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New FASB Guidance for Profits Interest Awards

The Financial Accounting Standards Board (FASB) clarified the scope of application for profits interest and similar awards in its Accounting Standards Update (ASU) 2024-01, Compensation—Stock Compensation (Topic 718): Scope Application of Profits Interest and Similar Awards.

The amendments provide illustrative examples intended to demonstrate how entities should determine whether a profits interest award is accounted for in accordance with Topic 718, Compensation—Stock Compensation, or in accordance with Topic 710, Compensation—General.

Who Is Affected by the Amended Guidance in ASU 2024-01?

The amendments apply to all reporting entities that provide employees or nonemployees with profits interest and similar awards and account for such awards as compensation in return for goods or services.

Background on Amended Guidance in ASU 2024-01

Unlike capital interest holders, profits interest holders only participate in future profits or equity appreciation and don’t have rights to the existing net assets of the issuing entity. Generally accepted accounting principles (GAAP) don’t define the term profits interest and the characteristics of profits interest awards can vary.


The amendments apply to all reporting entities that provide employees or nonemployees with profits interest and similar awards and account for such awards as compensation in return for goods or services.

In October 2018, the FASB received an agenda request to provide specific guidance about whether a profits interest award should be accounted for as a share-based payment arrangement under Topic 718 or similar to a cash bonus or profit-sharing arrangement under Topic 710.

The agenda request described a facts-and-circumstances approach that many entities apply in practice to determine whether a profits interest award is within the scope of Topic 718 or Topic 710. The agenda request also indicated that the application of this approach results in diversity in practice and inconsistent conclusions regarding similar fact patterns.

What Changes with the Amended Guidance in ASU 2024-01?

Without changing the guidance, the ASU amends certain language in the scope and scope exceptions section of Topic 718 to improve the clarity and operability.

The guidance in Topic 718 applies to all share-based payment transactions in which a grantor acquires goods or services to be used or consumed in the grantor’s own operations or provides consideration payable to a customer by either of the following:

  • Issuing—or offering to issue—its shares, share options, or other equity instruments to an employee or nonemployee
  • Incurring certain liabilities to an employee or nonemployee

Liabilities incurred to an employee or nonemployee are in the scope of Topic 718 when either of the following conditions are met:

  • The amounts are based, at least in part, on the price of the entity’s shares or other equity instruments. The phrase at least in part is used because an award of share-based compensation may be indexed to both the price of an entity’s shares and something else that’­­s neither the price of the entity’s shares nor a market, performance, or service condition.
  • The awards require or may require settlement by issuing the entity’s equity shares or other equity instruments.

Illustrative Example

The amendments require an entity to apply the above scoping guidance in Topic 718 to determine whether a profits interest or similar award is within the scope of Topic 718.

The amendments add Example 10 in ASC paragraphs 718-10-55-138 through 55-148 to illustrate how the scoping guidance applies to common features in a profits interest or similar award.

Below is a summary of the implementation guidance, as provided in ASU 2024-01, where the following assumptions apply to Cases A, B, C and D:

  • Entity X is a partnership. Before June 1, 20X1, Entity X had Class A units outstanding. On June 1, 20X1, Entity X grants Class B incentive units to employees of a subsidiary of Entity X in exchange for services.
  • An exit event may include an initial public offering, a change in control, or a liquidation of Entity X’s assets.

Case A

Additional Assumptions
  • The Class B units are profits interest units that are subordinated to the Class A units because after vesting they participate pro rata with the Class A units once the holders of the Class A units have received distributions equal to a predetermined distribution threshold established on the grant date of the Class B units.
  • The Class B units cliff vest at the end of three years of service.
  • Upon an exit event, the Class B units vest immediately if a grantee is still providing services to the subsidiary of Entity X. Upon such an event, the grantee would retain the vested Class B units, or if Class B units are settled through the exit event, Entity X would distribute proceeds to the Class B unit holders in the same manner as is described above.
  • If a grantee of the Class B units terminates employment with the subsidiary of Entity X (whether voluntarily, upon death, disability, or retirement or at the election of Entity X for reasons other than cause), any unvested Class B units will be forfeited for no consideration. If a grantee of the Class B units terminates employment after vesting, the grantee retains ownership of the vested Class B units, but upon the grantee’s termination of employment, Entity X has a call right to repurchase the Class B units. If the call right is exercised, Entity X would pay the grantee of the Class B units an amount of cash equal to the fair value of the Class B units on the call date.
Applicable Accounting

Class B units are accounted for in accordance with Topic 718 as the following indicate that Entity X is offering to issue shares or other equity instruments:

  • Either upon three years of service or an exit event, the grantor will have received the agreed-upon consideration and the award will vest.
  • Holding the vested Class B units provides the grantee with the right to participate in the residual interest of Entity X through periodic distributions or upon an exit event, or upon settlement proportionate to ownership of Class B units of Entity X in accordance with the distribution waterfall.

