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ASC 230 requires that upon the settlement or exercise of stock-based compensation awards, income taxes payable is reduced (or deferred taxes are adjusted, subject to normal valuation allowance considerations) for the tax effect of the deductions generated, and any windfalls or shortfalls are recorded in the income statement. Furthermore, ASC 230 requires that all tax-related cash flows resulting from share-based payments be reported as operating activities in the statement of cash flows.
When a reporting entity settles outstanding equity-classified stock awards with cash, the classification of the outflow in the statement of cash flows is dependent upon the amount of cash paid. If the cash paid to settle a stock award is less than or equal to the fair value of the award on the settlement date, then the amount of cash paid is charged to equity in the balance sheet and classified as financing activities in the statement of cash flows. However, if the amount paid to settle a stock award exceeds the fair value of the award on the settlement date, the amount paid in excess of fair value would be charged to compensation cost. As such, the cash payment to settle the stock award should be bifurcated in the statement of cash flows — a financing outflow equal to the settlement date fair value and an operating outflow for the amount paid in excess of the settlement date fair value.
If cash is paid to settle a liability-classified stock award, the amount of cash paid to repurchase the award would settle the liability, which would have already been charged to compensation expense. As such, a cash settlement of a liability-classified stock award should be classified as an operating cash outflow in the statement of cash flows.
Reporting entities/grantors may grant awards to employees/grantees that are exercisable prior to vesting so that the grantees’ holding period for the underlying stock begins at an earlier date to achieve a more favorable tax position. These awards have an “early exercise” feature. When grantees “early exercise” stock options, we believe that the cash received by the reporting entity/grantors should be presented as a cash inflow from financing activities. Although the underlying shares are not considered “issued” for accounting purposes when the cash is received (because the options are subject to vesting conditions), the cash represents proceeds in connection with awarding equity instruments that will not enter into the determination of net income.
Stock-based compensation plans may permit shares to be withheld by a reporting entity/grantor in exchange for agreeing to fund a grantee’s tax obligation. When the reporting entity/grantor pays the withholding taxes to the appropriate taxing jurisdiction, ASC 230 requires that the cash payment be presented as a financing outflow in the statement of cash flows.
The presentation as a financing activity follows the view that while the reporting entity made a cash payment to a taxing authority and not the grantee, in substance the reporting entity issued the gross number of shares to the grantee, and then repurchased from the grantee shares commensurate with the statutory tax withholding requirement. As a result, it would be appropriate to account for the “in substance” repurchase of shares as a purchase of treasury shares, which is a financing outflow.

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