The Financial Accounting Standards Board (FASB) last week finalized new accounting guidance on stock compensation – specifically on how to account for share-based payments, which is absent from current US Generally Accepted Accounting Principles (GAAP).
Entities often issue share-based payment awards that require a specific performance target – such as attaining a specified profitability metric or selling shares in an initial public offering – to be achieved in order for employees to become eligible to vest in the awards.
The FASB noted that an award with a performance target also usually requires an employee to render service until the performance target is achieved. However, in some cases, an award’s terms may dictate that the performance target could be achieved after an employee completes the requisite service period.
Many reporting entities account for performance targets, which could be achieved after the requisite service period, as performance conditions. These performance conditions could affect the vesting of the award and do not reflect the performance target in the estimate of the grant-date fair value of the award, according to the FASB. Other reporting entities treat those performance targets as nonvesting conditions that affect the grant-date fair value of the award.
Under Accounting Standards Update 2014-12, Compensation – Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period (a consensus of the FASB Emerging Issues Task Force), a performance target that affects vesting, and that could be achieved after the requisite period, would be treated as a performance condition.
The new rules state that a reporting entity should apply existing guidance on Topic 718 as it relates to awards with performance conditions that affect vesting to account for such awards. The performance target should not be reflected in estimating the grant-date fair value of the award.
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 periods for which the service has already been rendered. If it becomes probable that the performance target will be achieved before the end of the requisite service period, the remaining unrecognized compensation cost should be recognized prospectively over the remaining requisite service period, according to the FASB.
The total amount of compensation 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.
For all entities, the amendments are effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Earlier adoption is permitted. The effective date is the same for both public business entities and all other entities.