Subtopics

ASC 718, Compensation-Stock Compensation, provides guidance on share-based payments to employees and contains six subtopics:

• ASC 718-10, Overall, contains the high-level objectives and general guidance for the Topic
• ASC 718-20, Awards Classified as Equity, deals with share-based awards to employees classified as equity
• ASC 718-30, Awards Classified as Liabilities, deals with share-based awards to employees classified as liabilities
• ASC 718-40, Employee Stock Ownership Plans, contains the following subsections:
  • General
  • Leveraged employee stock ownership plans
  • Nonleveraged employee stock ownership plans
• ASC 718-50, Employee Share Purchase Plans, contains guidance for compensatory and noncompensatory plans
• ASC 718-60, Income Taxes, addresses accounting for income taxes related to share-based payment arrangements.

Scope and Scope Exceptions

ASC 718 applies to all entities and to all share-based payment transactions where the entity acquires employee services by issuing or offering to issue equity instruments or incurring liabilities to an employee that meet these conditions:

1. The amounts are based in whole or in part on the price of the entity's equity instruments
2. The awards require or may require settlement by issuing the entity's equity instruments.

If the purpose of awarding the shares is other than compensation, ASC 718 does not apply. ASC 718 does not apply to share-based payments for other than employee services.

Technical Alert

ASU 2014-12. In June 2014, the FASB issued ASU 2014-12, Compensation—Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved After the Requisite Service Period. The ASU was issued in response to the EITF Consensus on Issue 13-D. Current U.S. GAAP has no explicit guidance for these circumstances, thereby resulting in diversity in practice. ASU 2014-12 fills this need and provides that:

• A performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition.
• A reporting entity should apply existing guidance in Topic 718 as it relates to awards with performance conditions that affect vesting to account or such awards.
• Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved.
• The amount recognized should represent compensation costs attributable to the periods for which the requisite service has already been rendered.

Implementation information. ASU 2014-12 is effective for all entities for reporting periods, including interim periods, beginning after December 15, 2015. Early adoption is permitted. Entities have the option of applying the guidance prospectively or retrospectively but only to awards granted or modified after the effective date.

Overview

The economic substance of stock-based compensation is to provide compensation, resulting in an expense that should be reported by the entity using the fair value method of accounting. ASC 718 requires fair value accounting for almost all share-based payment plans.

ASC 718-10 provides guidance applicable to all share-based payment arrangements with employees. ASC 718-10, 718-20, and 718-30 are interrelated. Preparers should look to the general guidance in ASC 718-10 and then ASC 718-20 for additional guidance on awards classified as equity and ASC 718-30 for additional guidance on awards classified as liabilities. ASC 718-40 contains the accounting for employers' contributions to employee stock ownership plans (ESOP). This includes the measurement of compensation cost and the accounting for dividends paid on unallocated shares.

Accounting for Share-Based Payments

ASC 718 addresses share-based payments issued to employees. It covers plans for employees that convey shares of:

• the employer's stock,
• derivatives (such as options) related to the employer's shares, or
• cash in amounts tied to the value of the employer's shares.

All share-based plans are considered compensatory unless the benefit to employees is no greater than that which is available to shareholders generally. The benefit to recipients is assessed based both on the discount from market price and the number of shares they are eligible to buy. Virtually all plans will be considered compensatory for accounting purposes, including employee stock purchase plans that are noncompensatory under the federal tax laws.

Additionally, ASC 718 describes:

1. the prescribed pattern of compensation cost recognition,
2. the accounting for employee stock purchase plans, and
3. accounting for the income tax effects of share-based transactions.

It also requires that excess tax benefits be reported in the cash flow statement as a financing activity, rather than as an operating activity (these are currently reported as a reduction of income taxes paid).

With stock compensation plans, measurement of compensation expense is the primary issue for reporters in stock compensation. The objective of measurement of the plans is to estimate, as of the grant date, the fair value of the award that an employee earns as a result of requisite service and satisfying vesting requirements. The estimate of fair value reflects transferability and other restrictions if they are in effect when the award vests. Compensation cost is recognized only for those awards that vest (which obviously demands that estimates be made).

