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CAMPUS TO CLIENTS

Permanent component

of a temporary difference:

ASC Topic 740 analysis

Editor: In its November 2021 20-year review accounting for stock options, a mainstay
Annette Nellen, Esq., CPA, CGMA of financial restatements, Audit Analyt- in the equity compensation portfolio,
ics reports that accounting for income in detail.
Author: taxes has been among the top five issues
Allison L. Evans, CPA, Ph.D. causing restatements for the last decade GAAP stock option treatment
(ranking fourth in 2020). It continues to For financial reporting purposes, FASB
be an important area of knowledge for Accounting Standards Codification
practicing accountants and for students (ASC) Paragraph 718-10-35-2 requires
entering the field. An earlier Campus companies to expense the fair value of
to Clients column provides a compre- the stock options granted over the req-
hensive discussion of FASB Accounting uisite service period the employee must
Standards Codification (ASC) Topic provide to be entitled to the stock award,
740, Income Taxes, for classic temporary typically the vesting period. Entities can
and permanent differences including recognize the expense straight line over
construction of the effective tax rate the entire vesting period, or straight line
The process of reconciliation (the rate rec) (Evans, for each separately vesting portion of
the award if the company has a graded
“Constructing the Effective Tax Rate
accounting for Reconciliation and Income Tax Provi- vesting schedule (see ASC Paragraph
stock options, a sion Disclosure,” 50 The Tax Adviser 600 718-10-35-8).
While there are other aspects of
mainstay in the (August 2019)). granting options that will affect the ulti-
Stock options, as well as other types
equity compensation of stock-based equity compensation, are mate options compensation expense for
portfolio, is unique unique within the category of book-tax book purposes (e.g., projected number
of options that will vest), to retain focus
differences. While companies treat in-
within the category of centive stock options (ISOs) in the same on the income tax accounting analysis
book-tax differences. manner as other permanent differences, this column makes some simplifying
nonqualified options (NQOs) present assumptions throughout. Specifically,
a more complex case. Not only is the it will assume the corporation correctly
timing of book and tax expense different estimates 100% of the options granted
for NQOs, so is the ultimate expense will be exercised after they vest. It also
amount. Further, the tax deduction is assumes a cliff vesting plan, where
unknowable until the future point in all options vest in full after a certain
time when the employee exercises the number of years of employment. While PHOTO BY NANCY BARR-RAPER/ISTOCK
options. NQOs are therefore a unique expanding these simplifying assump-
case of a temporary difference that tions would change the mathematical
will also have a permanent component. computation of compensation expense
This column presents the process of each year, the conceptual underpinnings

40 August 2022 The Tax Adviser