Wait. . . Did FASB and the PCC Just Change GAAP Requirements On Profits Interests For Private Equity?
David Howell
Expert in valuation for private equity. I simplify financial reporting and GAAP | IFRS compliance for CFOs and accountants. Passionate about making complex fair value requirements easy to understand.
>>> What CFOs and accountants need to know about the recent amendment to ASC 718 specifically on profits interests!
A Little Background
Profits interests are a special form of share-based (equity) compensation that is common in private equity.
By design, profits interests usually have no cash value and a $0 tax basis when granted. They are typically junior in the waterfall, subordinate to preferences, and subject to vesting conditions or other restrictions.
Most profits interests offer the incentive of a payout when the value of the company increases and there is an exit transaction. There is risk relating to if, when, and what any distribution might be.
It may not always be clear if the grant date fair value of profits interests is particularly significant or material.
There can also be challenges identifying a profits interest and distinguishing these from other forms of incentive compensation in private equity such as phantom shares, options, bonus plans, or appreciation rights.
The Problem
For these and other reasons, there may be uncertainty regarding whether profits interests need to be reported under ASC 718.
This situation can lead to surprise, confusion, inconsistent practices . . . and disagreement.
Continued growth in private equity has generated on-going and increasing attention to this area by management, accountants, fund managers, and other stakeholders.
It’s not a new issue.
Accounting requirements for profits interests have been a subject of review at the Financial Accounting Standards Board (FASB) and the Private Company Counsel (PCC) going back to at least as early as 2018.
The Result
In March 2024 FASB issued Accounting Standards Update (ASU) 2024-01 as an amendment that is specifically directed to profits Interests.
The amendment is intended to provide examples to reduce:
The amendment has examples of several commonly observed forms of profits interests to help clarify the guidance.
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What Didn’t Happen
Although perhaps a hoped-for possibility, the amendment did not eliminate, reduce, or create alternatives to financial reporting requirements on profits interests under ASC 718.
If anything, the amendment demonstrated emphasis on these requirements for privately-owned companies.
What You Need to Do
Privately-owned companies need to adopt the amendment for annual periods beginning after December 15, 2025. The amendment can be done prospectively or retroactively, including any required disclosures. Early adoption is permitted.
Related considerations may include addressing issues relating to consistency in application for similar previous awards.
Adoption will require management establish grant date fair value estimates for profits interests using methods that conform to AICPA best practices. These methods are often different than management uses for other purposes and may require professional assistance.
Best, David
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