Excess/general tax benefits from stock based compensation
Anyone familiar with how the accounting goes for excess/general tax benefits for stock based compensation? from my understanding:
- Excess tax benefits from SBC subtract from cash flow from operations as the additional cash taxes are paid via a DTA
- Excess tax benefits added to cash flow from financing and additional paid in capital (APIC) on the equity side
I think I have most of it except how the excess tax benefits DON'T hit the income statement but still need to be subtracted from CFO and added to CFF. It's just a wash then right? No change in cash if it's not reflected in Net income to begin with (doesn't hit the income statement), and it's subtracted from CFO but then added back to CFF... feels like nothing happens.
You're Net Income was $100 w/o excess, is still $100 w/ excess, that $100 goes into Net Inc. line on CFS, you subtract whatever excess tax benefit (ETB) from the CFO and you add back the excess tax benefit in CFF....and you still have NO change in cash, NO change in Net income.
But that can't be it because we actually do realize ADDITIONAL cash tax savings....how does cash end up increasing though in the CFS?
I realize on the BS we've got APIC increasing by the ETB, but what increases on the other side to balance the BS? I'm assuming cash, but how? And if it is cash, then that means DTA doesn't change, right?
Moreover, does the APIC only increase by the ETB or the entire difference in SBC and actual value of the SBC? Because when we first issue SBC (let's say for $100), we get a $40 tax benefit ($40 tax rate), but APIC goes up by $100, not $40. So if that Stock-Based Compensation ends up being valued at $150, shouldn't APIC increase by $50? But if that's the case, then how does the rest of the BS balance?
You asked lots of separate questions so I'll just try to tackle each one.
First off, under current GAAP, ETB from SBC are recorded entirely in operating cashflow. If you're splitting between CFO and CFF you're using old accounting rules. View this link for the updated rules. The reason they’re entirely operating is that ETBs arise from income taxes, and under GAAP, income taxes are operating items. The old CFO/CFF “wash” was removed to better reflect actual cash taxes paid. Mechanically, when options vest (or are exercised), the company’s tax deduction is higher than the compensation expense it recorded for book purposes. That means the company writes a smaller check to the IRS, which is a real cash savings. Cash taxes paid go down, so operating cash flow goes up. There is no wash under the new rules. Even if the tax effect ultimately runs through equity or bypasses operating performance conceptually, cash taxes still live in CFO. On the balance sheet, at vest/exercise you reverse the deferred tax asset that was originally recorded for book compensation. Because the actual tax deduction is larger, you recognize an additional tax benefit through the income statement, which increases retained earnings. Cash increases because less tax is paid. So the BS movement is: cash up, DTA down, retained earnings up. APIC does not change at this stage.
"APIC goes up by $100 when SBC is issued, not $40, so shouldn't it go up by $50 if the stock is worth $150?"
Under current GAAP, there is only one APIC increase related to SBC, and that happens at grant/over vesting. APIC increases by the grant date fair value of the award ($100) because that is the amount of compensation expense the company recognizes. You do not increase APIC by the full $150, because the extra $50 of stock value belongs to the employee, not the company. The company recognizes compensation at grant value and then accounts for the tax effects separately. Any ETB flows through the income statement and retained earnings, not APIC. I could run through this example w/ numbers and journal entries but feeling very lazy right now
Thanks a lot! Thats very helpful and I will read the new rules.
I should have been more clear on this, in this case, I was also looking at the IFRS treatment. My source here was a BIWS guide. Under IFRS, they write, that if the fair value of the stock changes, this (small, incremental) changes are also recognized as DTAs and then once the fair value is actually granted in the end, the full DTA balance can be used to pay taxes.
BIWS writes this:
IFRS Treatment The main difference under IFRS is that the Deferred Tax Asset created by the initial Stock-Based Compensation is revalued whenever the value of the SBC changes. That reflects the changing value of the future Cash-Tax deductions when the SBC value changes. On the L&E side of the Balance Sheet, APIC within Common Shareholders’ Equity changes to balance this revaluation. Also, under IFRS, as soon as the SBC meets or exceeds its initial value, the company records “Tax Benefits” for it on the Income Statement. Finally, if the SBC’s value decreases, then it’s recorded as a “Tax Deficiency” on the Income Statement, equal to – Change in Value * Tax Rate. Here’s the schedule:
Income statement:
Cash flow statement:
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So my question is: No impact under IFRS in income statement but cash taxes increase, so we record a DTA, which is clear. But why does APIC increase by 1.3 (increase of fair value of 5 * tax rate)?
