OVERVIEW s National Professional Services Group invites you to watch a replay of our 90 minute webcast, during which specialists from our national office and accounting advisory practice lead an informative discussion on current issues in the design of and accounting for stock compensation arrangements. In this recorded webcast, our panel of specialists discuss: New guidance from the FASB on certain aspects of employee share based payments, including significant changes to income taxes and changes for private companies Modifications to existing awards The impact of performance and market conditions INDEX FASB s new guidance Slide 7 Modifications Slide 22 Performance and market conditions Slide 31
GLOSSARY OF KEY TERMS Cliff Vesting An award that vests as of a specific date. Employee Someone over whom the grantor of a stock based compensation award exercises or has the right to exercise sufficient control to establish an employer employee relationship based on common law. Graded Vesting An award that vests in stages over the award s contractual term. Market Condition A condition affecting the exercise price, exercisability, or other pertinent factors used in determining the fair value of an award under a share based payment arrangement that relates to the achievement of (a) a specified price of the issuer s shares or a specified amount of intrinsic value indexed solely to the issuer s shares or (b) a specified price of the issuer s shares in terms of a similar (or index of similar) equity security (securities). Performance Condition A condition affecting the vesting, exercisability, exercise price, or other pertinent factors used in determining the fair value of an award that relates to both (a) an employee s rendering service for a specified (either explicitly or implicitly) period of time and (b) achieving a specified performance target that is defined solely by reference to the employer s own operations (or activities). A performance target also may be defined by reference to the same performance measure of another entity or group of entities. Service Condition A condition affecting the vesting, exercisability, exercise price, or other pertinent factors used in determining the fair value of an award that depends solely on an employee rendering service to the employer for the requisite service period. A condition that results in the acceleration of vesting in the event of an employee s death, disability, or termination without cause is a service condition.
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Today s presenters Jay Seliber Partner, National Professional Services Group Jay.seliber@pwc.com Chad Kokenge Partner, US Accounting Advisory Leader Chad.a.kokenge@pwc.com Nicole Berman Director, National Professional Services Group Nicole.s.berman@pwc.com Scott Allender Senior Manager, National Professional Services Group Scott.r.allender@pwc.com 4
Agenda FASB s new guidance Modifications Performance and market conditions Questions 5
Poll question 1 Who receives stock-based compensation awards in your company? a) Only executives b) Senior management and higher c) Middle management and higher d) Most employees e) N/A or staff 6
FASB s new guidance 7
Future of stock compensation accounting Reasons for Change FASB Simplification Initiative FAS 123R Post- Implementation Review FASB s Private Company Council 8
Who is impacted and when? Public entities Annual and interim periods beginning after December 15, 2016 All other entities Annual periods beginning after December 15, 2017 and interim periods beginning after December 15, 2018 Early adoption is permitted for any entity in any interim or annual period; however, all amendments must be adopted at the same time 9
Future of stock compensation accounting Income Taxes Eliminate windfall pool All excess tax benefits and tax deficiencies to income Windfalls are operating outflows Cash paid for personal taxes on net settlement is financing outflows Cash Flow EPS Removes windfall tax component from treasury stock method Forfeitures Policy choice Estimated or actual Threshold increased to maximum marginal rate Net Tax W/H Private company Expected term Intrinsic value 10
Accounting for income taxes Current Guidance versus Simplified Guidance Windfalls recognized in APIC Windfall pool tracking Shortfalls recognized as: 1. APIC, if sufficient pool, or 2. Tax expense All windfalls and shortfalls recognized through income tax expense Windfalls recognized when excess deduction occurs, not when utilized to reduce cash taxes Rationale/Implications Tracking windfall pool is complex Under proposed amendments, no need to maintain a windfall pool Volatility in income, EPS, effective tax rate Discrete item in the quarter it occurs, not part of the effective tax rate Transition Excess tax benefits/deficiencies recognized as income tax benefit/expense in income statement upon vesting/settlement - Prospective Excess tax benefits recognized regardless whether benefit reduces taxes payable (subject to valuation allowance considerations) Modified retrospective 11
