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FASB Proposes to Introduce Illustrative Example of Profits Interest Awards in U.S. GAAP

Denise Lugo  Editor, Accounting and Compliance Alert

· 5 minute read

Denise Lugo  Editor, Accounting and Compliance Alert

· 5 minute read

Businesses have two months to weigh in on a FASB proposal that provides an example to illustrate how to account for profits interest awards—a form of compensation to employees in return for goods or services.

The board on May 11, 2023, issued Proposed Accounting Standards Update (ASU) No. 2023-ED300Compensation—Stock Compensation (Topic 718) Scope Application of Profits Interest Awards, to clarify when profits interest awards should be reported as stock compensation.

The proposal aims to reduce reported complexity and eliminate accounting differences among businesses by clarifying whether profits interest and similar awards should be accounted for as a share-based payment arrangement within the scope of Topic 718, Compensation—Stock Compensation, according to proposed text.

Profits interests are popular among partnerships and Limited Liability Companies (LLCs), providing employees or other service providers that hold them with the opportunity to participate in future profits and/or equity appreciation of the business.

The proposal provides an example of four fact patterns that show how to evaluate common terms and characteristics of profits interest awards, including an employee’s forfeiture of an award that, upon termination of employment with the business, has vested according to the contract but does not meet the definition of vested in Topic 718.

The provisions could cause more profits interest awards to be reported under Topic 718 than previously, adding incremental costs for some entities, the proposal states.

If finalized, the guidance can be applied either retrospectively to all prior periods presented in the financial statements, or prospectively to profits interest awards granted or modified on or after the effective date. If a business applies the guidance prospectively, it will be required to disclose the nature of and reason for the change in accounting principle.

The comment period ends on July 10.

Privately Held Companies Flagged the Topic

The topic was brought to the FASB by the Private Company Council (PCC), a panel that works with the board to develop and amend U.S. GAAP for privately held companies. Because profits interest holders only participate in future profits and/or equity appreciation and have no rights to the existing net assets of the partnership, the FASB said it heard that it can be complex to determine whether a profits interest award should be accounted for as a share-based payment arrangement under Topic 718, or as a cash bonus or profit-sharing arrangement under Topic 710, Compensation— General, or other Topics.

The PCC and others asked the FASB to provide clarifying examples for when paragraph 718-10-15-3 should be applied to profits interest awards.

Paragraph 718-10-15-3 applies to shares, share options or other equity instruments owed or paid to employees and customers that meet either of the following conditions: a) The amounts are based, at least in part, on the price of the entity’s shares or other equity instruments. (The phrase at least in part is used because an award of share-based compensation may be indexed to both the price of an entity’s shares and something else that is neither the price of the entity’s shares nor a market, performance, or service condition.); and b) The awards require or may require settlement by issuing the entity’s equity shares or other equity instruments.

 

This article originally appeared in the May 15, 2023 edition of Accounting & Compliance Alert, available on Checkpoint.

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