Transitioning to ASU 2018-07

If your company grants equity awards to nonemployees, you are probably excited that ASU 2018-07 now allows you to account for awards to nonemployees in the same manner as awards granted to employees (with some exceptions, see last week’s blog entry). Here are six things you need to know before you adopt the new standard.

1.  Public companies must adopt the ASU by the first fiscal year beginning after December 15, 2018. Private companies get an extra year for annual periods and an extra two years for interim periods.

2.  Early adoption is permitted but only if companies have adopted ASC 606, which is the new revenue recognition standard. I could explain why, but it’s complicated and, trust me, you don’t care. Calendar-year public companies have already adopted ASC 606, so if that describes your company, you can adopt at any time up until the effective date.

3.  For most areas of the ASU, companies will use the modified retrospective transition method. Under this approach, companies value equity awards issued to nonemployees as of the date they adopt the ASU; any expense recorded for the awards in the future will be based on this value (assuming the awards are not subsequently modified).  If the to-date expense for an award as of the adoption date differs from the total amount of expense previously recorded for the award as of the end of the company’s last fiscal period, the difference is recorded as a cumulative adjustment to retained earnings (for equity awards, the offsetting adjustment is to paid-in-capital).

If companies adopt in an interim period, they’ll have to recalculate the expense recognized for nonemployee awards in any prior interim periods during the fiscal year of adoption based on the adoption date fair value.

4.  For equity awards, only the unvested portion is included in the transition. You are done expensing any vested portions of equity awards, so there’s nothing to transition for them.

5.  In many cases, a cumulative adjustment may not be necessary. Under ASC 505-50, mark-to-market accounting was required for nonemployee awards, which meant the awards were revalued as of the end of every fiscal period and expensed based on the new fair value. When companies adopt the ASU, they will have just calculated the fair value for nonemployee awards as of the last day of the period ending just before the company’s adoption date. Because the valuation was performed just one day before the adoption date, we expect that most companies will use it as the adoption date fair value of the award, eliminating any need for a cumulative adjustment.  

6.  Cumulative adjustments are necessary in some circumstances. Most notably, if a company is changing its policy with respect to how forfeitures are handled, such as for performance awards held by nonemployees or if the company changes how it accounts for forfeitures of service-based nonemployee awards. Cumulative adjustments will also be necessary if the ASU causes awards to switch from liability to equity treatment and for private companies that decide to switch to the intrinsic value method to account for their liability awards.

Thanks to Ken Stoler at PwC for helping us understand the transition guidance, particularly when cumulative adjustments are necessary.