Nonemployee Treatment May Be Getting a Whole Lot Easier
On June 15, the Financial Accounting Standards Board (FASB) met and reached consensus on a series of revisions to the accounting for share-based payments to nonemployees.
FASB had earlier put off this review in order to get Accounting Standards Update No. 2016-09 (ASU 2016-09) out the door. According to its notes, the FASB decided to make a separate project out of nonemployee treatment because the accounting presents a host of standalone issues. But the need for revision was nonetheless clear due to the complicated and disparate treatment of nonemployee awards relative to employee awards. Also, separate nonemployee award treatment represents an area of divergence between US GAAP and IFRS.
To understand what the FASB is dealing with, let’s review the current model for share-based payments to nonemployees.
The first task is to define a nonemployee. Simply put, a nonemployee is any individual who is not classified as an employee. ASC 718-10-20 uses the common law definition of an employee, pointing to IRS Revenue Ruling 87-41 for further support. The one exception is nonemployee directors, who don’t meet the definition of an employee, but are generally treated as employees for ASC 718 purposes.
Since ASC 718 is currently limited to share-based payments to employees, we must look elsewhere for applicable guidance. This takes us to subtopic ASC 505-50, which covers share-based payments outside the scope of ASC 718 (i.e. those to nonemployees). Rather than a grant-date fair value model, ASC 505-50-30-11 requires that awards under its purview be measured at the earlier of “the date at which a commitment for performance by the counterparty to earn the equity instruments is reached (a performance commitment)” and “the date at which the counterparty’s performance is complete.”
In practice, this usually means the vesting date, since the latter condition is typically earlier and performance completion is generally understood to mean vesting. Between the grant date and vest date, awards are marked to market. Unlike liability-classified awards, which are also marked to market, equity-settled awards to nonemployees are recognized in APIC rather than a liability account.
The constant remeasurement of fair value for nonemployee awards (i.e. each period from grant date to vest date) is a big reason why companies are excited about extending ASC 718 to include nonemployees. From a marketplace participant framework, it’s hard to find economic differences between a share-based payment award given to an employee and an identical one given to a nonemployee. The economics of the instrument itself are the same. And from a shareholder perspective, there’s no difference between an employee rendering a service and a nonemployee rendering a service.
In fact, under IFRS, virtually all share-based payment awards fall under the same treatment within IFRS 2 (Share-based Payment). Therefore, the FASB’s simplification here is also a positive step toward convergence.
Before we begin the wait for the final ASU, one final topic worth discussing is how the treatment will change for events occurring after performance is complete (i.e. after an award vests). Under ASC 505-50, other generally accepted accounting principles (GAAP) come into play. This often leads us to ASC 815 (Derivatives & Hedging), a highly technical topic that is not for the faint of heart. However, if the changes take place as proposed, ASC 718 would govern in those cases. This is important because post-vest modifications do occasionally occur and the modification framework within ASC 718 applies more closely than the logic in other GAAP.
ASC 718 does limit its own scope to a period of 60 to 90 days beyond the point when an employee is no longer providing service to the company, so postemployment modifications should still be made with extraordinary care.
We welcome your thoughts and your questions. For a full description of the proposed changes, please visit the FASB’s website.