FASB Seeks to Add Guidance on Profits Interest Awards

The Financial Accounting Standards Board (FASB) issued a proposed Accounting Standards Update (ASU) on Thursday that would add illustrative guidance to help companies determine whether profits interest and similar awards should be accounted for as a share-based payment arrangement.

In the proposed ASU, the FASB says:

Certain entities provide employees or other service providers with profits interest awards to align compensation with an entity’s operating performance and provide those holders with the opportunity to participate in future profits and/or equity appreciation of the entity. The term profits interest is not defined in GAAP but differentiates those interests from capital interests held by investors that provide those holders with rights to the existing net assets in a partnership. Because profits interest holders only participate in future profits and/or equity appreciation and have no rights to the existing net assets of the partnership, stakeholders have indicated that it can be complex to determine whether a profits interest award should be accounted for as a share-based payment arrangement (Topic 718, Compensation—Stock Compensation) or similar to a cash bonus or profit-sharing arrangement (Topic 710, Compensation—General, or other Topics). As a result, stakeholders have highlighted existing diversity in practice.

Currently, entities evaluate the terms, conditions, and characteristics of a profits interest award and apply judgment to determine whether to account for the award under Topic 718 or Topic 710. However, stakeholders have indicated that there is diversity in practice even when evaluating similar fact patterns. Therefore, stakeholders requested examples to clarify when the guidance in Topic 718 should be applied to profits interest awards (referred to herein as the “scope application issue”). In addition, entities accounting for economically similar awards consistently would benefit investors and other allocators of capital.

The Private Company Council (PCC) recommended that the FASB add a project that would provide illustrative guidance for all reporting entities that account for profits interest and similar awards. The board added that project, Scope Application of Profits Interests Awards: Compensation—Stock Compensation (Topic 718), to its technical agenda in December 2022.

According to the FASB, the amendments in the proposed ASU would improve GAAP “by adding an illustrative example that includes four fact patterns to demonstrate how an entity would apply the scope guidance in paragraph 718-10-15-3 to determine whether a profits interest award should be accounted for in accordance with Topic 718. The fact patterns in the proposed illustrative example focus on the scope conditions in paragraph 718-10-15-3. The proposed illustrative example is intended to reduce (1) complexity in determining whether a profits interest award is subject to the guidance in Topic 718, and (2) existing diversity in practice.”

Stakeholders have until July 10 to review and provide comments on the proposed ASU.