Following up on an alert I sent out on November 1, 2013 (
FASB Proposes Update to ASC 718), the Financial Accounting Standards Board (FASB) recently issued Accounting Standards Update 2014-12 to provide explicit guidance on the accounting for performance share awards if the performance target can be achieved after an employee terminates (here’s a link:
ASU 2014-12).
The ASU essentially adopts the provisions as proposed in ASU EITF-13D by adding paragraph 718-10-30-28 to ASC 718, which states, in part, that “a performance target that affects vesting and that could be achieved after an employee’s requisite service period shall be accounted for as a performance condition.”
How it works
Under ASC 718, there is a distinction between “performance conditions” and “market conditions.” Performance conditions (internal metrics like earnings) are considered vesting criteria and are not reflected in the per-unit, grant-date fair value whereas market conditions (like relative TSR) are not considered vesting criteria and are reflected in the grant-date fair value of each target unit.
If an award with performance conditions pays in shares, it’s generally treated as an “equity instrument” and the price per unit (or share) is fixed as of the date of grant. However, the ultimate cost of the award is adjusted over time to reflect the actual number of units that vest. So price (P) is fixed, but quantity of shares (Q) fluctuates.
For a retirement-eligible employee that earns an award after the performance period ends, P x Q is recognized immediately with Q based on the “probable outcome.” This Q is adjusted over time as the "probable outcome" changes. For this employee, ASU 2014-12 basically says to continue adjusting Q until the end of the performance period, even if the employee no longer works at the company. Had the employee not been retirement-eligible until after the performance period ends, then the cost would be spread out over the performance period (e.g., P x Q ÷ 3 for each year of a 3-year performance plan, with Q adjusted over time) and ASU 2014-12 would not apply.
Some observations:
- The vesting period and requisite service period do not have to be the same (e.g., the vesting period can be longer than requisite service period)
- The guidance is inconsistent with IFRS 2
- IASB amended IFRS 2 in December 2013 to require that performance conditions be accounted for as “nonvesting conditions” to be reflected in the grant-date fair value of the award (similar to the treatment of market conditions like relative TSR ranking)
- The Task Force acknowledges this divergence in accounting standards, but thought the treatment under ASU 2014-12 is consistent with the FASB’s conclusions on the treatment of performance conditions under FAS 123(R)
- For companies that follow IFRS 2, they have the daunting task of incorporating performance conditions in to the fair value of the award. Prior to the adoption of FAS 123(R), the FASB concluded that reflecting a performance condition in the grant-date fair value of an award generally was not considered to be measurable with sufficient reliability for financial reporting purposes
- As noted in the alert I sent last November, this guidance might be in response to changes companies made to vesting criteria to maintain deductibility under 162(m) after the issuance of Revenue Ruling 2008-13
- Revenue Ruling 2008-13 provides that compensation will not be treated as performance-based under Section 162(m) if it is payable regardless of performance in the event of certain terminations (e.g., retirement)
- After the issuance of Rev. Rul. 2008-13, many companies modified incentive plans to delay payouts to terminated executives until the end of the performance period and actual performance is determined.
Effective date and transition
This update will be effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Earlier adoption is permitted. The amendments may be applied either (1) prospectively to all awards granted or modified after the effective date or (2) retrospectively to all awards outstanding as of the beginning of the earliest award presented in the financial statements and to all new or modified awards thereafter.
I hope you find this alert helpful. If you have any questions about this or anything related to executive compensation, please do not hesitate to call me.
Talk to you soon.
Andy
