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. 

Accounting for ESPPs: Part II: Contributions & Recognition

Part II of our Accounting for ESPP White Paper:


Estimated Contributions

Once the fair value has been established, the total expense must be calculated and then the expense recognized over the vesting period (time until purchase).

To calculate total expense, you must estimate the contributions for the period. This should be calculated at the employee level so that (in some cases) after the purchase the expense can be adjusted based on the actual shares purchased.

Generally, you should calculate the estimated contributions with the assistance of payroll. When the participant enrolls in most plans they will specify what percentage of included pay types they would like deducted from their pay[1] and used to purchase shares. Once that % is known, the % is multiplied by the estimated pay for the purchase period. 

Example of Estimated Contributions

Some companies attempt to calculate a different estimate for each employee for each purchase period based on planned pay increases. We discourage this practice since it complicates the process and can more easily be performed with the true-up at the purchase date.

Limits

Nearly all plans apply a limit on the number of shares that can be purchased by an employee on any given purchase date. For 423-qualified ESPPs, each participant is limited to purchasing $25,000 of value within a calendar year.[3] These limits should be applied to the contribution estimate to reduce variability in expense and make the estimates more accurate.

Once estimated contributions are calculated, the contributions at the participant level are divided by the estimated purchase price to arrive at an estimated number of shares purchased. Total expense is derived by multiplying estimated shares by the fair value per share calculated on the enrollment date.  

Recognition

Once the total expense for the ESPP is calculated (see prior blog post), the expense is recognized over the service period: the time from enrollment to vest/purchase. 

Originally under FTB 97-1, accelerated recognition was required, meaning that each purchase period was expensed from the enrollment date to the respective purchase date, resulting in front-loaded expense.

Accelerated Recognition

When FAS 123(R) was released in 2005, the requirement for accelerated recognition was eliminated. So, the majority of companies now use straight-line attribution.

Straight-line Recognition

Please note that whichever method you are using for your employee stock options and/or restricted stock/units (accelerated or straight-line), you should use the same method for your ESPP expense recognition. 

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[1] Remember that purchase plans vary widely in which pay types they include in ESPP deductions. Some plans include commissions, overtime, and bonuses, which can make estimating pay extremely challenging. Some companies exclude these pay types from the estimate and simply perform a true up process after the purchase occurs. This simplifies the process and may reduce variability in expense but may not be acceptable to some auditors. Including only regular wages in included pay types simplifies the process without requiring the true up. 

[2] Rounded down to the nearest whole share.

[3] For offering periods that span a calendar year any unused limit from the prior year may be “carried forward” to subsequent calendar years. Calculating these limits is complex and generally estimating the maximum shares under the limit is best practice followed by a true up after the purchase occurs. 

The Mod Squad - The NASPP Blog

My blog today is a link to another blog (that I authored, so I think it's okay to share)... Modification accounting. Big fun. BIG.

http://www.naspp.com/blog/2012/08/the-mod-squad.html

Equity Edge: Saving a Copy of Expense Allocation - Recognition - Audit Export View

How many of you who are Equity Edge users consistently save off a copy of your Audit Export view of the Expense Allocation - Recognition report EACH reporting period?

If not, I'd highly recommend you get into the habit, it will ease things greatly if/when you ever get into a circumstance where you have to "prove out" how the estimated forfeiture rate was being applied to your expense.

We are helping a client convert systems and this very sort of question has arisen, but of course the client doesn't have the supporting detail from their old system, only the summary and can only show the forfeiture rate applied at the group level. We can still get the job done, but the soft copies of the details of the application of the forfeiture rate would reduce the amount of effort significantly.

This "Audit Export" report view feature was added in 7.0 or 7.1, I can't remember which. And is a terrific tool for a wide variety of reasons. You can audit nearly ALL of the report calculations with the data on the report. And the exceptions to that "almost all" rule are very rare exceptions. No more "black box" expensing, you can see exactly HOW and WHY Equity Edge calculated the expense that it did. Easy, peasy, lemon-squeezy.

If you have leading zeros on your grant numbers:
Remember to save the export into CSV format, not XLS or XLSX. Then rename the CSV to a .TXT extension before you open it will Excel so that the Text to Data wizard will open automatically and you can then specify the "text" data type for the Number column so that you preserve those leading zeros on your grant numbers.