Accounting for equity when going global: implications for US GAAP and IFRS 2

As the European tech scene evolves, expansion across borders is becoming a practical consideration for more and more companies. These days, you’ll likely be recruiting in multiple countries across Europe, or even in the US, at the same time as your investor base expands beyond home as well. 

This often leaves finance teams caught at the intersection of two complex projects at the same time. First, there’s getting to grips with new or amended share plans that reflect expectations of employees or contractors across jurisdictions. Then, as new funding rounds close and investors come on board, boosting the sophistication of accounting and financial reporting means managing complex projects like potentially converting from statutory GAAP to IFRS or US GAAP.

If you’re a finance leader in one of these companies, you may well be seeing (and designing) more creative and complex equity packages to keep up with international headcount and investor expectations. Building equity plans that match cultural and financial expectations in different markets means striking a delicate balance.  Although companies are used to offering bigger equity packages to US hires, European employees are smartening up to value equity the way their Silicon Valley counterparts have for decades. 

On that note, companies and operators need to know which equity plan changes should be flagged to your accounting team because of potential reporting implications. Here we run through eight of these scenarios, summarising potential accounting implications under IFRS (as dictated by IFRS 2 Share-based payments) or US GAAP (as dictated by ASC 718 Compensation - Stock Compensation) to keep up with any accounting conversions you may go through. 

1. Granting shares to non-employees (e.g. contractors or non-executive directors)

As your company grows, you’ll likely begin to see the value in extending your share plan beyond just employees. This could include giving shares to non-employees like consultants or advisory board members. This strategy serves a dual purpose: it acknowledges their significant contributions to business growth, and aligns their interests with your objectives. 

Accurately classifying whether grants are to employees or non-employees can often be a fine line, especially for directors. But it’s important, not only for tax classification and returns but also accounting treatment. 

‍Implications under IFRS: Under IFRS 2, it’s assumed that you can appropriately fair value the goods or services that the non-employee has provided, and use this as the fair value for the shares granted. In the rare case that you challenge this assumption, it’s possible to use the value of the shares or options awarded to determine the ‘worth’ of the services provided. 

‍Implications under US GAAP: Grants issued to non-employees need to be part of any conversion to US GAAP. Unlike IFRS 2, the value of shares given to non-employees are measured based on the grant date fair value of the shares, much like shares issued to employees. 

2. Hedging variability to employees by tying variable share awards to a fixed payout

As you expand internationally, you might introduce awards that result in a variable number of shares awarded in order to correspond with a fixed monetary amount. This could be a way to manage exchange rate fluctuations and market variability, but also hedges against employee uncertainty in the value they will receive from their share awards upon vesting, and therefore could prove an important recruiting technique. However, tying the future benefit for employees to a fixed payout rather than shares may have important accounting implications.

Implications under IFRS: The classification for fixed-payout/variable-share arrangements will depend on whether the payout is truly fixed to a monetary value or based on market conditions. Transactions that are settled in a variable number or shares are generally classified as equity, and so are measured at the grant date fair value. 

‍Implications under US GAAP: If you’re transitioning to US GAAP, the emphasis is on the design of the award at the grant date. If the design of the plan is to grant a variable number to shares tied to a fixed cash amount, this would be classified as a liability under US GAAP. 

‍Important note about equity vs. liability classification: This scenario involves conclusions around equity vs. liability classification in share plans. There are important differences when shares are classified as liabilities under US GAAP, as discussed throughout this blog. However, the treatment of liability-classified awards is similar between IFRS and US GAAP: the liability must be re-measured until settlement date based on the changes in fair value of the shares. This is an important accounting distinction as equity-classified awards do not generally require re-measuring. 

3. Staying conservative on withholding tax calculations

Adopting a conservative approach to withholding tax calculations for equity compensation can be a prudent strategy, especially as you expand internationally. Conservatism on withholding calculations can ensure compliance with multinational tax regulations and avoid unexpected tax liabilities for both you and your employees. However, if you choose to be conservative and withhold more than the minimum tax amount when employees exercise their shares, this can have an effect on the equity classification of your share plan. 

Implications under IFRS: If the tax you withhold is lower than the employee’s tax obligation, the award is classified as equity. If the withholding is higher than the employee’s obligation, only the portion exceeding the obligation is classified as a liability. 

Implications under US GAAP: US GAAP dictates that if the net tax settlement exceeds the maximum statutory rate, the entire award should be classed as a liability. This difference leads to implications in subsequent accounting, detailed in the equity vs. liability note above. 

4. Opening up the share plan to employees of an acquired company 

Integrating employees of an acquired company into your existing share plans is a common practice as you scale. Doing this can foster a sense of unity and alignment with your goals and culture. However, when you grant shares to newly acquired employees during or after an acquisition, there are accounting implications to consider. Particularly, opting to roll these grants into the purchase price or to separate them out as share awards can raise internal questions. 

‍Implications under IFRS: If the primary purpose of the awards is to compensate employees for past services leading up to acquisition, this is normally part of purchase consideration. However, if the awards are meant to incentivise employees in the future, then they would be post-acquisition service costs.

‍Implications under US GAAP: There isn’t expected to be a difference in how these types of awards issued during acquisition are treated under US GAAP. 

Important note about acquisitions: There isn’t normally an IFRS/US GAAP difference between how share awards are classified as part of an acquisition (consideration vs. service cost). However, it’s important to consider if you’re going through a conversion exercise where the share awards were part of purchase consideration, there may be a difference in how goodwill is calculated as part of that acquisition. 