Great thread here. Admittedly I know very little about IFRS so I had to do quite a bit of researching. Feel free to fact check me, but this is my understanding:
IFRS 2 and IAS 12: under IFRS, the deferred tax associated with SBC is updated as the expected future tax deduction changes (and for many awards that expected deduction moves with the share price/intrinsic value). So while GAAP generally doesn’t remeasure the DTA each period this way, IFRS does.
So under IFRS:
The DTA moves each period as SBC FV changes
The offset does not go to cash; it goes to equity (APIC). That's why APIC increases by $1.3mm (5 * 25% TR in the example). So now we increase the DTA by the same amount ($1.3mm). The key question is what balances that entry?
It definitely isn't cash; you are not paying more taxes and you're not receiving any. This will be a non-cash adjustment.
The JE would be:
Dr. Deferred Tax Asset $1.3mm
Cr. APIC $1.3mm
That means assets (the DTA) and equity both increase by $1.3mm, while cash and net income are unchanged for this step. IFRS is essentially saying that the incremental expected tax deduction arises because the equity award is now worth more, so the related deferred tax effect is treated as equity related rather than operating performance. So that's it. It actually does balance, no cash entry is needed.
Basically, the company expects to save $1.3mm in cash taxes in the future, so it increases the DTA. Because that benefit comes from stock appreciation rather than operations, the offset is recorded in equity. In other words, if you issue SBC and its value increases, the tax benefit attributable to that increase is equity-driven and is treated as such under IFRS.
Ok now here's where it gets intricate. Any excess tax benefit beyond the cumulative IFRS 2 expense can go through P&L. (IAS 12.68A-68B)
Quick example:
Assumptions
Grant-date fair value of SBC (IFRS 2 expense): $100
Cumulative IFRS 2 expense recognized by vest date: $100
Tax rate: 25%
Share price at vest: $150
Step 1: What IFRS 2 has recognized
Compensation expense: $100
Maximum benefit that can be attributed to equity: 100*25% = $25. This is the equity-related ceiling.
Step 2: Actual tax deduction
Tax deduction: $150
Actual tax benefit: $150*25% = $37.5
Step 3: Split the tax benefit to P&L
Tax benefit from IFRS 2 expense: $25 that goes to APIC
Excess tax benefit: $12.5 that goes to P&L (income tax benefit)
Total: $37.5
For the equity portion you would debit DTA and credit Equity for $25. For the P&L portion you would debit DTA and credit ITB on the P&L.
TLDR for this caveat: Tax benefits from SBC go to equity (APIC) up to the amount of compensation expense recognized under IFRS 2, and anything beyond that is treated as an ITB and runs through the P&L.
To make it crystal clear:
IFRS allows tax benefits to be treated as equity up to the amount of compensation you've already charged to equity. Once the expected tax deduction implies more tax benefit than the comp expense you've recognized, the extra part can no longer be justified as equity related, and gets charged to the P&L. For this "rule" to trigger you basically need the share price to rise substantially above the grant-date fair value or the number of awards expected to vest substantially increases.
Happy to be corrected if I'm missing any nuance here or misinterpreted something. IFRS isn't my specialty
Sorry for coming back to this just now.
In general, what you are writing makes a lot of sense. In that case, it everything would indeed balance as the journal entry would be Dr. DTA Cr. APIC which is a non-cash procedure.
However, according to BIWS (which is my primary source as this topic is quite hard to research as you pointed out), the actual cash taxes paid increase when we recognize the DTA, so the change in fair market value has a cold, hard impact on how many taxes we have to pay each year:
Here they write that the increase of SBC of +5 each year leads to 1.3 more taxes paid via a DTA. This write up the DTA and in the end you can "use" the full DTA once the options are exercised.
With this treatment, cash taxes are equal to book taxes but with a timing difference.
If FV change did not have an impact on cash taxes, then the DTA would be a kind of "free tax credits" from the government and you don't have to pay so much taxes if your stock rises which feels counterintuitive.
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And if the journal entry is Dr. DTA Cr. Cash, then I would be at my "old problem" again --> What does the Cr. APIC entry of +1.3 balance and why?
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