Example Tax accounting Shortfall Facts January 1, 2015 grant of 100,000 RSUs vest in 3 years. Grant date FV $20. FV at vesting is $16. Tax rate is 30% Current Guidance Over vesting period Comp expense = $2m Tax benefit (income) = $600k At settlement Tax shortfall (APIC)* - $120k Simplified Guidance Over vesting period Comp expense = $2m Tax benefit (income) = $600k At settlement Tax shortfall (P&L) - $120k * Assumes sufficient windfall pool exists to offset the shortfall 12
Accounting for income taxes EPS considerations Current Guidance versus Simplified Guidance How do the proposed amendments impact diluted EPS? Included in the calculation of assumed proceeds Recognized in the income statement (No longer included in the calculation of assumed proceeds) Rationale/Implications No longer includes excess tax benefits or tax deficiencies in assumed proceeds under treasury stock method Generally will increase dilutive effect Transition Prospective 13
Classification of excess tax benefits on statement of cash flows Current Guidance versus Simplified Guidance In the cash flow statement, when displaying windfalls. Displayed gross as an operating outflow and a financing inflow Combined with other income tax cash flows within operating cash flows Rationale/Implications The current treatment is the only exception from single line presentation of taxes within operating cash flows Transition Prospective OR retrospective 14
Poll question 2 Of the items in the FASB s new guidance, which will be most significant for your company? a) The expanded tax withholding limits is a game-changer b) The income tax expense volatility will cause a lot of heartburn c) The impact on EPS since that is a key investor metric d) The impact on the cash flow statement e) Don t know or staff 15
Forfeitures Current Guidance versus Simplified Guidance Estimate of forfeitures required Policy election Estimate forfeitures OR Account for forfeitures when they occur Rationale/Implications Tracking forfeiture estimates can be complex and costly Under either method, compensation cost will be recognized for all awards that ultimately vest Actual forfeiture approach will result in greater expense earlier in award life Entity-level policy decision, not award-by-award election Assessment of likelihood of vesting still required in certain circumstances Transition Modified retrospective 16
Minimum statutory tax withholding requirements Current Guidance versus Simplified Guidance Does net settlement result in liability classification? Employer s minimum statutory withholding requirements Employee s maximum statutory tax rate in applicable jurisdiction Rationale/Implications Determining the minimum required rate can be complex Creates tension with tax law, which requires at least minimum to be withheld Amendment reduces the complexity single maximum rate typically known Transition Modified retrospective 17
Classification of employee taxes paid on statement of cash flows on net settlement Current Guidance versus Simplified Guidance In the cash flow statement, when displaying cash paid by an employer when directly withholding shares No guidance on classification Classified as a financing activity Rationale/Implications Diversity in practice today Transition Retrospective 18
Practical expedient Intrinsic value Current Guidance versus Simplified Guidance In valuing liability-classified awards, non-public companies Not permitted to change from a fair value to intrinsic value measurement One-time election to switch from a fair value to intrinsic value measurement Rationale/Implications Some non-public companies were not aware that liability-classified awards could be measured at intrinsic value when they initially adopted ASC 718 Provides a second chance Transition Modified retrospective 19
Practical expedient Expected term Current Guidance versus Simplified Guidance In determining the expected term of an option, non-public companies Required to estimate period until exercise Practical expedient simplified method to estimate the expected term for certain awards Rationale/Implications SEC already allows simplified method for certain stock options. Midpoint between vest and expiration Proposed amendment codifies acceptability for private companies, and expands it for awards with performance conditions Transition Prospective 20
Poll question 3 Will your company early adopt the new stock-based compensation guidance? a) Yes b) Not sure yet, but probably c) No d) Don t know or staff 21
REVIEW QUESTIONS 1. Which of the following statements is not correct regarding the FASB s new share based payment simplification guidance? a. Under the new guidance, windfalls will be recorded in equity, and shortfalls will be recorded in equity to the extent of previous windfalls, and then to the income statement. b. Under the new guidance, all of the tax effects related to share based payments at settlement (or expiration) will be recognized through the income statement. c. All tax related cash flows resulting from share based payments will be reported as operating activities on the statement of cash flows. 2. Under the FASB s new share based payment simplification guidance, entities may withhold an amount without resulting in liability classification of the award. a. Up to the employees maximum individual tax rate in the relevant jurisdiction. b. Up to the employer s minimum statutory tax withholding requirement. c. Equal to the employees tax liability.
