Stock Compensation, Accounting for Share-Based Payments
Many entities compensate their employees, not by “cash salary,” but rather by using equity awards, commonly in the form of what is referred to as “stock compensation.” The amendments in Accounting Standards Update 2014-12 – Compensation – Stock Compensation (Topic 718), apply to all reporting entities that grant their employees share-based payments in which the terms of the award provide that a performance target that affects vesting could be achieved after the requisite service period.
Entities commonly issue share-based payment awards to employees requiring a specific performance target be achieved in order for the employee to become eligible to vest in the awards. Examples of typical performance targets include: an entity attaining a specified profitability metric, or the entity selling shares in an initial public offering (IPO). Generally, awards with performance targets also require the employee to render services until the performance target is achieved. In some cases, however, the terms of an award may provide that the performance target could be achieved AFTER the employee completes the requisite service period. The requisite service period is the period during which an employee is required to provide service in exchange for an award. Current U.S. generally accepted accounting principles (U.S. GAAP) does not contain explicit guidance on how to account for those types of share-based payments.
The amendments in ASU 2014-12 require that a performance target that affects vesting, and that could be achieved after the requisite service period, be treated as a performance condition. Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved, and should represent the compensation cost attributable to the period (or periods) for which the requisite service already has been rendered. If the performance target becomes probable of being achieved before the end of the requisite service period, the remaining unrecognized compensation cost for which requisite service has not yet been rendered should be recognized prospectively over the remaining requisite service period.
The total amount of compensation cost recognized during and after the requisite service period should reflect the number of awards that are expected to vest, and should be adjusted to reflect those awards that ultimately vest. The requisite service period ends when the employee can cease rendering service and still be eligible to vest in the award if the performance target is achieved. The stated vesting period [which includes the period in which the performance target could be achieved] may differ from the requisite service period.
ASU 2014-12 does not change existing U.S. GAAP that requires the performance condition to be substantive in order to be relevant to the accounting treatment. Also, a substantive performance condition that is uncertain, such as an IPO, may result in no compensation cost being recognized during the requisite service period.
AAFCPAs recommends that companies evaluate adding liquidity events as performance conditions to share-based payment arrangements as a result of this clarification.
What are the Effective Dates?
The amendments in ASU 2014-12 are effective for annual periods beginning after December 15, 2015. Earlier adoption is permitted.
Entities may apply the amendments in ASU 2014-12 either:
- Prospectively to all awards granted or modified after the effective date; or
- Retrospectively to all awards with performance targets that are outstanding as of the beginning of the earliest annual period presented in the financial statements, and to all new or modified awards thereafter.