Accounting Standards Update: 4/23/24

The Financial Accounting Standards Board (FASB) regularly issues Accounting Standards Updates (ASUs) to make changes to the FASB Accounting Standards Codification (ASC), the primary source of Accounting Principles Generally Accepted in the United States (GAAP).

Below highlights the recently issued ASUs, including:

• ASU 2024-01, Compensation – Stock Compensation (Topic 718): Scope Application of Profits Interest and Similar Awards
• ASU 2024-02, Codification Improvements–Amendments to Remove References to the Concepts Statements

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ASU 2024-01, Compensation – Stock Compensation (Topic 718): Scope Application of Profits Interest and Similar Awards

The FASB issued ASU 2024-01, Compensation–Stock Compensation (Topic 718): Scope Application of Profits Interest and Similar Awards which clarifies how an entity determines whether a profits interest or similar award (hereafter a “profits interest award”) is:

1. within the scope of ASC 718, Compensation–Stock Compensation, or
2. not a share-based payment arrangement and instead within the scope of other guidance.

Summary

The ASU adds an illustrative example, Example 10: Profits Interest and Similar Awards (Example 10), to ASC 718-10-55. Example 10 includes a new illustration with four fact patterns, Cases A through D, to demonstrate how an entity should apply the scope guidance in paragraph 718-10-15-3 to determine whether profits interest award should be accounted for in accordance with Topic 718. The cases illustrated in Example 10 are summarized below.

The fact patterns in the illustrative example focus on the scope conditions in paragraph 718-10-15-3. The illustrative example is intended to reduce:

1. complexity in determining whether a profits interest award is subject to the guidance in Topic 718, and
2. existing diversity in practice.

The amendments in paragraph 718-10-15-3 improve its overall clarity and operability without otherwise changing the guidance.

Case A: Award Is a Share-Based Payment Arrangement

Case A provides an example wherein the Class B units cliff vest at the end of three years of service or fully vest upon an exit event if the grantee is still providing services to Entity X. Upon an exit event, the grantee would retain the vested Class B units or, if the Class B units are settled through an exit event, Entity X would distribute proceeds to the Class B unit holders on a pro rata basis along with the Class A units once the Class A unit holders have received distributions equal to a predetermined distribution threshold established on the grant date of the Class B units.

The guidance in Case A concludes that in the evaluation of whether the condition in ASC 718-10-15-3(a) is met, the following facts indicate that Entity X is offering to issue shares or other equity instruments and that the Class B units are therefore within the scope of ASC 718:

• The Class B units vest upon three years of service or an exit event.
• Holding the vested Class B units gives the grantee the right to participate in the residual interest of Entity X through periodic distributions, upon an exit event, or upon settlement proportionate to ownership of Class B units of Entity X in accordance with the distribution waterfall described above.

Case B: Award Is a Share-Based Payment Arrangement

Case B provides an example wherein the Class B units vest only upon an exit event. When such exit event occurs, the grantee would retain the vested Class B units in a manner similar to the grantee in Case A. If the Class B units are settled through an exit event, Entity X would distribute proceeds to the Class B unit holders on a pro rata basis with the Class A units once the Class A unit holders have received distributions equal to a predetermined distribution threshold established on the grant date of the Class B units. Additionally, the Class B units are eligible to begin participation in nonforfeitable operating distributions on the grant date.

The guidance in Case B concludes that in the evaluation of whether the condition in ASC 718-10-15-3(a) is met, the following facts indicate that Entity X is offering to issue shares or other equity instruments and that the Class B units are therefore within the scope of ASC 718:

• The Class B units vest upon an exit event.
• Holding the vested Class B units gives the grantee the right to participate in the residual interest of Entity X through periodic distributions, upon an exit event, or upon settlement proportionate to ownership of Class B units of Entity X in accordance with the distribution waterfall described above.

Case C: Award Is a Share-Based Payment Arrangement (Phantom Share)

Case C provides an example wherein the grantee of Class B phantom share units is only eligible to receive cash upon an exit event. If such an event occurs, the Class B phantom share units are cash-settled based on their fair value, which is calculated by reference to the price of the Class A units of Entity X as determined on the date of the exit event. Further, to receive any proceeds, the grantee must be providing services when the exit event occurs.

The guidance in Case B concludes that in the evaluation of whether the condition in ASC 718-10-15-3(b)(1) is met, Entity X has incurred a liability to the grantee that is based, at least in part, on the price of Entity X’s shares and that the Class B phantom share units are therefore within the scope of ASC 718.

Case D: Award Is Not a Share-Based Payment Arrangement (Phantom Share)

Case D provides an example wherein the grantee of Class B phantom share units is only eligible to participate in Entity X’s operating distributions equal to 1% of the preceding fiscal year’s net income after the grantee provides three years of services. Further, the grantee is not eligible to participate in any proceeds upon an exit event, and the Class B phantom share units are forfeitable upon the grantee’s termination for any reason at any time.

The guidance in Case D concludes that in the evaluation of whether the criteria in ASC 718-10-15-3(a), (b)(1), and 15-3(b)(2) are met, the following facts indicate that the Class B phantom share units are not within the scope of ASC 718:

• The Class B units do not give the grantee the right to receive shares or other equity instruments of Entity X.
• The proceeds from operating distributions received by the holder of Class B units are based on an operating metric.
• There are no circumstances in which Entity X would be required to issue its equity shares or other equity instruments to the holder of Class B units.

For fact patterns like those in Case D other Codification Topics, such as ASC 710, Compensation–General would be applied.

Effective Date and Transition

For public business entities, ASU 2024-01 is effective for fiscal years beginning after Dec. 15, 2024, and interim periods within those annual periods. For all other entities, ASU 2024-01 is effective for fiscal years beginning after Dec. 15, 2025, and interim periods within those annual periods. Early adoption is permitted.

The ASU can be applied either:

1. retrospectively to all prior periods presented in the financial statements, or
2. prospectively to profits interest or similar awards granted or modified on or after the date the entity first applies the guidance, with disclosure that describes the nature and reason for the change in accounting principle.

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ASU 2024-02, Codification Improvements–Amendments to Remove References to the Concepts Statements

The FASB has issued Accounting Standards Update (ASU) No. 2024-02, Codification Improvements—Amendments to Remove References to the Concepts Statements. This ASU contains amendments to the Codification that remove references to various FASB Concepts Statements.

Summary

This update contains amendments to the Codification that remove references to various Concepts Statements. In most cases, the references were unnecessary and not required to understand or apply the guidance. In other cases, the references were used in previous Statements to provide guidance in certain relevant areas. Since FASB Concepts Statements are nonauthoritative, the FASB Board believes that references to Concepts Statements in the Codification could imply that the Concepts Statements are authoritative. Removing all references to the Concepts Statements will simplify the Codification and draw a distinction between authoritative and nonauthoritative literature. Application of the amendments is not expected to have a significant effect on current accounting practices of most entities.

Effective Date and Transition

For public business entities, ASU 2024-02 is effective for fiscal years beginning after Dec. 15, 2024. For all other entities, ASU 2024-01 is effective for fiscal years beginning after Dec. 15, 2025. Early adoption is permitted.

The ASU can be applied either:

1. prospectively to all new transactions recognized on or after the date that the entity first applies the amendments, or
2. retrospectively to the beginning of the earliest comparative period presented in which the amendments were first applied. If applying retrospectively, an entity shall adjust the opening balance of retained earnings as of the beginning of the earliest comparative period presented.

For questions on how to implement these new accounting standards, please contact your KSM advisor or complete this form.