REVIEW QUESTION ANSWERS 1. Which of the following statements is not correct regarding the FASB s new share based payment simplification guidance? a. Under the new guidance, windfalls will be recorded in equity, and shortfalls will be recorded in equity to the extent of previous windfalls, and then to the income statement. b. Under the new guidance, all of the tax effects related to share based payments at settlement (or expiration) will be recognized through the income statement. c. All tax related cash flows resulting from share based payments will be reported as operating activities on the statement of cash flows. a. Correct. Under current guidance, tax benefits in excess of compensation cost ( windfalls ) are recorded in equity, and tax deficiencies ( shortfalls ) are recorded in equity to the extent of previous windfalls, and then to the income statement. b. Incorrect. Under the new guidance, all of the tax effects related to share based payments at settlement (or expiration) will be recognized through the income statement; while the simplification will reduce some of the administrative complexities by eliminating the need to track a windfall pool, it will increase the volatility of income tax expense. c. Incorrect. All tax related cash flows resulting from share based payments will be reported as operating activities on the statement of cash flows, a change from the current requirement to present windfall tax benefits as an inflow from financing activities and an outflow from operating activities. 2. Under the FASB s new share based payment simplification guidance, entities may withhold an amount without resulting in liability classification of the award. a. Up to the employees maximum individual tax rate in the relevant jurisdiction. b. Up to the employer s minimum statutory tax withholding requirement. c. Equal to the employees tax liability. a. Correct. The simplification allows entities to withhold an amount up to the employees maximum individual tax rate in the relevant jurisdiction without resulting in liability classification of the award. b. Incorrect. Currently, employers are permitted to withhold shares upon settlement of an award to satisfy the employer s tax withholding requirement without causing the award to be liability classified; however, the amount is strictly limited to the employer s minimum statutory tax withholding requirement. c. Incorrect. The simplification allows entities to withhold an amount up to the employees maximum individual tax rate in the relevant jurisdiction without resulting in liability classification of the award.
Modifications 22
Accounting for modifications under ASC 718 General principle Two-step process to account for the modification - Calculate the difference between the fair value immediately before and immediately after the modification (incremental fair value) - Reassess probability of vesting immediately before and immediately after modification Type I: Probable-to-Probable Type II: Probable-to-Improbable Type III: Improbable-to-Probable Type IV: Improbable-to-Improbable Recognize original grant date fair value plus any incremental fair value Uncommon in practice. Incremental value plus grant date value only recognized if award becomes probable Similar to forfeiture and new grant. New measurement of value. Recognize over remaining service period. Similar to Type III. New measure of expense only recognized if award becomes probable. Total recognized compensation expense should at least equal the award s grant date fair value, unless on the modification date it is not probable that the employee will meet the original award s performance or service condition 23
Impact of award modifications on EPS Diluted EPS Treat the modification as if there was a cancellation and new issuance of an award Treat before and after awards separately Include each separate award for weighted average period that each was outstanding Reference: Financial Statement Presentation Guide 24
Poll question 4 What level of change to systems and processes do you expect as a result of the new stockbased compensation standard? a) Significant change expected b) Moderate change expected c) Minimal change expected d) We need to talk to our service provider e) Not sure or staff 25
