{"id":96865,"date":"2022-04-21t12:00:31","date_gmt":"2022-04-21t16:00:31","guid":{"rendered":"\/\/www.g005e.com\/?p=96865"},"modified":"2023-12-13t17:18:18","modified_gmt":"2023-12-13t22:18:18","slug":"must-knows-about-accounting-for-sbc","status":"publish","type":"post","link":"\/\/www.g005e.com\/2022\/04\/21\/must-knows-about-accounting-for-sbc\/","title":{"rendered":"must-knows about stock-based comp"},"content":{"rendered":"
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new rules make it easier, but traps remain for awards that are not carefully structured. <\/strong><\/p>\n

by kei morita<\/em>
\nholthouse carlin & van trigt llp<\/a><\/em><\/p>\n

kei morita is a principal in the los angeles office of holthouse carlin & van trigt llp. <\/em><\/p>\n

with the war for talent at a fever pitch these days, stock-based compensation (sbc) is one of the most effective ways for private companies to attract and retain valued workers. it\u2019s also a very effective way for early-stage companies and other private entities to preserve cash flow while allowing key employees to share in the company\u2019s growth. but the sbc accounting rules and calculations can be very complex.<\/p>\n

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while fasb and the private company council (pcc) issued guidance<\/a> late last year to make it somewhat easier for private companies to account for share-based awards, many challenges still remain. if you\u2019re a cfo, controller, treasurer, hr director or another stakeholder in a privately held company \u2013 or have clients that are privately held companies \u2013 it\u2019s critical to follow the sbc accounting rules correctly.
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\nwhen private companies must treat employee sbc awards as an expense<\/strong><\/p>\n

having worked with many technology startups and other early-stage companies, i can\u2019t tell you how often i see their accounting for sbc awards overlooked. by the time they start raising larger funding rounds \u2013 typically in the series a or b round \u2013 they typically need to be audited and must become gaap-compliant. that\u2019s when the fire drill starts, because most private\/early-stage companies do not have adequate resources in-house to handle complex gaap accounting and financial reporting for sbc awards. that can be problematic because larger investors typically want a third party to sign off on the accuracy of the startup\u2019s financials. they want assurance that the company is not doing anything fraudulent or failing to follow generally accepted accounting guidance.<\/p>\n

also, when private companies are cavalier about their sbc accounting in their early years, it can be very costly and time-consuming to change from non-gaap to gaap standards as they prepare for an ipo, sale or other exit. trust me, i\u2019ve been there, done that, and it\u2019s not fun.<\/p>\n

below are important sbc accounting considerations, no matter where a company is in its evolution:<\/p>\n

1. asc 718<\/strong> \u2013 any u.s. entity (following gaap) that provides sbc to its employees, contractors, advisors and legal service providers, etc., is required to account for sbc in accordance with accounting standards codification (asc) topic 718 (compensation-stock compensation). common types of sbc subject to asc 718 include stock options, restricted stock units (or rsus), stock appreciation rights (sars), phantom stock plans and profits interest. similar awards with certain characteristics may require an in-depth analysis to determine whether they need to be accounted for as sbc under asc 718. such awards may include profits interest (with certain characteristics, to be discussed further below), profit-sharing arrangements and cash-deferred compensation plans.<\/p>\n

a) incentive stock options<\/strong> \u2013 generally speaking, an iso is a stock option that can only be granted to an employee and that does not result in any employee income (or employer deduction) at exercise, unless there is a \u201cdisqualifying disposition\u201d or a sale of the underlying purchased shares within one year of acquisition. an employee who\u2019s been granted an iso has the option, but not the obligation, to purchase vested shares of the company\u2019s underlying equity (e.g., common stock) at a predetermined price, or strike price within a set timeframe \u2013 typically 10 years from the grant date.<\/p>\n

b) non-qualified stock options<\/strong> \u2013 an nso is a stock option that does not meet the iso requirements (see above), and if exercised, the employee, vendor or director holding them will have compensation income equal to (and the employer is entitled to a deduction for) the difference between the fair value of the stock at the time and the exercise price.<\/p>\n

c) restricted stock<\/strong> \u2013 a restricted stock arrangement is one in which an employee is granted stock that is subject to a vesting requirement and is nontransferable at the time of grant. while the stock is restricted, the employee may have dividend and voting rights (or the dividends may be reinvested or paid at vesting). when the restrictions lapse, the employee has compensation income equal to the value of the stock (less any amount he or she has paid for the stock) under irc section 83. alternatively, the employee may be entitled to make a section 83(b) election and be taxed based on the value of the restricted stock at the time of grant. this enables the employee to convert subsequent appreciation from ordinary income to capital gains.<\/p>\n

d) stock appreciation rights (sars)<\/strong> \u2013 give an employee the right to receive the value of stock appreciation, payable in shares or in cash, without having to tender an exercise price. sometimes, sar plans cap the appreciation to which the employee is entitled.<\/p>\n

e)<\/strong> phantom stock<\/strong> \u2013 under a phantom stock plan, an employee is granted a hypothetical number of units of stock that are convertible into cash or common stock of the company after a period of time. similar to sars, the form of phantom stock plans can come with cash-settlement or stock-settlement features. typically, though, phantom stock plans are structured as cash-settled awards.<\/p>\n

2.<\/strong> know the difference between stock compensation (718) and general compensation (710)<\/strong> \u2013 to determine which accounting guidance to apply, you need to analyze carefully whether the value of your awards is based, at least in part, on the price of your shares or other equity instruments or if the awards require settlement by issuing your equity shares or other equity instruments. if the awards meet one of these conditions, they must be accounted for under asc 718; otherwise, they are likely subject to other guidance, such as asc 710. the accounting and disclosure requirements in asc 718 are quite different from those in asc 710.<\/p>\n

3. profits interest awards<\/strong> \u2013 this type of compensation, similar to a cash bonus, has become more popular in recent years, particularly among venture capital-backed or private equity-backed companies. a profits interest award is essentially a right to receive any residual profits after distributions to other equity holders. significant accounting challenges arise in accounting for profits interests, including whether they ought to be accounted for under asc 718 or asc 710. if the awards must be accounted for as sbc under asc 718, there are additional complexities around the valuations of profits interests and the timing of when their value should be recorded as a cost in the financial statements.<\/p>\n

4. <\/strong> equity-classified awards vs. liability-classified awards<\/strong> \u2013 when sbc awards are within the scope of asc 718, the company needs to determine whether the sbc awards are considered equity-classified or liability-classified awards. under asc 718, sbc awards with certain characteristics are classified as liabilities. for example, sbc awards that will be settled in cash or settled in stock that can be redeemed within six months after exercise are considered liability-classified awards. for nonpublic entities, liability-classified awards must be revalued at fair value or intrinsic value every time gaap-based financial statements are prepared \u2013 until the awards are settled or expire.<\/p>\n

accounting for equity-classified awards is based on the grant-date fair value. unlike liability-classified awards, equity-classified awards are not<\/strong> subject to revaluation (unless the awards are subsequently modified), even if the company\u2019s value increases significantly.<\/p>\n

5. vesting considerations<\/strong> \u2013 sbc awards typically include one, or combination of, the following vesting conditions:<\/p>\n