7.3 Stock Compensation
Because the receipt of employee services in exchange for a share-based payment award is a noncash item, the granting of such awards is not presented in the statement of cash flows.
However, in presenting cash flows under the indirect method, an entity would present the compensation cost recognized in net income in each reporting period as a reconciling item in arriving at cash flows from operations. In addition, an entity must present any cash paid by employees (e.g., the exercise price) to the entity for such awards as cash inflows from financing activities.
However, the complexity of stock compensation arrangements often leads to
additional presentation issues related to an entity’s statement of cash flows. This
section discusses the following presentation issues:
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Cash received upon early exercise of a share-based payment award.
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Income tax effects of share-based payment awards.
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Settlement of equity-classified share-based payment awards.
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Settlement of liability-classified share-based payment awards.
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Remittances of statutory withholding on share-based payment awards.
For more information about the accounting for share-based payment awards, see
Deloitte’s Roadmap Share-Based
Payment Awards.
7.3.1 Cash Received Upon Early Exercise of a Share-Based Payment Award
An early exercise refers to an employee’s ability to change his or her tax position by exercising a share-based payment award and receiving shares before the completion of the requisite service period (i.e., before the award is vested). The early exercise of an award results in the employee’s deemed ownership of the shares for U.S. federal income tax purposes, which in turn results in the commencement of the holding period (under the tax law), allowing any subsequent appreciation in the value of the shares received (and realized upon the sale of those shares) to be taxed at a capital gains rate rather than an ordinary income tax rate.
Under ASC 718, an early exercise of a share-based payment award is not
considered substantive for accounting purposes (see ASC 718-10-55-31(a)). That
is, the share is not considered “issued” because the employee is still required
to perform the requisite service to earn the share. Although the share is not
considered issued, the cash received from the early exercise represents proceeds
from the issuance of an equity instrument and would still be classified as a
financing activity. As a result, such cash would be recognized as a cash inflow
from financing activities under ASC 230-10-45-14(a).
In addition, as defined in ASC 230-10-20, cash flows from operating activities are “generally the cash effects of transactions and other events that enter into the determination of net income.” A transaction in which cash is received from an employee who elects to early exercise an option is not the type of transaction that enters into the determination of net income.
7.3.2 Income Tax Effects of Share-Based Payment Awards
Before the issuance of ASU 2016-09, entities were required to present any realized
excess or deficient tax deductions (“excess tax benefit” or “tax deficiency”) on
a gross basis as separate components of financing activities.2 However, ASU 2016-09 clarified that the income tax effect of any excess
tax benefit or tax deficiency is recognized in the income statement; therefore,
excess tax benefits or tax deficiencies represent operating activities in a
manner consistent with other cash flows related to income taxes.
7.3.3 Settlement of Equity-Classified Share-Based Payment Awards
When settling an equity-classified share-based payment award, an entity presents the settlement in its statement of cash flows on the basis of whether the amount paid to settle the award is greater than or less than the fair-value-based measure of the award on the settlement date:
- Amount paid to settle the award does not exceed the fair-value-based measure of the award on the settlement date — In accordance with ASC 718-20-35-7, if the cash paid to repurchase the equity-classified award does not exceed the fair-value-based measure of the award on the repurchase date, the cash paid to repurchase the award is charged to equity. That is, repurchase of the equity-classified award is viewed as reacquisition of the entity’s equity instruments. Accordingly, the cash paid to reacquire the entity’s equity instruments is presented as a cash outflow for financing activities under ASC 230-10-45-15(a), which indicates that payments of dividends or other distributions to owners, including outlays to reacquire the entity’s equity instruments, are cash outflows for financing activities.
- Amount paid to settle the award exceeds the fair-value-based measure of the award on the settlement date — If the cash paid to repurchase the equity-classified award exceeds the fair-value-based measure of the award on the repurchase date, the cash paid in excess of the fair-value-based measure of the award is viewed as compensation for additional employee services and is recognized as additional compensation cost. Accordingly, if the equity-classified award is repurchased for an amount in excess of the fair-value-based measure, the portion of the cash paid to reacquire the entity’s equity instruments that equals the fair-value-based measure of the award is presented as a cash outflow for financing activities under ASC 230-10-45-15(a). The portion of the cash paid in excess of the fair-value-based measure, for additional employee services, is presented as a cash outflow for operating activities under ASC 230-10-45-17(b), which notes that cash payments to employees for services are cash outflows for operating activities.
Example 7-2
Company A is making a tender offer to repurchase $20 million of common stock in
the aggregate (the stock was originally distributed as
share-based compensation awards) from its current
employees. On the basis of an independent third-party
valuation, A concludes that the purchase price paid to
the employees for the common stock exceeds the fair
value of the common stock by a total of $4.5 million. In
accordance with ASC 718-20-35-7, the amount paid to
employees up to the fair value of common stock acquired
should be recognized in equity as a treasury stock
transaction and should therefore be presented as a cash
outflow for financing activities. The $4.5 million that
was paid in excess of the fair value of the common stock
constitutes compensation expense and is therefore
presented as a cash outflow for operating
activities.
7.3.4 Settlement of Liability-Classified Share-Based Payment Awards
In accordance with ASC 718-30, the grant-date fair-value-based measure and any
subsequent changes in the fair-value-based measure of a liability-classified
award through the date of settlement are recognized as compensation cost.
Accordingly, the cash paid to settle the liability-classified award is
effectively payment for employee services and is presented as a cash outflow for
operating activities under ASC 230-10-45-17(b).
