In other words, windfalls or shortfalls are inevitable. Settlements will almost always occur at amounts greater than or less than the initial fair value. The appeal of the APIC pool is that it buffers the income statement from both positive and negative hits stemming from DTA reversals. The APIC pool is the off-balance sheet pool of excess benefits that can be used to absorb tax deficiencies, and it’s inflated by tax windfalls. Tax windfalls are added to, and tax shortfalls subtracted from, the APIC pool. The difference between a DTA and the actual tax benefit results in a “tax windfall” (aka excess benefit) if the DTA is less than the benefit a “tax shortfall” (aka deficiency) arises if the DTA is greater. When an award is settled and the actual tax benefit, if any, is realized, the DTA is reversed from the balance sheet. At the close of each reporting period, the balance in the DTA should be equal to the cumulative recorded compensation cost for outstanding awards multiplied by the relevant corporate tax rate. At the same time the DTA is recorded, a deferred tax benefit is recorded in the income statement, which reduces current period tax expense. The DTA represents a future deductible amount that will produce tax savings at a later date. This is accomplished by recording a DTA on the balance sheet. A key principle of ASC 740 is that the tax benefit of a deduction that is available for both book and tax purposes, but differs in terms of timing (a so-called temporary difference), should be recognized on the books at the same time as the book expense. The crux of the DTA issue in ASC 718 is that expense under GAAP (also called “book rules”) is calculated and allocated differently from under tax rules, thereby creating a requirement to reconcile between the two sets of rules. The tax benefit that the company receives at settlement and recognizes in its tax return is generally equal to the intrinsic value of the award on the date of the settlement event. Whereas ASC 718 requires measuring compensation cost using fair value principles and recognizing this cost over the requisite service period (generally the vesting period), the tax deduction is only recorded on a company’s tax return when a settlement event occurs (a “taxable event”). In contrast, the tax code per the Internal Revenue Service (IRS) has always treated share-based payment awards as an expense. The adoption of ASC 718 in 2004 required companies to recognize in their financial statements compensation cost arising from the issuance of share-based compensation instruments under a fair value methodology. There are also a host of specific rules and issues that layer on top of the basic mechanics. Differences between these respective measures of value (taken at different times) are typically recorded in additional paid-in-capital (APIC). The basic mechanics of tax accounting for equity awards entail setting up a deferred tax asset (DTA) based on the cumulative book expense for awards that are expected to result in future tax deductions, and reversing that DTA when settling the award for tax purposes. The Current Deferred Tax Accounting Model To help you prepare, here’s a refresher on the current deferred tax model, along with an illustration of exactly what it means to eliminate the APIC pool and an introduction to the concept of tax settlement forecasting. We’ve been actively watching FASB’s deliberations pertaining to forthcoming revisions to ASC 718. As we help organizations unpack what the changes are likely to mean for them, much of our time has been spent on the tentative revisions to the deferred tax accounting model.Īt this writing, it appears likely we’ll see an exposure draft that eliminates the APIC pool and causes windfalls and shortfalls to flow through the P&L.
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