FASB Offers Help Calculating Tax Impact Of Expensing

Companies that don’t have the historical data necessary to properly calculate the tax impact associated with stock option expensing now have a shortcut option, courtesy of the Financial Accounting Standards Board.

FASB issued a proposed staff position recently that describes the shortcut approach. It is open for a brief public comment period before FASB finalizes it.

Stock option expensing rules as described in FAS Statement No. 123(R) require companies not only to track the cost of issuing options, but also the tax impact. The cost of issuing options is deductible both for tax and accounting purposes, but the system for doing so is complex, even by experts’ own assessment.

Powell

“What’s scary is that it’s complicated for everyone,” said Stacy Powell, national practice leader for equity compensation with Chicago Consulting Actuaries.

When companies grant options and set a value using their chosen valuation method, they also must calculate the tax benefit they can expect to earn when the options are exercised. They book that projected deduction for accounting purposes as a tax asset, or a future tax benefit.

When the option is eventually exercised, the actual tax impact likely will differ from the original booked asset, since it was based on a projection. But companies don’t directly add or subtract such variances on the income statement; instead, they account for them in a separate fund called the additional paid-in capital pool, or APIC pool.

Dunn

William Dunn, a partner with the Human Resources Services group of PricewaterhouseCoopers, says the APIC pool is just like the “give-a-penny/take-a-penny” dish often found at a retail cash register. “When you have extra, you toss it into the dish,” he said. “If you’re short, you can use the dish to pay your taxes. If there’s nothing in the dish, it’s a hit to earnings.”

The APIC pool is a critical fixture in how companies are supposed to account for the tax impact of share-based payment awards. Statement No. 123(R) includes a provision that allows companies to go back to the 1995 implementation of the original Statement No. 123—which required companies to account for options via footnote, not a line item on the income statement—and calculate an APIC pool as if they had been expensing options all along.

“When companies adopt 123(R), at times they’ll have an actual tax deduction that is less than the anticipated deduction,” said Ellie Kehmeier, deputy managing tax director with Deloitte. “It means you’ve booked a tax benefit that didn’t come true, so you have to recapture it as a tax expense. To the extent you have an APIC pool, you can offset the deficiency against the APIC pool.”

Missing Historical Data

FASB, in its proposed statement, says it operated under a “fundamental assumption” that companies have the historical data to establish an opening APIC pool based on prior years’ accounting for value grants and their related tax impact.

“The board believed that prepared would have the information necessary to comply with the transition requirements of Statement 123(R),” FASB said. “The board did not receive feedback in the public comment period indicating that the information was not, in fact, available. However, subsequent discussions with constituents on certain implementation matters associated with Statement 123(R) have made it clear that a significant number of constituents do not have that information readily available and, in some cases, they may not be able to recreate that information.”

So why do companies now say they can’t create an opening APIC pool to comply with the tax accounting requirements of stock option expensing rules? Experts cite various causes.

Companies may have transitioned among different accounting systems or from manual to electronic systems over the years, making older data harder to capture. Mergers, acquisitions, spin-offs, divestitures and other such changes make historical data hard to track. Varying tax rates among different jurisdictions make calculations complicated.

Neuhausen

Ben Neuhausen, national director of accounting for BDO Seidman offered another possible explanation. Before stock option expensing became required, “it was a footnote disclosure,” he said. “Companies may not have been very meticulous with their footnote records.”

Whatever the cause for the missing historical data, now companies will have an optional method when FASB approves its proposed staff position. The alternative method is a calculation that involves easier-to-find gross figures, but which may understate the actual APIC pool if companies were working with real numbers, sources said.

Kehmeier said the alternative method is easier to calculate, but appears to double count expenses for partially vested options and presents other drawbacks as well. “If companies have their original data, they’ll get a better APIC pool using real data,” said Powell. “The shortcut will give them something to work with if they have no valid data.”

Dunn said the alternative method is a solution for companies with no data, but presents an option for companies that have the data. “Now it’s out there as an alternative option, so for companies with the data, it gives them a choice,” he said. “I think it’s shortsighted for a company to say they don’t have the resources and use the shortcut. If they’ve got the data, they owe it to their shareholders to do the analysis.”

Kehmeier

Kehmeier said FASB’s guidance helps shed some light on questions about the APIC pool, but experts are still hoping for more implementation guidance, especially on overseas options and the relation of stock option expensing rules with research and development credits and a new tax deduction for manufacturers.

“This in no way addresses all the complexities,” she said. “There are differences of opinion [regarding implementation issues] among accounting firms, and even within accounting firms this stuff is so complex.”

The proposed FASB staff position is available in the box above, right, as is related coverage and standards.