Financial Reporting Financial Reporting
  March 2006   

 Issues Covered
























 

 

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How are cash flow statements affected?

The income tax benefit from option exercises can substantially reduce or eliminate a company's current tax liability. Under FASB Statement No. 95, Statement of Cash Flows, and EITF Issue No. 00-15, "Classification in the Statement of Cash Flows of the Income Tax Benefit Received by a Company upon Exercise of a Nonqualified Employee Stock Option," the entire tax benefit, whether recorded in earnings or APIC, is an operating cash flow. Under Statement 123(R), excess tax benefits will be treated as a financing cash inflow rather than an operating cash inflow. As noted previously, for purposes of computing the income tax provision, the analysis of excess or deficient tax benefits is performed on an aggregate basis for all options exercised and all shares vested in a year. By contrast, for the cash flow statement, the analysis of excess or deficient tax benefits is performed on an individual grant basis. That is, the excess tax benefits for each individual grant with an excess tax benefit are aggregated to compute the amount of tax benefit treated as a financing cash inflow, with no offset for individual grants with deficient tax benefits. For example, assume that two stock options are exercised in 2006, one with an excess tax benefit of $100 and the other with a shortfall of $80. The excess and the shortfall are netted for purposes of computing the tax provision and the credit to APIC, and a net $20 would be added to APIC. On the cash flow statement, the $100 excess tax benefit will be reflected as a financing cash inflow; the $80 shortfall will not be netted. Thus, a company needs records and procedures to track this information on an individual grant basis.

Practical note: Companies should be mindful of the potential quantitative effect on operating cash flow, because the change may have an impact on compliance with debt covenants or on ratios or other measurements that use cash flow information.

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Copyright © 2006, BDO USA,LLP. Material discussed in this Financial Reporting newsletter is meant to provide general information and should not be acted upon without first obtaining professional advice appropriately tailored to your individual facts and circumstances.