Accounting for ESPPs: Part III: True Ups, Tax Accounting, and Diluted EPS

Part III of Accounting for ESPPs: True-ups, Tax Accounting, and Diluted EPS

True Up at Purchase

Since you’ve estimated the number of shares that will be purchased upfront (see previous blogs), you’ll want to true up to the actual shares once the purchase occurs, right? Not so fast! In only a few cases are true ups appropriate under ASC 718.

  

Tax Accounting

As with Incentive Stock Options (ISOs), 423-qualified ESPP do not afford the company a tax deduction at “exercise” (at purchase). A tax deduction is only triggered by the disqualifying disposition (DD) of the purchased shares. Due to this treatment, a deferred tax asset may not be booked in anticipation of the tax deduction, since the DD cannot be assumed.[3]

Instead, if a DD occurs, the company treats the ensuing tax deduction as a reduction to tax expense.[4]

Basic Earnings per Share

In the period in which each purchase occurs, the issued shares should be weighted for the time they were outstanding as common stock during the period and included in your basic earnings per share.  Only purchased shares are included in Basic EPS, not shares that will be purchased in the future.

Diluted Earnings per Share

Just as with stock options, ESPP plans are potentially dilutive to your company’s earnings per share, therefore they should be included in your dilutive shares.

The Treasury Stock Method (TSM) defined by ASC 260 also applies to these awards. A high-level summary of the TSM for ESPPs is outlined below:

Please forgive the wonky numbering/formatting on the footnotes. That's what happens when you covert a Word document to blogger.

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[7] A reset is a feature in some plans with multiple purchase periods within an offering. If the price of the stock is lower on the date the next purchase period begins, all enrolled participants are automatically reset to the new, lower price.

[8] A rollover is a feature in some plans with multiple purchase periods within an offering. If the price of the stock is lower on the date the next purchase period begins, all enrolled participants are automatically re-enrolled in a new offering with the new, lower price.

[3] Regardless of the fact pattern of dispositions at your company.

[4] Prior to the adoption of ASU 2016-09, the actual tax deduction was compared to the expense for the award, but that was eliminated, greatly simplifying the process.

[5] The TSM assumes that all shares are vested and exercised/purchased/issued as a worst-case scenario, then mitigates that worst case by assuming that the hypothetical proceeds from the hypothetical issuance are used to purchase back stock on the open market, thereby lessening the dilution resulting from the purchase.