FASB Proposes Clarifications to Scope Guidance on Profits Interest Awards
Overview
On May 11, 2023, the FASB issued a proposed ASU1 that would clarify how an entity determines whether it is required to
account for profits interest awards (and similar awards) in accordance with ASC
7182 or other guidance. Comments on the proposed ASU are due by July 10,
2023.
Background
In October 2018, the FASB received an agenda request related to providing
specific guidance on whether a profits interest award should be accounted for as
a share-based payment arrangement under ASC 718 or in a manner similar to a cash
bonus or profit-sharing arrangement under ASC 7103 or other ASC topics. The agenda request noted that the absence of such
guidance has resulted in diverse accounting for these awards.
Connecting the Dots
Nonpublic entities such as limited partnerships, limited liability
companies, or similar pass-through entities may grant special classes of
equity, frequently in the form of profits interests. While the legal and
economic form of these awards can vary, they should be accounted for on
the basis of their substance. If an award has the characteristics of an
equity interest, it represents a substantive class of equity and should
be accounted for under ASC 718; however, an award that is, in substance,
a performance bonus or a profit-sharing arrangement would be accounted
for as such in accordance with other U.S. GAAP (e.g., typically ASC 710
and ASC 4504 for employee arrangements). See Section
2.6 of Deloitte’s Roadmap Share-Based Payment Awards for more
discussion of profits interest awards and other awards issued by
pass-through entities.
In response to the agenda request, the FASB’s Private Company Council (PCC)
formed a working group in August 2020 to assess whether there were pervasive
practice-related issues associated with accounting for profit interest awards.
The PCC and the PCC Technical Agenda Consultation Group discussed at various
meetings the issue of scope and other related matters as well as research and
outreach performed by the FASB staff.
At the April 2022 PCC meeting, the PCC submitted for the Board’s consideration an
illustrative example of scope application requirements and transition guidance.
The PCC also recommended that the scope guidance not be limited to private
companies because (1) certain public companies could be required to account for
profits interest awards that remain outstanding if they filed a Form S-1 with
the SEC and (2) the profits interest awards could, in certain situations, remain
outstanding after an initial public offering (e.g., in an “Up-C” structure). The
PCC further suggested that the Board add a project on profits interest to its
technical agenda.
Accordingly, in December 2022, the Board added to its technical agenda a project
on developing an illustrative example of how an entity would apply the scope
guidance in ASC 718 to determine whether to account for a profits interest award
under ASC 718.
Main Provisions of the Proposed ASU
The proposed ASU would add to U.S. GAAP an example illustrating four scenarios in
which an entity applies the scope criteria in ASC 718-10-15-3 to determine
whether to account for a profits interest award in accordance with ASC 718. The
illustrative example is intended to reduce (1) complexity in the determination
of whether a profits interest award is subject to the guidance in ASC 718 and
(2) diversity in practice.
Connecting the Dots
The proposed ASU’s example illustrates two scenarios in which profits
interest awards are within the scope of ASC 718 and two in which they
are outside of it. Paragraph BC19 of the proposal states that the
example is “not intended to be all-inclusive.” Thus, an entity “should
consider all relevant facts and circumstances when determining whether a
profits interest award should be accounted for in accordance with Topic
718.”
Proposed Effective Date and Transition
Effective Date
The effective date will be determined after the Board considers stakeholder
feedback on the proposal.
Transition
Entities would apply the proposed amendments either “(1) retrospectively to
all prior periods presented in the financial statements or (2) prospectively
to profits interest awards granted or modified on or after the effective
date.”
If prospective application is chosen, an entity would have to disclose “the
nature of and reason for the change in accounting principle.”
Contacts
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Aaron Shaw
Partner
Deloitte &
Touche LLP
+1 202 220
2122
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Sean May
Partner
Deloitte &
Touche LLP
+1 415 783
6930
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Chinmay Goswami
Senior Manager
Deloitte &
Touche LLP
+91 9599 822
009
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