The Financial Accounting Standards Board (FASB) has issued a proposed Accounting Standards Update (ASU) that would improve generally accepted accounting principles (GAAP) by adding illustrative guidance to help companies determine whether profits interest and similar awards should be accounted for as a share-based payment arrangement.

“The term profits interest is not defined in GAAP but differentiates those interests from capital interests held by investors that provide those holders with rights to the existing net assets in a partnership,” FASB explained in the ASU. “Because profits interest holders only participate in future profits and/or equity appreciation and have no rights to the existing net assets of the partnership, stakeholders have indicated that it can be complex to determine whether a profits interest award should be accounted for as a share-based payment arrangement (Topic 718) or similar to a cash bonus or profit-sharing arrangement (Topic 710, Compensation—General, or other Topics). As a result, stakeholders have highlighted existing diversity in practice.”

The proposed changes are to Topic 718 of the FASB Accounting Standards Codification, which outlines how companies should expense equity awards in their income statements.

Accounting Today explained that FASB's Private Company Council (PCC) and other stakeholders have noted that there are differences in practice among businesses in how they account for these awards, whether as a share-based payment arrangement under Topic 718 or similar to a cash bonus or profit-sharing arrangement under Topic 710. Because some public business entities may also have to account for profits interest awards, the PCC recommended that FASB develop guidance for all reporting entities that account for profits interest and similar awards.

FASB is asking for comments on the proposal by July 10, 2023.