Measurement Alternatives for Awards Classified as Equity—Nonpublic Companies

Stocks or options issued as part of an employee stock compensation plan must be measured at fair value. Because nonpublic companies do not trade shares on an exchange, it may be difficult for those companies to estimate the value of the underlying stock, and, thus, its volatility. ASC 718 provides a measurement alternative for nonpublic companies where it may not be possible for a nonpublic company to estimate its fair value. Nonpublic companies may choose to use either fair values or continually updated calculated values to measure equity- or liability-classified awards. If the entity chooses to update based on a calculated value, it calculates the value using the historical volatility of the appropriate industry sector index. (ASC 718-10-30-20)

Note that no such choice is available for nonvested or vested stock awards, which are to be measured using grant-date fair values.

If a nonpublic reporting entity chooses to use the calculated value alternative, the calculated value of an equity-classified award will have to be reestimated each reporting period. However, if a company uses the fair value alternative no reestimation is required, which could reduce fluctuations in reported earnings. If nonpublic companies choose the fair value approach, they will not later be able to return to the use of calculated value, because fair value is deemed preferable for purposes of applying ASC 250 (accounting changes).

Recognizing Compensation

Modification of Awards

ASC 718 holds that freestanding financial instruments issued to employees in exchange for past or future employee services are subject to the recognition and measurement provisions of ASC 718 throughout the life of the instruments, unless their terms are modified when the holder is no longer an employee. ASC 718 also holds that, for instruments originally issued as employee compensation and then modified, and where that modification to the terms of the instrument is made solely to reflect an equity restructuring that occurs when the holders are no longer employees, no change in the recognition or the measurement (due to a change in classification) of those instruments will result if both of the following conditions are met:

1. There is no increase in the fair value of the award (or the ratio of intrinsic value to the exercise price of the award is preserved—i.e., the holder is made whole), or the antidilution provision is not added to the terms of the award in contemplation of an equity restructuring; and
2. All holders of the same class of equity instruments (for example, stock options) are treated in the same manner.

Other modifications of the instrument (that is, any modification that fails to meet the dual tests above) that take place when the holder is no longer an employee, are subject to the modification accounting guidance set forth by ASC 718, as addressed above. Following modification, the accounting for such instruments, no longer held by employees, must follow GAAP, including ASC 480 if applicable.

The definition of short-term inducement in the glossary of terms included the phrase or settlement of an award. This reference raised a question about possible interaction between different provisions of the standard. FASB did not intend for a short-term inducement deemed to be a settlement to affect the classification of the award for the period it remains outstanding (for example, change the award from an equity instrument to a liability instrument). Therefore, an offer (for a limited time period) to repurchase an award should be excluded from the definition of a short-term inducement, and not be accounted for as a modification. However, if an entity has a history of settling its awards for cash, the entity should consider whether at the inception of the awards it has a substantive liability.

The incremental compensation cost resulting from a modification of an award is measured as the excess of the fair value of the modified award over the fair value of the original award measured immediately prior to the modification. Modifications can occur because of repricing, extending the life, or changing the vesting condition of the award. Cancellations of existing awards and concurrent replacement with new ones have to be accounted for as modifications. In practice, modifications will rarely result in recognized compensation costs less than the fair value of the award at the grant date, but this could conceivably result if the original service or performance vesting conditions were not expected to be satisfied at the modification date.

ASC 718-30, Awards Classified as Liabilities

Accounting for Employee Stock Options

Under ASC 718, fair value accounting must be applied in measuring compensation expense. Ideally, fair value would be market-observed. An observable market price, if available for an option with similar features, should be used as the estimate of fair value of the employee option. However, in most cases, due to the nature of employee stock options (which lack exchangeability, etc.), observable market prices will not be available. Therefore, the reporting entity will have to estimate the fair value of the employee share option using a valuation model that meets the requirements of ASC 718. The valuation model takes into account the following factors, at a minimum:

1. Exercise price of the option.
2. Expected term of the option, taking into account several things including the contractual term of the option, vesting requirements, and postvesting employee termination behaviors. (The SEC states in 718-10-S99 that a registrant cannot use an expected term that is shorter than the vesting period.)
3. Current price of the underlying share.
4. Expected volatility of the price of the underlying share. (According to the SEC in 718-10-S99, a registrant may consider historical volatility in determining expected volatility, which in turn should take into consideration historical volatility over a period generally commensurate with the expected or contractual option term, as well as regular intervals for price observations. A registrant can also ignore a period of historical volatility if it can support a conclusion that the period is not relevant to estimating expected volatility due to nonrecurring historical events. The SEC would also not object to the use of an industry sector index to determine the expected volatility of its share price.)
5. Expected dividends on the underlying share.
6. Risk-free interest rate(s) for the expected term of the option.

