The “call” for simplification has been answered! We’re talking, of course, about an amendment to FASB’s Accounting Standard Update (ASU), Compensation–Stock Compensation (Topic 718). The amendment clarifies and illustrates when it is appropriate to account for profits interests under Topic 718. If you have profits interests or plan to issue them to your employees or nonemployees, this amendment will assist you in determining how to select the appropriate authoritative guidance.
Profits interests are often issued to employees and nonemployees to reward them for continued service and to give them the opportunity to participate in future profits or equity of the company in the event of a transaction. This is often accomplished through the issuance of profits interests units, which are awarded for no consideration. The units qualify as profits interests within the meaning of the IRS Revenue Procedure code, whereby, the individual is not taxed at the date of grant but rather upon payout in the future.
Often, profits interests are structured with a distribution threshold, which requires certain distributions to be achieved before the profits interests become viable to the holder — hence, the ability to participate in the future profits or equity of the company.
Historically, there has been uncertainty surrounding and limited guidance on whether to account for profits interests by following Topic 718 or Accounting Standards Codification 710, Accounting for Deferred Compensation. As a result, accounting for profits interests has been inconsistent. Even when Topic 718 was identified as the correct guidance, it was still unclear whether the interests should be accounted for as equity or a liability.
The amendment to Topic 718 has added much needed clarity around this process through illustrative examples based on the facts of the profits interests award. The illustrative examples, added to paragraph 718-10-15-3 of the ASU, include four different fact patterns to assist companies in selecting the appropriate authoritative guidance. The examples aim to help offer more consistency in applying profits interests accounting guidance across the board.
The amendment to Topic 718 is effective for private entities for annual periods beginning after December 15, 2025, with early adoption permitted. As you issue different types of incentive awards for your company, including profits interests, be sure to consider the accounting impact these awards could have on your financial statements.
Contact Beth Reho or a member of your service team to discuss this topic further.
Cohen & Co is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law with your professional advisers.