Case B

Additional Assumptions
  • The Class B units are profits interest units that are subordinated to the Class A units because once granted, they participate pro rata with the Class A units once the holders of the Class A units have received distributions equal to a predetermined distribution threshold established on the grant date of the Class B units.
  • The grantee of the Class B units is eligible to begin participating in nonforfeitable operating distributions at the grant date.
  • The Class B units only vest upon an exit event. Upon such an event, the grantee would retain the vested Class B units, or if Class B units are settled through the exit event, Entity X would distribute proceeds to the Class B unit holders in the same manner as is described above. Class B units are forfeitable upon the grantee’s termination for any reason at any time before an exit event.
Applicable Accounting

Class B units are accounted for in accordance with Topic 718 as the following indicate that Entity X is offering to issue shares or other equity instruments:

  • Upon an exit event, the grantor will have received the agreed-upon consideration and the award will vest.
  • Holding the vested Class B units provides the grantee with the right to participate in the residual interest of Entity X through periodic distributions or upon an exit event, or upon settlement proportionate to ownership of Class B units of Entity X in accordance with the distribution waterfall.

Case C

Additional Assumptions
  • The Class B units don’t entitle the grantee to receive equity instruments of Entity X. This type of unit is often referred to as a phantom share unit.
  • The grantee of the Class B units is not eligible to participate in distributions in the ordinary course of business.
  • The grantee of the Class B units is eligible to receive cash upon an exit event. Upon an exit event, the Class B units vest immediately and must be settled in cash on the basis of the fair value of the Class B units. The fair value of the Class B units is calculated by reference to the price of Class A units of Entity X as determined at the date of the exit event.
  • The grantee of the Class B units must be providing services when the exit event occurs to receive any proceeds, and the Class B units are forfeitable upon the grantee’s termination for any reason at any time before an exit event.
Applicable Accounting

Class B units are accounted for in accordance with Topic 718. While the Class B units don’t entitle the grantee to receive shares or other equity instruments, the cash proceeds received by the grantee upon settlement in an exit event are based, at least in part, on the price of Entity X’s shares.

Case D

Additional Assumptions
  • The Class B units don’t entitle the grantee to receive equity instruments of Entity X. This type of unit is often referred to as a phantom share unit.
  • The grantee of the Class B units is eligible to participate in operating distributions made by Entity X equal to one percent of the preceding fiscal year’s net income. The grantee of the Class B units is eligible to begin participating in these operating distributions after three years of service.
  • The grantee of the Class B units isn’t eligible to participate in any proceeds distributed upon an exit event.
  • The Class B units are forfeitable upon the grantee’s termination for any reason at any time.
Applicable Accounting

Class B units aren’t accounted for in accordance with Topic 718 as the scope criteria isn’t met, as follows:

  • The Class B units don’t entitle the grantee to receive shares or other equity instruments of Entity X and there’s no circumstance in which Entity X would be required to issue its equity shares or other equity instruments.
  • The proceeds received by the grantee related to operating distributions are based on an operating metric of Entity X and aren’t based, at least in part, on the price of Entity X’s shares.

Effective Dates

For public business entities, the amendments are effective for annual periods beginning after December 15, 2024, and interim periods within those annual periods.

For all other entities, the amendments are effective for annual periods beginning after December 15, 2025, and interim periods within those annual periods.

Early adoption is permitted for both interim and annual financial statements that haven’t yet been issued or made available for issuance. If adopted in an interim period, the amendments must be adopted as of the beginning of the annual period that includes that interim period.

Transition Requirements

The amendments should be applied either:

  • Retrospectively to all prior periods presented in the financial statements
  • Prospectively to profits interest and similar awards granted or modified on or after the date at which the entity first applies the amendments

If the amendments are applied retrospectively, an entity is required to provide the disclosures for a change in accounting principle in accordance with Topic 250, Accounting Changes and Error Corrections, in the period of adoption.

If the amendments are applied prospectively, an entity is required to disclose the nature of and reason for the change in accounting principle.

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If you have questions about the amended guidance in ASU 2024-01 and how it could impact accounting for your business, please contact your Moss Adams professional.

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