Note that an entity may enter into an agreement to repurchase (or offer to repurchase) an equity-classified award for cash. Depending on the facts and circumstances, the agreement to repurchase (or offer to repurchase) may be accounted for as either (1) a settlement of the equity-classified award or (2) a modification of the equity-classified award that changes the award’s classification from equity to liability, followed by a settlement of the now liability-classified award.
If the agreement to repurchase (or offer to repurchase) is considered a
settlement of an equity-classified award, the cash paid to reacquire the
entity’s equity instruments is presented in a manner consistent with the
discussion in the previous section. If the agreement to repurchase (or offer to
repurchase) is considered a modification of the equity-classified award that
changes the award’s classification from equity to liability, the cash paid to
settle the liability-classified award should be presented in the statement of
cash flows in a manner similar to the conclusion above. That is, under ASC
230-10-45-17(b), the cash paid to settle the liability-classified award is
effectively payment for employee services and is presented as a cash outflow for
operating activities.
7.3.5 Remittances of Statutory Withholding on Share-Based Payment Awards
Regardless of whether the employer meets the employee’s statutory tax
withholding requirement for liability-classified or equity-classified
share-based payment awards through either a net settlement feature or a
repurchase of shares upon exercise of an employee share option (or vesting of a
nonvested share), an entity must account for the withholding as two transactions
in the statement of cash flows. That is, in substance, this transaction is (1) a
gross issuance of shares and (2) a repurchase of the amount of shares needed to
satisfy the employee’s statutory tax withholding requirement. Therefore, the
presentation in the statement of cash flows must also reflect the two
transactions.
First, the gross issuance of shares is presented as a financing activity. For example, the cash received for an employee share option as payment for the exercise price of the award is classified as a financing cash inflow. In contrast, for a nonvested share award, because no cash is received from the employee, the gross issuance of shares is presented as a noncash financing activity.
In the second step, when an employee elects to have shares withheld to satisfy
its statutory withholding tax obligation, the employer is deemed to have
repurchased a portion of the shares that were received by the employee in the
first step. While the employee does not receive cash directly, the employer has,
in substance, repurchased shares from the employee and remitted the cash
consideration to the tax authority on the employee’s behalf. Because the cash
payment is related to a repurchase of stock, it is presented as a financing cash
outflow.
In some circumstances, an exercise of the award may occur in one reporting
period while the amount withheld for tax purposes may not be remitted to the tax
authority by an employer, on behalf of the employee, until a subsequent
reporting period. In these circumstances, for the second step of the
transaction, the financing cash outflow is reported in the period in which the
cash is paid to the tax authority. In the initial reporting period, the employer
has issued the gross amount of shares and is deemed to have repurchased the
requisite number of shares needed to satisfy the employee’s statutory tax
withholding requirement by issuing a note payable to the employee. The note
payable issued for the repurchase amount is viewed as a noncash event that has
no impact on the statement of cash flows. In the subsequent reporting period,
the employer remits the payment for the note payable; however, the employee
requests that the amount be remitted to the tax authority on the employee’s
behalf instead of directly to the employee. This results in the financing cash
outflow.
Example 7-3
An entity grants 1,000 nonvested shares to an employee. The plan allows the
employer to net-settle the award to cover the statutory
tax withholding requirement. Upon vesting, the entity
withholds 250 shares to cover the statutory withholding
requirement and issues the employee the remaining 750
shares. For cash flow purposes, the entity must account
for this transaction as (1) the gross issuance of 1,000
shares and (2) the repurchase of 250 shares to satisfy
the statutory withholding requirement. Because no cash
is received from the employee for the nonvested share
award, the gross issuance of the 1,000 shares is
classified as a noncash financing activity. The
“repurchase,” through the net settlement feature, of the
250 shares to satisfy the statutory withholding
requirement is classified as a financing cash outflow.
The contemporaneous “receipt of cash,” through the net
settlement feature, from the employee and the remittance
of cash by the entity to the tax authority have no net
impact on the statement of cash flows.
Connecting the Dots
In June 2018, the FASB issued ASU 2018-07,3 which simplifies the accounting for share-based payments granted
to nonemployees for goods and services. Under the ASU, most of the
guidance on share-based payments to nonemployees is aligned with the
requirements for share-based payments granted to employees. As a result,
much of the guidance in ASC 718, including most of its requirements
related to classification and measurement of share-based payment awards
to employees, will apply to nonemployee share-based payment
arrangements. The ASU also revises ASC 230-10-45-15(a) to extend the
requirement to classify, as a financing activity, a repurchase of shares
to satisfy an employee’s statutory tax withholding obligation related to
share-based payments granted to nonemployees.
Footnotes
2
ASU 2016-09 removed ASC 230-10-45-14(e), which stated
that the following was a cash inflow from financing activities: “Cash
retained as a result of the tax deductibility of increases in the value
of equity instruments issued under share-based payment arrangements that
are not included in the cost of goods or services that is recognizable
for financial reporting purposes. For this purpose, excess tax benefits
shall be determined on an individual award (or portion thereof) basis.”
Such excess tax benefits were the same amounts that an entity was
required to show as an operating cash outflow in accordance with ASC
230-10-45-17(c), which the ASU also removed.
3
The amendments in ASU 2018-07 are effective for
public business entities for fiscal years beginning after
December 15, 2018, including interim periods within those fiscal
years. For all other entities, the amendments are effective for
fiscal years beginning after December 15, 2019, and interim
periods within fiscal years beginning after December 15, 2020.
Early adoption is permitted, provided that the adoption date is
no earlier than the date on which an entity adopts ASC 606.