Spin-off transactions A spin-off is an equity restructuring under ASC 718, which generally creates a number of complex stock-compensation issues Nature of the award modification Impact of mandatory anti-dilution provision Key considerations Attribution of stock-based compensation cost Stock prices to be used in the incremental fair value calculation The exchange/modification of awards in connection with a spin-off transaction without antidilution provisions will usually result in incremental compensation cost 26
Who recognizes the expense? After the spin-off, each entity recognizes compensation cost related to awards held by its employees regardless of which entity originally granted the awards Each entity continues to account for the awards as employee awards, including awards to purchase the other entity s stock 27
Awards exchanged in a business combination Acquirer accounting Awards (acquiree & replacement) measured at fair value at the acquisition date Awards (or portion of) attributable to precombination services is included as part of the purchase consideration - Only included in purchase consideration if the acquirer is obligated to issue replacement awards Awards (or portion of) attributable to postcombination services is charged to earnings in the postcombination financial statement Calculation of amount of fair value attributed to precombination and postcombination services Precombination services Fair value of the acquiree award X Precombination service (vesting) period completed prior to the exchange Greater of: Total service (vesting) period of the replacement award Postcombination services Total fair value of the acquirer replacement award Less: Portion attributable to precombination services OR Original service (vesting) period of the acquiree award 28
Assessing what is exchanged in the business combination Acquirer may: Assume existing compensation arrangements Establish new arrangements Factors to consider in analysis include: The reasons for the transaction Who initiated the transaction The timing of the transaction Transaction arranged primarily for the economic benefit of the acquirer (or combined entity) Not deemed to be part of the consideration transferred for the acquiree Should be accounted for separately from the business combination 29
Poll question 5 What did you find to be the biggest challenge in accounting for stock-based compensation in a recent business combination or spin-off? a) Integration of systems b) New plan design c) Modification of awards d) Taxes e) We have not had a recent transaction or staff 30
REVIEW QUESTION 1. Which of the following statements is not correct regarding modifications accounted for under ASC 718, Compensation Stock Compensation? a. The difference between the fair value immediately before and immediately after the modification must be calculated (incremental fair value). b. The probability of vesting immediately before and immediately after modification must be assessed. c. The total recognized compensation expense should be less than the award s grant date fair value.
REVIEW QUESTION ANSWERS 1. Which of the following statements is not correct regarding modifications accounted for under ASC 718, Compensation Stock Compensation? a. The difference between the fair value immediately before and immediately after the modification must be calculated (incremental fair value). b. The probability of vesting immediately before and immediately after modification must be assessed. c. The total recognized compensation expense should be less than the award s grant date fair value. a. Incorrect. The difference between the fair value immediately before and immediately after the modification must be calculated (incremental fair value). b. Incorrect. The probability of vesting immediately before and immediately after modification must be assessed. c. Correct. The total recognized compensation expense should at least equal the award s grant date fair value, unless on the modification date it is not probable that the employee will meet the original award s performance or service condition.
