Before the issuance of ASU 2024-01 in March 2024, there was no specific guidance on whether profits interest awards should be treated as share-based compensation under ASC 718 – analogous to cash bonus or profit sharing arrangements under ASC 710 – or if other treatment was appropriate. In fact, as “profits interest” is not a term defined in the ASC Master Glossary, most looked to the IRS definition as a “partnership interest rather than a capital interest.” Accordingly, there was much diversity in practice.
The terms, characteristics and conditions of each award were to be evaluated to inform judgment as to whether to account for the award under ASC 718 or 710. However, many, if not most, profits interest agreements specifically stated the avoidance of share-based compensation in order to prevent taxable compensation to the grantee under US IRC Section 409A. Not surprisingly, most private middle-market companies seemingly chose the ASC 710, or bonus approach, rather than treatment as share-based compensation under ASC 718, since the bonus approach did not require the cost or effort of a valuation of the award and was consistent with the tax treatment.
Scope of ASU 2024-01
This ASU applies to all reporting entities that account for profits interest or similar awards as compensation to employees or nonemployees in return for goods or services.
Main Provisions
ASU 2024-01 contains a very thorough example that has four cases with varying fact patterns, each highlighting key considerations to help an entity evaluate typical terms and characteristics of such awards. While not all-encompassing, the example should be very valuable in helping to assess a number of varied situations. Importantly, the example and cases are presented in a manner that is logical and easy to follow.
Note, more of these awards will now have differing GAAP and tax treatment. Disclosures follow the guidance provided in ASC 710 or 718, based on the determination for each specific award.
Effective Dates
These amendments are effective for all fiscal years beginning after December 15, 2025; early adoption is permitted. These provisions should be applied either 1) retrospectively to all prior periods presented or 2) prospectively to profits interest or similar awards granted or modified after the adoption date. Awards granted prior to adoption will not be affected.