In practice, there are likely to be ranges of reasonable estimates for expected volatility, dividends, and option term. The closed-form models, of which Black-Scholes (now Black-Scholes-Merton) is the most widely regarded, are predicated on a set of deterministic assumptions that remain invariate over the full term of the option. In the real world, this condition is almost always not met. For this reason, current thinking is that a lattice model, of which the binomial model is an example, would be preferred. Lattice models explicitly identify nodes, such as the anniversaries of the grant date, at each of which new parameter values can be specified (e.g., expected dividends can be independently defined each period).

If a reporting entity changes from the BSM model to a binomial model, the change will be deemed a change in accounting estimate, not a change in accounting principle. A change from a binomial model back to a less desirable BSM model is to be discouraged, but apparently not prohibited if use of BSM or a similar closed-form model is supportable. The presumption is that moving from a binomial model to the BSM model would not be well received.

Other features that may affect the value of the option include changes in the issuer's credit risk, if the value of the awards contains cash settlement features (i.e., if they are liability instruments). Also, contingent features that could cause either a loss of equity shares earned or a reduction of realized gains from sale of equity instruments earned, such as a clawback feature (for example, where an employee who terminates the employment relationship and begins to work for a competitor is required to transfer to the issuing enterprise shares granted and earned under a share-based payment arrangement—see the illustrations in ASC 718) would be factors affecting the valuation model.

Market, performance, or service conditions may affect vesting. An award becomes vested at the date the employee's right to receive or retain shares no longer has any of these conditions. Vesting may be conditional on satisfying two or more conditions. Regardless of the conditions that must be satisfied, the existence of a market condition requires recognition of compensation cost if service has been rendered, even if the market condition is never satisfied.

The definition of an employee used in ASC 718 is that given by IRS Ruling 87-41. In addition, ASC 718 requires that nonemployee directors, acting in their role as members of the company's board of directors, be treated as employees if they were elected by the shareholders or appointed to the board and will be subject to election at the next shareholder election. Any awards granted to these individuals for their service as directors would be considered to be employee compensation.

The grant date is defined as the date when the employer and employee have a mutual understanding of the key terms and conditions of the share-based compensation arrangement and all necessary authorizations of those conditions have occurred. The service inception date is the first day of the requisite service period. Compensation cost is attributed over the service period.

If a given option plan involves the payment of compensation to the employees, such compensation cost should be recognized in the period(s) in which the services being compensated are performed. If the grant is unconditional, which means it effectively is in recognition of past services rendered by the employees and does not depend on the rendering of further service, then compensation is reported in full in the period of the grant. If the stock options are granted before the service inception date, compensation cost should be recognized over the periods in which the performance is scheduled to occur. Whether compensation cost is recognized ratably over the periods or not is a function of the vesting provisions of the plan. If the plan provides for cliff vesting, compensation will be accrued on an essentially straight-line basis, while if it provides for graded vesting, the pattern of recognition is subject to election and may be more complex. The accounting for graded vesting plans under ASC 718 represents a change from current practice.

Option fair value calculations. Before presenting specific examples of accounting for stock options, simple examples of calculating the fair value of options using both the Black-Scholes-Merton and the binomial/lattice methods are provided. First, an example of the Black-Scholes-Merton closed-form model is provided.

Black-Scholes-Merton actually computes the theoretical value of a so-called European call option, where exercise can occur only on the expiration date. American options, which include most employee stock options, can be exercised at any time until expiration. The value of an American-style option on dividend paying stocks is generally greater than a European-style option, since preexercise the holder does not have a right to receive dividends that are paid on the stock. (For non-dividend-paying stocks, the value of American and European options will tend to converge.) Black-Scholes-Merton ignores dividends, but this is readily dealt with, as shown below, by deducting from the computed option value the present value of expected dividend stream over the option holding period.

Black-Scholes-Merton also is predicated on constant volatility over the option term, which available evidence suggests may not be a wholly accurate description of stock price behavior. On the other hand, the reporting entity would find it very difficult, if not impossible, to compute differing volatilities for each node in the lattice model described later in this section, lacking a factual basis for presuming that volatility would increase or decrease in specific future periods.

The Black-Scholes-Merton model:

The Black-Scholes-Merton valuation is illustrated with the following assumed facts; note that dividends are ignored in the initial calculation, but will be addressed once the theoretical value is computed. Also note that volatility is defined in terms of the variability of the entity's stock price, measured by the standard deviation of prices over, say, the past three years, which is used as a surrogate for expected volatility over the next twelve months.

