Narrow Changes to Share-Based Rules Will Simplify Accounting, Attorney Says

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By Mary Hughes

Jan. 15 — Accounting for stock-based compensation will get easier and less costly in 2015 when the Financial Accounting Standards Board is expected to act on proposed revisions to its share-based payment standard.

The proposed changes might be adopted in final form as early as the first or second quarter of 2015, said Ken Stoler, a partner with PricewaterhouseCoopers LLP based in Los Angeles.

The proposed changes are part of FASB’s simplification initiative in which the standards-setting organization is considering narrow, targeted changes that will make accounting easier and less expensive for companies without detriment to investors, Stoler said in a mid-December interview with Bloomberg BNA.

Of the three main changes affecting stock compensation, the one most relevant to the legal community is the proposed change to the statutory minimum withholding rule of Accounting Standards Codification 718 applicable to stock-based compensation, Stoler said.

Statutory Minimum Withholding

The statutory minimum withholding rule is an exception to ASC 718 that permits an employer to settle an employee award in cash and stock and still have the award classified as equity rather than as a liability.

Without the exception, when an employer settles an award partially in cash—to pay withholding tax on the employee’s behalf—and settles the remaining shares on the employee in equity, this net-settlement feature creates liability accounting, which is “a bad thing,” as far as most companies are concerned, Stoler said.

If an agreement is classified as equity, the value is fixed at the grant date; if it’s classified as a liability, it will get mark-to-market treatment for the life of the arrangement, Stoler said. Mark-to-market accounting creates volatility and potentially much higher expense charges, he said.

Under the current rule, as long as a company doesn’t withhold at a greater rate than the statutory minimum, it can still account for the award as equity, he said. “But you’ve got to stick to the statutory minimum threshold,” because if “you go $1 over that magic number, you create a liability accounting for the entire award, not just for that $1,” he said.

Figuring out the statutory minimum withholding rate for purposes of the exception is complicated, because the rate will be different for every jurisdiction worldwide, and in the U.S., for federal and state rates, Stoler said.

“Determining federal, state and foreign rates for employees who move from jurisdiction to jurisdiction is complicated,” he said. In countries that have no statutory minimum withholding, it’s an even bigger issue because “the employer can’t withhold anything, yet employees have a tax bill,” he said.

“This is the current state of the accounting rules that FASB proposes to change” to take some of the pain out of the statutory minimum withholding calculation, he said.

Alternative Approach

The alternative approach under consideration will keep the exception, but change the rate at which the company can withhold taxes from the statutory minimum to the maximum marginal rate, Stoler said. “The expectation is that the maximum marginal rate is a much easier number to figure out,” Stoler said.

An employer will be able to use the maximum marginal rate in the relevant jurisdiction in place of the statutory minimum withholding rate. Today, in the U.S., the statutory rate for most people is a flat 25 percent; however, it's likely that the employee's maximum marginal tax rate is higher, so that in complying with the FASB rule, the employer can't withhold all of the tax owed by the employee, Stoler said.

Currently, the maximum marginal rate for U.S. federal tax purposes is 39.6 percent, he said. That “39.6 percent rate might be the rate a company would use, if the proposed change is adopted,” he said. The higher rate might cover all or most of the employee's tax, so that the individual isn't left with a tax bill and in need of cash to pay it, he said.

To Do List

Stoler said lawyers should take steps to:

• Look at the language in the award documents. Make it clear in legal documents that if the company does a net settlement, it will only withhold up to the statutory minimum rate and no more.

• If the rules change, go back and revisit legal documents. Consider whether the company wants to allow for withholding more, reopen existing arrangements and modify terms, or apply the new rule to new arrangements going forward. 


The second proposed change would allow companies to recognize forfeitures on an actual rather than an estimated basis, Stoler said.

Under the FASB rules, companies are required to recognize the cost of stock awards, he said. To do so, companies have to estimate how many people aren't going to earn the award, Stoler said. For example, if a company grants awards with a three-year vesting period to 100 employees, by the end of that three-year period, some people will have left without earning the award, Stoler said.

Estimating forfeitures involves “a lot of process ” and can be costly, he said. The proposed rule would allow companies either to continue to estimate forfeitures or to recognize forfeitures as they occur and true up expense at that time for that person, he said.

The third and most controversial of the three proposals is an issue mainly for accountants, Stoler said. It takes a different approach to accounting for income taxes upon vesting or settlement of employee stock awards, he said. FASB is proposing to require all excess tax benefits and tax deficiencies to be recognized within the income statement—a move that reduces complexity but creates more volatility, Stoler said.

International Accounting

One other change on the horizon also deals with statutory minimum withholding—in international accounting.

A proposal from the International Accounting Standards Board would bring the International Financial Reporting Standard 2, Share-Based Payment (IFRS 2), in line with U.S. generally accepted accounting principles as currently found in ASC 718—the exception for net-settled awards under review by FASB, Stoler said.

IASB currently doesn't allow for the net settlement exception, which has been a source of complaints from companies around the globe, he said. The change would “conform international accounting standards to what we have today in the U.S.,” even as FASB moves to change from statutory minimum withholding to maximum marginal rates, he said.

The takeaway for lawyers is that changes might be coming through on the international side, and they need to understand those changes when helping their clients, Stoler said.

The IASB changes might come about in 2015, he said.

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To contact the editor responsible for this story: Sue Doyle at