Certain entities provide their employees or non-employees with profits interest awards in exchange for goods or services to align compensation with an entity’s operating performance.
The term ‘Profits Interest’ is not defined in the GAAP, but these interests provide the holders the right to participate in the entity’s future profits and/or equity appreciation. ‘Profits interest’ differs from ‘other equity interests’ that provide the holders with rights to the existing net assets in a partnership, or a limited liability company, or similar pass-through entities.
As the profits interest holders only have a right in the future profits and/or equity appreciation and have no rights in the existing net assets of the entity, the entities find it difficult to determine whether a profits interest award should be accounted as a share-based payment (Topic 718 – Stock Compensation) or similar to cash bonus or profit-sharing arrangement (Topic 710 – Compensation- General, or other Topics).
On account of the complexity, there existed a diversity in practice.
Thus, with the help of illustrative examples, this amendment provides clarification on the scope guidance in paragraph 718-10-15-3 and helps to determine when the accounting guidance as per Topic 718 should be applied to profits interest share awards.