The foregoing was a simplistic single-period, two-outcome model. A more complicated and realistic binomial model extends this single-period model into a randomized walk of many steps or intervals. In theory, the time to expiration can be broken into a large number of ever-smaller time intervals, such as months, weeks, or days. The advantage is that the parameter values (volatility, etc.) can then be varied with greater precision from one period to the next (assuming, of course, that there is a factual basis upon which to base these estimates). Calculating the binomial model, then, involves the same three calculation steps. First, the possible future stock prices are determined for each branch, using the volatility input and time to expiration (which grows shorter with each successive node in the model). This permits computation of terminal values for each branch of the tree. Second, future stock prices are translated into option values at each node of the tree. Third, these future option values are discounted and added to produce a single present value of the option, taking into account the probabilities of each series of price moves in the model.

A big advantage of the binomial model is that it can value an option that is exercisable before the end of its term (an American-style option). This is the style that employee share-based compensation arrangements normally take. FASB prefers the binomial model, because it can incorporate the unique features of employee stock options. Two key features that FASB recommends that companies incorporate into the binomial model are vesting restrictions and early exercise. Doing so, however, requires that the reporting entity had previous experience with employee behaviors (e.g., gained with past employee option programs) that would provide it with a basis for making estimates of future behavior. In some instances, there will be no obvious bases upon which such assumptions can be developed.

The binomial model permits the specification of more assumptions than does the Black-Scholes-Merton, which has generated the perception that the binomial will more readily be manipulated so as to result in lower option values, and hence lower compensation costs, than the Black-Scholes-Merton. But this is not necessarily the case: switching from Black-Scholes-Merton to the binomial model can increase, maintain, or decrease the option's value. Having the ability to specify additional parameters, however, probably does give management greater flexibility and, accordingly, will present additional challenges for the auditors who must attest to the financial statement effects of management's specification of these variables.

To calculate option values using either the Black-Scholes-Merton or binomial models without the aid of computer software would be very difficult, but hardly impossible. Fortunately, reasonably priced software is widely available to perform these calculations. What managers must do is determine the assumptions that should be used to create an unbiased, representative value of the options. Following are specific examples of accounting for share-based compensation as required under ASC 718.

Accounting for Stock Appreciation Rights and Tandem Plans

Modifications of Awards of Equity Instruments

In some instances awards previously issued but not yet settled are later modified in ways that may or may not change the classification (e.g., liability to equity). ASC 718 requires that modification of the terms or conditions of an equity award is to be treated as an exchange of the original award for a new award. In substance, the event is accounted for as if the entity repurchases the original instrument by issuing a new instrument of equal or greater value, incurring additional compensation cost for any incremental value.

Incremental compensation cost in such circumstances is to be measured as the excess, if any, of the fair value of the modified award—determined in accordance with the provisions of ASC 718—over the fair value of the original award immediately before its terms are modified. These measures are to be based on the share price and other pertinent factors at the modification date. Any effect of the modification on the number of instruments expected to vest is also to be reflected in determining incremental compensation cost. The estimate at the modification date of the portion of the award expected to vest may also be subsequently adjusted, if necessary, as estimates or experience may dictate prior to final settlement.

The total recognized compensation cost for an equity award will at least equal the fair value of the award at the grant date, except for those instances when, at the date of the modification, the performance or service conditions of the original award are not expected to be satisfied. Accordingly, the total compensation cost measured at the date of a modification will be (1) the portion of the grant-date fair value of the original award for which the requisite service is expected to be rendered (or has already been rendered) at that date, plus (2) the incremental cost resulting from the modification.

The change in compensation cost for an equity award measured at intrinsic value (if elected for nonpublicly held companies) is to be measured by comparing the intrinsic value of the modified award, if any, with the intrinsic value of the original award, if any, immediately before the modification.

If a modification results in what had been a liability award becoming an equity award, the amount of the fair value (or implicit value, if such were elected as a measurement strategy by a nonpublic company), the amount becomes “fixed” as of the modification date, and this will differ from the amount that would have been recognized had the award been classified as equity at inception. On the other hand, if an award was originally equity and after modification becomes a liability, to the extent that the liability equals or is less than the amount recognized in equity for the original award, the offsetting debit is a charge to equity. To the extent that the liability exceeds the amount recognized in equity for the original award, the excess is recognized as compensation cost.

