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Narrow Private Company Proposal to be Issued Related to Equity-Classified Stock Options

Thomson Reuters Tax & Accounting  

· 5 minute read

Thomson Reuters Tax & Accounting  

· 5 minute read

By Denise Lugo

A Private Company Council (PCC) decision to leverage Internal Revenue Code Section 409A valuation procedures for finding the current price on an underlying share for certain types of stock options, will be issued as a proposal for public comment, the FASB decided by a 6 to 1 vote.

The board plans to propose that private companies can opt to utilize valuation procedures in IRC Section 409A and the associated Treasury regulations to figure out the current price input used to determine the “grant-date fair value of an equity-classified share option award,” terminology that speaks to the nuances of the matter being addressed. IRC Section 409A, effective January 1, 2005, regulates taxation of nonqualified deferred compensation.

The proposal will provide a practical expedient that enables companies to use a valuation in accordance with the “presumption of reasonableness” requirements of Section 409A. When a valuation qualifies for the “presumption of reasonableness” it is expected to be a reasonable application of a reasonable valuation method, according to a board handout. A practical expedient is a cost-effective way of achieving the same or a similar accounting or reporting objective as an original provision in GAAP.

Private company accountants will be able to weigh in by early April for 45 days on whether the proposed alternative would ease cost and complexity, the board said on February 12, 2020.

The proposal “can help clarify and even some places ease costs and I think that would actually reduce audit costs,” FASB Vice Chairman James Kroeker said. “Because the tax valuation does have potential consequences to the entity even though the tax may be on the employee I think there are penalties, false filing fees and I think that in it of itself reduces audit costs.”

Kroeker said the amendments would be a good alternative for private companies. “I put it in the context of the subjectivity of the number we’re talking about in the first place and then how much user reliance there is or isn’t on the exact number of stock compensation versus the fact that it occurred,” he said.

Providing an Option

The PCC, the panel that advises the FASB on private company matters, in 2019 flagged “measurement of grant-date fair value of equity-classified share-based awards” as an area that is costly and complex for private companies. The PCC mid-December 2019 voted that a proposed should be issued on the topic.

PCC members said an accounting alternative would reduce costs for private companies by eliminating the need for them to perform two separate valuations: one for GAAP; and, one for tax purposes.

The proposal would amend Topic 718, Compensation–Stock Compensation. The scope of the amendments would be applicable to awards issued to employees and nonemployees. The expedient should be electable prospectively, on an award by award basis for all qualifying awards, according to a FASB staff analysis.

Some FASB members suggested staff accountants research the amount of cost savings the changes would bring, as well as gain insight from auditors about the topic.

“I think we should have additional outreach and ask a question about the audit cost and make sure that we understand is there a real cost savings for audit or not and we can talk about that and you guys can meet with auditors about what they would do differently, if anything,” FASB Chairman Russell Golden said.

Botosan Sole Dissent

FASB member Christine Botosan dissented because of skepticism that the proposal would ease cost and provide more useful information.

“Generally I would support differences between public and private companies where there is a substantial cost savings in the information that is being provided to the typical users of private company financial statements. But this is not a case where I see there being substantial cost savings,” Botosan said.

“I think the staff has done extensive outreach and from that outreach what I understood is behavior on the preparer side is not going to change. And the reason why it’s not going to change is because they’re not doing this estimation of fair value of stock for accounting purposes, they’re doing it because they’re signing an option contract with a counterparty and that is going to determine how much someone is going to pay for the stock in the future because it becomes the basis for determining what the exercise price of the option is,” she said.

Botosan said staff research revealed that it is relatively rare for an entity to get two valuations. “I find it very hard to believe that companies are routinely reporting one fair value to the IRS and a different fair value for accounting purposes. That would seem very odd to me,” she said. “I think that what we’re essentially going to do is just codify widespread existing practice. I think existing practice is clearly currently allowed, I think people understand that and that’s why we see generally just one valuation being done.”

As for the audit cost savings, said Botosan, “I’m very concerned that there’s confusion about whether this practical expedient is going to provide a safe harbor for the audit of the inputs into the 409A valuation if the 409A evaluation is being used.”


This article originally appeared in the February 14, 2020 edition of Accounting & Compliance Alert, available on Checkpoint.

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