Performance and market conditions 31
Summary of vesting conditions Condition Market condition affects vesting, or something other than vesting (e.g. exercise price, term, etc.) Performance or service condition affects vesting. Performance or service condition affects something other than vesting (e.g. exercise price, term, quantity) Considered in estimating grant date fair value? Yes No, not considered FV determined for each possible outcome assuming performance condition is met Adjustment to compensation cost for outcome of condition Cost NOT adjusted if condition not met, so long as requisite service provided. Cost recognized only for awards that ultimately vest. Cost based on FV of award whose outcome ultimately achieved. If a combination award (more than one condition) contains a market condition, it is treated based on the market condition guidance. 32
Impact of vesting conditions Type of condition Market Performance Service Advantages Lower initial estimate of fair value, therefore fixed expense may be lower each period Charge only recognized when performance target is probable Charges are reversed for awards that do not ultimately vest Compensation charges are reversed for awards that do not ultimately vest Disadvantages Compensation cost is never reversed, even if options do not ultimately vest May require complex valuation techniques Performance condition not included in valuation of grant, resulting in a larger charge Assess probability every period If targets are not all set upfront, would typically delay grant date Service condition not included in valuation of grant, resulting in a larger charge 33
EPS considerations Included in the computation of diluted EPS if the awards are dilutive and their conditions: - Have been satisfied at the reporting date, or - Would have been satisfied if the reporting date was the end of the contingency period Not a probability assessment If included in the computation, use the treasury stock method to calculate dilutive shares Reference: Financial Statement Presentation Guide 34
Poll question 6 What type of vesting conditions does your company s plan(s) require? a) Service only b) Market only c) Performance only d) More than one of the above e) Don t know, N/A, or staff 35
Attribution model Service conditions & graded vesting Graded-vesting method Straight-line method Market or performance conditions & graded vesting Graded-vesting attribution method must be used Other considerations If awards cliff vest, compensation cost should be recognized on a straight-line basis When using straight-line, compensation cost recognized must at least equal the value of the vested portion of the award 36
Straight Line vs. Graded expense attribution Comparison of expense Example award with 3 year annual vesting, grant date fair value $300 Straight Line Graded 200 150 150 100 100 50 50 0 Year 1 Year 2 Year 3 0 Year 1 Year 2 Year 3 Tranche 1 Tranche 2 Tranche 3 37
Poll question 7 Would you attend a webcast during the summer (July/August) or during quarter/yearend close (Jan/Feb/Apr/July/Oct)? a) Yes b) Yes in the summer, but not during a close c) Not in the summer, but yes during a close d) No e) Not sure or staff 38
REVIEW QUESTIONS 1. Which of the following is an advantage of using a market condition? a. There is a lower initial estimate of fair value; therefore fixed expense may be lower each period. b. Compensation cost is never reversed, even if options do not ultimately vest. c. Charge only recognized when performance target is probable. 2. Which of the following award conditions allow for use of the straight line attribution method for graded vesting features? a. Service conditions. b. Market conditions. c. Performance conditions.
REVIEW QUESTION ANSWERS 1. Which of the following is an advantage of using a market condition? a. There is a lower initial estimate of fair value; therefore fixed expense may be lower each period. b. Compensation cost is never reversed, even if options do not ultimately vest. c. Charge only recognized when performance target is probable. a. Correct. There is a lower initial estimate of fair value; therefore fixed expense may be lower each period. b. Incorrect. This is a disadvantage of using a market condition. c. Incorrect. This is an advantage of a performance condition. 2. Which of the following award conditions allow for use of the straight line attribution method for graded vesting features? a. Service conditions. b. Market conditions. c. Performance conditions. a. Correct. Under ASC 718, a company may elect to use either attribution method for an award with graded vesting features and only service conditions. The company should make a policy decision and apply this policy consistently for all awards with similar features. b. Incorrect. If awards with market conditions include graded vesting features, the graded vesting method should be used and the straight line method should not be used. c. Incorrect. If awards with market conditions include graded vesting features, the graded vesting method should be used and the straight line method should not be used.
Q&A 39
Upcoming webcasts FASB s new revenue recognition guidance: implementation update May 17 Debt modifications and extinguishments May 25 Private company mid-year update June 7 Current accounting and reporting developments (Q2) June 15 FASB standard setting update June 20 Impairment of financial assets After release of FASB s final standard 40
webcasts on-demand CPE credit available upon passing a knowledge check SEC comment letter trends Commercial and industrial companies Financial institutions Revenue recognition & FERF 2015 survey results: Assessing impact and implementation Latest developments on implementation of new revenue standard How revenue recognition will change Consolidation Navigating the FASB s new consolidation standard - Financial services industry Navigating the FASB s new consolidation standard - Commercial and industrial companies Private companies 2015 Year-end accounting & reporting developments Accounting challenges - acquisitions, dispositions, refinancings and more Other financial reporting topics Pension accounting Foreign currency Lease accounting Derivatives and hedging EPS 41
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