5. Changing leaver definitions to appeal to employee expectations

There are distinct differences in how companies define “good” and “bad” leavers in European and US share plans. In general, Europe has more employee-friendly leaver provisions, allowing more flexibility for shares or share options to be retained for longer after an employee departs the company, while the US is generally more strict about whether or not employees are able to keep their shares upon leaving the company. 

It may be difficult to use a global leaver definition in your share plans, as leaver clauses may draw on employment laws in the countries where you are granting awards. However, the general rule of thumb is that the broader your definition of “bad leaver”, the lower the value an employee will attribute to those shares. If you’re thinking about changing your leaver clauses, this could have some accounting implications as well. 

Implications under IFRS: Forfeitures must be estimated at grant date and the difference between expected and actual forfeitures is ‘trued up’ in each accounting period.

Implications under US GAAP: Unlike IFRS 2, US GAAP lets you choose between estimating forfeitures, or recognition of actual forfeitures as and when they occur. 

6. Modifying your vesting schedule to improve employee retention or align with country expectations

As your company expands internationally, adapting vesting schedules becomes crucial in aligning with global workforce trends and retention strategies. You may find traditional four-year linear vesting schedules increasingly challenged by more dynamic models, like back-loaded vesting, which offer a smaller percentage of options in early years and a larger percentage later. This approach, particularly relevant in Europe, focuses more on using share plans as a form of employee retention rather than initial employee attraction to your company. If you’re changing your plan strategy to drive retention rather than recruitment, or vice versa, it may be wise to use the vesting schedule as a lever to do so. Of course, changing the vesting schedule can lead to remeasurement of those plans and impact your accounting & reporting of compensation costs.

Implications under IFRS: Changes to vesting schedules generally results in modification accounting under IFRS 2, requiring a revaluation of the fair value of the awards granted. However, if the changes in vesting schedule decrease the fair value, those modifications are generally ignored. Only increased to the fair value would be accounted for, with the incremental fair value being recognised over the remaining vesting period. 

Implications under US GAAP: Unlike IFRS, US GAAP allows for modification accounting for both an increase or decrease in the overall fair value of awards granted. This may result in a lower amount of compensation cost recognised, especially where vesting periods are extended or backloaded which would generally be expected to result in more estimated forfeitures.  

7. Introducing performance-based vesting to reward and incentive long-term value and growth

As your company grows, consider bringing in performance conditions if you haven’t already, particularly for senior executives. This approach aligns equity compensation with the achievement of key targets that drive long-term value, such as revenue growth. However, it's wise to remember two key caveats. 

This method is most effective for top-level executives whose decisions directly influence your company's primary goals. Also, you should still balance performance-based vesting with a traditional, time-based approach to ensure that executives are rewarded fairly, while keeping incentives around those shares in place, given that external factors can impact performance targets that otherwise devalue the options granted. 

Implications under IFRS: Performance conditions will change the way fair value is measured at grant date, to take into account the probability of meeting performance conditions. Changes to the likelihood of achieving performance conditions mean you might need to adjust the expense recognised over the vesting period. 

‍Implications under US GAAP: While US GAAP treats performance conditions’ impact on fair value in a similar way to IFRS 2, US GAAP may demand that you assess performance conditions beyond the ‘service period’ (the time during which an employee or non-employee has provided service to the company), which is not a requirement under IFRS.

8. Inclusion of acceleration clauses in anticipation of an exit event

When you’re involved in mergers, acquisitions, or IPOs, you may encounter various approaches to option vesting in your share plans. 

In the US, it's common for vested options to become exercisable under the same terms as offered to shareholders during ownership changes. You might see unvested options continue to vest following an IPO, but they often lapse in the case of acquisitions, leading to new retention programs for key staff. 

When considering provisions for your executive team, you may consider 'double-trigger' acceleration, which only happens if there's both a change of control and a termination or demotion. This can be important to retain employees who are key to a successful exit. However, be mindful that broad acceleration policies, particularly for non-executive staff, are rare in the US and could influence acquisition negotiations. European startups often adopt wider acceleration clauses. 

GAAP Implications: Modification accounting will be needed when the acceleration clauses are initially included in your share plans, or when plans are modified after acquisition. This is because adding acceleration clauses will change the expected vesting period, as well as the estimated forfeitures, as well as potentially affecting the probabilities of any performance conditions attached to your share plans. The potential GAAP differences in modification accounting upon change in fair value of share plans have been covered in topics 5, 6 and 7 above. When the acceleration clause is actually triggered and you settle your share based payments during the vesting period, any unrecognised compensation cost would be recognised immediately under both IFRS and US GAAP. 

A tactic to reduce equity admin: look at vesting frequency 

Do these considerations seem like a lot to implement? If so, I don’t blame you! But some simple tactics can save time and complexity for the teams managing this load.

One piece of practical advice: take a look at the frequency of your vesting. Opting for a quarterly vesting schedule, as opposed to a monthly one, can ease the administrative burden on your accounting team. Fewer vesting events translate to less frequent calculations, fewer journal entries, and potentially simpler record-keeping. This reduced frequency can streamline the process of tracking and managing equity compensation, allowing your team to allocate resources more efficiently. (However, before changing your vesting frequency, you should also consult tax experts as certain jurisdictions may require more regular vesting.) 

Interested in learning more about international accounting and financial reporting? You’ll find much more on the Ledgy website, or you can drop me a line on LinkedIn!

Disclaimer: The information provided in this article is for educational and informational purposes only and should not be construed as financial or strategic advice. Any decisions regarding equity, accounting, investments, or business strategies should be made after consulting with qualified professionals or specialists in the field.