 Net income: $2.0 million (Before recognition of compensation expense related to the share option grant) Weighted-average common shares outstanding at 12/31/x1: 200,000 8

9 Diluted EPS calculation For the year ended December 31, 20x1 Current GAAP ASU Net income before SBP compensation expense $2,000,000 $2,000,000 Compensation expense related to SBP, net of income taxes $800,000 4 years 60% (net of related tax effect of 40%) (120,000) (120,000) Net Income 1,880,000 1,880,000 Weighted-average shares outstanding 200, ,000 Incremental Shares 30,925 50,725 Total weighted-average shares outstanding 230, ,725 Diluted EPS $8.14 $7.50 9

10 Incremental shares calculation Current GAAP ASU Shares assumed issued on exercise of options (100,000 options outstanding at beginning of year + 98,000 options outstanding at end of year) 2 99,000 99,000 Shares repurchased at average market price Total assumed proceeds $100 average price (68,075) (48,275) Incremental shares 30,925 50,725 Assumed proceeds from exercise of options 99,000 (average options outstanding) $40 $3,960,000 $3,960,000 Average unrecognized compensation cost related to future services for EPS purposes 867, ,500 Tax benefits credited to equity on assumed exercise based on average market price less weighted-average exercise price 1,980, Total assumed proceeds $6,807,500 $4,827,500 10

11 Excess tax benefit cash flow classification What s changing? Requires an entity to present excess tax benefits as an operating activity. Observations Will result in increase in operating cash flows. Eliminates need to separately identify gross tax benefits. Transition prospective or retrospective transition method. 11

12 Forfeitures What s changing? Estimate forfeitures (current GAAP) or reverse compensation cost of forfeited awards when they occur. Does not apply to modifications or business combinations. Applies to service condition only. Observations Entity-wide election for all award types. Greater volatility if forfeitures occur unevenly. May have known future forfeitures that can t be eliminated yet (e.g. planned layoff). Transition Cumm Catch to BOY retained earnings. 12

13 Forfeitures business combination example Acquirer replacement awards AC exchanges replacement awards that require one year of postcombination service for awards of TC for which employees had completed 4 of the 5 years of the requisite service period before the business combination. The FV of both awards is $100 at the acquisition date. At the acquisition date, AC estimates that 10% of the replacement awards will be forfeited. 13

14 Amount attributed to pre-combination service Acquisition date fair value of award (ADFV) $100 Service provided to date 4 years Total service required 5 years 80% 80 Less estimated forfeitures in Year 5 (10%) (8) $72 14

15 Forfeitures accounting policy comparison Amount attributed to post-combination service If forfeitures are estimated If forfeitures are recognized as they occur ADFV $100 $100 Less estimated forfeitures (10) Less amount attributed to pre-combination service (72) (72) Amount initially attributed to post-combination service $18 $28 15

16 Forfeitures comparison, continued Assumptions for post-combination accounting 10% forfeiture estimate is accurate Forfeitures occur in month 6 of Year 5 Amount attributed to post-combination service If forfeitures are estimated If forfeitures are recognized as they occur Gross Forfeitures Quarter 1 $4.5 $7 $ 0 Quarter (5) Quarter Quarter $18 $23 ($5) $18 16

17 Tax withholding requirement What s changing? Tax withholdings of up to the maximum individual statutory tax rate in the applicable jurisdiction are permitted. Share withholding disbursements are required to be classified as a financing activity on SOCF. Observations Allows companies to determine a single rate for all employees in a jurisdiction. May result in implementation complexities. Policy choice currently, predominant practice is financing activity. Viewed as a substantive treasury share repurchase. Transition Cumm Catch to BOY retained earnings and retrospective for cash flows. 17

18 Practical expedients for nonpublic entities What s changing? Entities can elect to use the simplified method to determine expected term. Permits a one-time policy election to change from measuring all liabilityclassified awards at fair value to intrinsic value. Observations Could be useful for nonpublic entities that do not have relevant historical data. Measurement change provides another opportunity for entities to make this policy election. Transition Prospective for expected term, Cumm Catch to BOY retained earnings for measurement change. 18

19 Practical expedient - expected term Is vesting only dependent on a service condition? Yes Award contains a market condition practical expedient does not apply No No Vesting is dependent upon satisfying a performance condition Yes Is the performance condition probable of being achieved? No Yes Estimate the expected term as the midpoint between the requisite service period and the contractual term Is the service period explicitly stated? Yes No Estimate the expected term as the contractual term, if the service period is implied 19

20 Effective date and transition Public entities Interim and annual periods beginning after December 15, Other entities Annual periods beginning after December 15, 2017 and interim periods in the following year. Early adoption is permitted in any interim or annual period. However, entities must adopt the entire ASU in the same period. If other than first quarter adoption, issues to be adopted prospectively or by cumm catch are as of beginning of year. 20

21 Key points to remember! Some of these changes are policy elections. Consider how increased volatility in reported earnings may affect the entities you audit. Transition provisions for each issue is different. Early adoption is permitted in any interim or annual period. However, entities must adopt the entire ASU in the same period. See Defining Issues

22 Thank you