The Financial Accounting Standards Board (FASB) has expanded the scope of its stock compensation guidance to include share-based payments to nonemployees for goods and services. The amendment to U.S. Generally Accepted Accounting Principles (GAAP) eliminates existing guidance that called for businesses that give stock awards to independent contractors or consultants to follow a separate standard from the one used for employee stock compensation.
Businesses have typically followed the guidance in Accounting Standards Codification (ASC) Topic 718 for stock payments to employees. But shares used to pay nonemployees (such as contractors or consultants) have been accounted for according to ASC Subtopic 505-50, Equity — Equity-Based Payments to Non-Employees. That guidance was formerly Emerging Issues Task Force (EITF) Issue No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services.
For years, companies that offered stock awards have expressed frustration over having to follow different accounting models based on whether the recipient of the award is an employee or a contractor. In each case, the stock awards were measured at fair value. But the two pieces of guidance differ with regard to the measurement’s timing.
Under existing guidance, the measurement date for nonemployees is determined at the earlier of the date at which 1) the commitment for performance is complete, or 2) the counterparty’s performance is complete. This requires judgment and tracking issues that have led to inconsistencies in financial reporting, especially if nonemployees are awarded stock options on a one-by-one basis, rather than a single large grant.
Rationale for nonemployee guidance
EITF Issue No. 96-18 was published in 1996. At that time, the FASB chose to apply different stock compensation guidance to nonemployees because independent contractors and consultants were perceived as having significant freedom to move from company to company. In the late 1990s, the U.S. stock market was in the midst of what was, to that point, the longest bull run in history, and stock awards were being treated as a de facto currency. In theory, independent contractors could watch stock price movements to determine where to work.
The dot-com bubble burst in 2000, and stocks fell into a deep bear market during the global financial crisis of 2008. While a new bull market was underway by 2009, the FASB now believes the assumptions behind EITF Issue No. 96-18 were overstated, because full-time employees also have the freedom to move from job to job.
Time for change
In June 2018, the FASB issued updated guidance that will expand the scope of ASC 718 to include share-based payments to nonemployees for goods and services. Accounting Standards Update (ASU) No. 2018-07, Compensation — Stock Compensation: Improvements to Nonemployee Share-Based Payment Accounting, aligns the guidance for stock compensation to employees and nonemployees. And it replaces ASC Subtopic 505-50.
“This standard will make it easier for companies to account for the share-based payments they provide to service providers, suppliers, and other people that are not employees,” said FASB Chairman Russell Golden.
The amendments in ASU No. 2018-07 apply to all share-based payment transactions in which a grantor acquires goods or services to be used or consumed in a grantor’s own operations by issuing share-based payment awards. But the amended guidance does not cover stock compensation that’s used to provide financing to the company that issued the shares or to stock awards tied to a sale of goods or services as part of a contract accounted for according to ASC Topic 606, Revenue from Contracts with Customers.
Under the updated guidance, nonemployee share-based payments are measured with an estimate of the fair value of the equity the business is obligated to issue at the grant date. The grant date is the date the business and the stock award recipient agree to the terms of the award. Essentially, compensation will be recognized in the same period and in the same manner as if the company had paid cash for goods or services instead of stock.
The updated standard is effective for public companies for fiscal years that begin after December 15, 2018, and the quarterly and other interim periods in those years. Private companies have an extra year to implement the changes for annual reports and two years for reporting periods of less than a year. Early adoption is generally permitted, but businesses aren’t allowed to follow the changes in ASU No. 2018-07 until they’ve implemented the new revenue recognition standard.
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