A share-based payment award may also be modified as a result of an acquisition. ASC 805 describes the accounting for several instances where an acquirer exchanges its share-based payment awards for rewards held by the employees of an acquiree. If the acquiring entity replaces an acquiree's share-based awards when it is not obligated to do so, then all of the fair-value replacement cost is to be recognized as postcombination compensation expense. If the acquirer's replacement award requires some additional employee service, a portion of the replacement award's fair-value cost should be attributed to postcombination compensation expense.

ASC 718, 740, Income Taxes

Under U.S. income tax laws, the amount that is deductible in connection with a share-based compensation arrangement is limited to intrinsic value. This is generally defined by the amount by which the fair (market) value of the compensation exceeds the amount paid, if any, by the recipient, at the exercise date (not the grant date). For example, if an option grant is made when the underlying stock is trading at $34, and the option is exercisable at that price, and it is later exercised when the stock is trading at $55, the deductible amount will be $21 per share, based on the intrinsic value of the option as of the exercise date, which becomes observable only upon actual exercise. However, under ASC 718, compensation expense will have been recognized for the fair value of the option when granted, computed using either the Black-Scholes-Merton or lattice model as illustrated earlier in this section. Depending on other facts, that option value may have been $5, $10, or some other amount per share; it would not, however, be the same as the intrinsic amount other than by sheer coincidence.

Additionally, the timing of the compensation expense recognition will differ between tax and financial reporting. For financial reporting, expense is recognized over the expected service period, as explained above. For tax, the expense is deductible at the actual exercise date. Options not exercised (i.e., forfeited) thus never give rise to taxable deductions, whereas under GAAP the compensation cost would have been expensed.

It is thus inevitable that both the timing and the amounts of compensation expense related to share-based compensation will differ. To the extent that these are timing differences, interperiod tax allocation (deferred tax accounting) will be appropriate. The cumulative amount of compensation cost that will result in a tax deduction is to be considered a deductible temporary difference. This applies both for instruments classified as equity and for those categorized as liabilities. Any compensation cost recognized in the financial statements for instruments that will not result in a tax deduction should not be considered to result in a deductible temporary difference under ASC 740.

In general, the fair value of stock-based compensation, which is computed at grant date and recognized over the vesting period as compensation cost in the financial statements, will not be tax deductible currently, giving rise to deferred tax benefits measured with reference to the book compensation expense recognized. Ultimately, when the employee's options vest and are exercised, the company is able to deduct the intrinsic value, measured by the spread between fair value on exercise date and exercise price. To the extent this exceeds the fair value of the stock-based compensation recognized as GAAP-basis expense, the tax effect of that excess tax deduction is treated as a contribution to paid-in capital. If (less likely, but quite possible) the tax deduction is lower than the compensation already recognized for financial reporting purposes, this shortfall in tax benefits is additional compensation cost—in effect, the employer entity incurred higher compensation cost in connection with the share option program since it received less than the anticipated tax benefits related thereto.

If the exercise results in a tax deduction prior to the actual realization of the related tax benefit—because the entity, for example, has a net operating loss carryforward—then the tax benefit and the credit to additional paid-in capital for the excess deduction would not be recognized until that deduction reduces taxes payable.

However, to the extent that the excess stems from a reason other than changes in fair value of the entity's shares between the measurement date for accounting purposes (grant date, generally) and the later measurement date for income tax purposes (exercise date), that portion of the tax effect is to be reported in income (i.e., in the tax provision). For example, a change in the tax rate could result in such a difference.

Differences between the deductible temporary difference that arises and the tax deduction that would have resulted based on the current fair value of the entity's shares should not be considered either in measuring the gross deferred tax asset or in determining the need for a valuation allowance created by the application of ASC 718.

If there should be an excess of cumulative compensation cost recognized for financial reporting purposes over the tax deductible amount (e.g., due to options lapsing unexercised), the write-off of the deferred tax asset (net of valuation allowance, if any) is first to be offset against any remaining additional paid-in capital from previous awards accounted for under the fair value method; any remaining excess should be recognized in income (the tax provision). The additional paid-in capital available to absorb tax effects is referred to as the APIC pool.

Consistent with the treatment of excess tax deductions for share-based compensation as being essentially similar to capital contributions, ASC 718 requires that the realized tax benefit applicable to the excess of the deductible amount over the compensation cost recognized under GAAP be reported in the cash flow statement as both a cash inflow from financing activities and a cash outflow from operating activities. This is required whether the cash flow statement is being presented under the direct method or the indirect method.

