Facebook Earnings Get Near $1 Billion Tax Windfall from Accounting Change

02/02/17 09:26 AM EST
By Michael Rapoport 

Facebook Inc.'s 2016 earnings got a boost of more than $900 million from an accounting change -- and the same change could help lift earnings at other technology companies.

Facebook said Wednesday after the market closed that its full-year earnings reflected a $934 million reduction in its income-tax provision, including $214 million in the fourth quarter, from a new rule affecting the accounting for stock payments to employees. The tax reductions contributed to big increases in the company's fourth-quarter and 2016 net income.

The change, which accounting rule-makers enacted last March, is expected to increase the earnings of companies like Facebook that are heavy users of employee stock compensation. Companies like Microsoft Corp. and Alphabet Inc. have already adopted the change and saw increases in their earnings, and more such increases are expected when all companies adopt the change this year.

"It's a windfall," said Jack Ciesielski, president of accounting-research firm R.G. Associates, who issued a report in October on the effects of the change.

David Wehner, Facebook's chief financial officer, said on the company's fourth-quarter conference call that the move was "purely an accounting convention change and doesn't change the cash taxes we pay." A Facebook spokesman declined to comment further.

The Financial Accounting Standards Board, which sets U.S. accounting rules, approved the change in an attempt to simplify companies' accounting for employee stock payments. The accounting is changing in several different ways, but most of the effect on earnings has to do with the tax benefits that companies get when their employees exercise the stock options they've been granted.

That is a compensation cost to the company, and it is tax-deductible. When options are exercised, it is typically after the company's stock price has risen, making them more valuable, and so the company recognizes "excess tax benefits" -- the deductions over and above those it expected to realize when the options were first granted.

Under the old rules, those excess tax benefits go into the company's shareholder equity. But under the FASB change, they will be recognized on the income statement immediately -- and that reduces the company's provision for taxes, boosting net income.

The opposite could also happen -- a "tax deficiency" that would lower earnings, if options expire unexercised -- though almost all of the companies adopting the change so far have reported benefits.

The change helped Facebook's fourth-quarter net income soar to $3.57 billion, up from $1.56 billion a year ago. Full-year earnings were $10.22 billion, up from $3.69 billion.

In addition, Facebook's retained earnings -- the total of a company's past profits and losses, minus any dividends it pays out -- got a boost of $1.67 billion as of the beginning of 2016.

The FASB change also boosts Facebook's operating cash flow, because the excess tax benefits are now classified as cash flow from operations instead of from financing. The company's total cash flow remains the same.

Companies are required to adopt the change effective this year. Hundreds of companies like Facebook have chosen to adopt it early, with 2016 earnings, although Mr. Ciesielski said they haven't always disclosed the change well.

Microsoft adopted the change effective last March, and said in its annual report that its excess tax benefits lowered its tax provision by $402 million for the fiscal year that ended in June. Alphabet said it recorded excess tax benefits of $211 million for the first quarter of 2016, when it adopted the change. Microsoft declined to comment; Alphabet couldn't be reached for comment.

Write to Michael Rapoport at Michael.Rapoport@wsj.com


(END) Dow Jones Newswires

February 02, 2017 09:26 ET (14:26 GMT)

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