It is possible that an entity has issued dividends to employees holding nonvested shares, nonvested share units, or outstanding options. If so, it should recognize the income tax benefit as an increase to additional paid-in-capital, but only if the deduction reduces income taxes payable.

Other ASC 718 Matters

The most common share-based compensation arrangements have been presented. Other more complicated awards have been developed. Some of these are presented below. For a further discussion with examples refer to ASC 718.

ASC 718-40, Employee Stock Ownership Plans

There has been a steady increase in the number of corporations that are entirely or partially employee-owned under terms of ESOPs. The accounting for ESOP is governed by ASC 718-40.

Depending on what motivated the creation of the ESOP (e.g., estate planning by the controlling shareholder, expanding the capital base of the entity, rewarding and motivating the work force), the sponsor's shares may be contributed to the plan in annual installments in a block of shares from the sponsor, or shares from an existing shareholder may be purchased by the plan.

ESOPs are defined contribution plans in which shares of the sponsoring entity are awarded to employees as additional compensation. Briefly, ESOPs are created by a sponsoring corporation which either funds the plan directly (unleveraged ESOP) or, more commonly, facilitates the borrowing of money either directly from an outside lender (directly leveraged ESOP) or from the employer, which in turn will borrow from an outside lender (indirectly leveraged ESOP).

Borrowings from outside lenders may or may not be guaranteed by the sponsor. However, since effectively the only source of funds for debt repayment is future contributions by the sponsor, GAAP requires that the ESOP's debt be considered debt of the sponsor even absent a guarantee.

When recording the direct or indirect borrowings by the ESOP as debt in the sponsor's statement of financial position, a debit to a contra equity account, not to an asset, is also reported. This is necessary since the borrowings represent a commitment (morally if not always legally) to make future contributions to the plan and this is certainly not a claim to resources. Significantly, this results in a “double hit” to the sponsor's statement of financial position (i.e., the recording of a liability and the reduction of net stockholders' equity), which is often an unanticipated and unpleasant surprise to plan sponsors. This contra equity account is referred to as “unearned ESOP shares” in accordance with provisions of ASC 718-40. If the sponsor itself lends funds to the ESOP without a “mirror loan” from an outside lender, this loan should not be reported in the employer's statement of financial position as debt, although the debit should still be reported as a contra equity account.

As the ESOP services the debt, using contributions made by the sponsor and/or dividends received on sponsor shares held by the plan, it reflects the reduction of the obligation by reducing both the debt and the contra equity account on its statement of financial position. Simultaneously, income and thus retained earnings will be impacted as the contributions to the plan are reported in the sponsor's current statement of earnings. Thus, the “double hit” is eliminated, but net worth continues to reflect the economic fact that compensation costs have been incurred.

The interest cost component of debt service must be separated from the remaining compensation expense. That is, the sponsor's income statement should reflect the true character of the expenses being incurred, rather than aggregating the entire amount into a category which might have been denoted as “ESOP contribution.”

In a leveraged ESOP, shares held serve as collateral for the debt and are not allocated to employees until the debt is retired. In general, shares must be allocated by the end of the year in which the debt is repaid. However, to satisfy the tax laws, the allocation of shares may take place at a faster pace than the retirement of the principal portion of the debt.

Under ASC 718-40, the cost of ESOP shares allocated is measured based upon the fair value on the release date for purposes of reporting compensation expense in the sponsor's income statements. This is in contradistinction to the actual historical cost of the shares to the plan.

Furthermore, dividends paid on unallocated shares (i.e., shares held by the ESOP) are not treated as dividends, but rather must be reported in the sponsor's income statement as compensation cost and/or as interest expense. Of less significance to nonpublic companies is the fact that under the new rules only common shares released and committed to be released are treated as being outstanding, with the resultant need to be considered in calculating both basic and diluted EPS.

Note that in all the foregoing illustrations the effect of income taxes is ignored. Since the difference between the cost and fair values of shares committed to be released is analogous to differences in the expense recognized for tax and accounting purposes with regard to stock options, the same treatment should be applied. That is, the tax effect should be reported directly in stockholders' equity, rather than in earnings.

ASC 718-50, Employee Share Purchase Plans

Employee share purchase plans are not compensatory if their terms are no more favorable than those available to all holders of the same class of shares and if all employees that meet limited employment qualifications may participate in the plan on an equitable basis.

Other Sources