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Private Company Accounting Rules Coming in Q4 Related to Equity-Classified Share-Based Awards

Denise Lugo  Editor, Accounting and Compliance Alert

· 5 minute read

Denise Lugo  Editor, Accounting and Compliance Alert

· 5 minute read

The FASB on August 4, 2021, unanimously voted to issue a narrow accounting workaround related to pricing equity-classified share option awards, endorsing its Private Company Council’s (PCC) June decisions for private companies.

The guidance would provide a simpler, less costly way—for a limited population of private companies—to determine the current price input associated with equity-classified share-based awards within the scope of Topic 718, Compensation—Stock Compensation, including awards issued to employee and non-employees.

Companies would apply the expedient on a “measurement-date by measurement date basis.”

“On the plus side it clarifies existing practice and eliminates – albeit rare – those instances where a company may have gotten multiple valuations,” FASB member Susan Cosper said. “I think that one of the important refinements is leveraging language from [IRS Section] 409A and I also think that maybe one of the areas that has the potential to have a more significant cost savings is in the area of leveraging valuations in the previous 12 months,” she said. “And I think it’s also important just to say – because I think that maybe there was some confusion in the proposal – that this improvement does not change or eliminate any audit guidance.”

The rules will be issued in the fourth quarter this year, a FASB public relations person confirmed after the meeting.

The guidance would take effect prospectively for qualifying awards granted or modified during fiscal years beginning on or after December 15, 2021, and interim periods in the following year. Early adoption would be allowed.

Slightly Different from Proposal

Under current more complex rules, when determining the grant-date fair value of those awards, a valuation technique such as an option pricing model is typically used, which requires various inputs, including the fair value of the equity shares underlying a share-option award (referred to as the current price input).

The new guidance would allow private companies to use a practical expedient to determine the current price input of equity-classified share-based awards in accordance with certain valuation procedures described in the U.S. Internal Revenue Code Section 409A and the associated Treasury Regulations (Section 409A), the board affirmed. A practical expedient is a cost-effective way of achieving the same or a similar accounting or reporting objective of a specific rule.

Section 409A would be referenced as an example, but the rules would also include facts and circumstances (as stated in Section 409A) to consider for reasonable valuations.

The “basis for conclusions” section of the final standard should clarify that 409A treasury regulations is being used as an example of something that meets “a reasonable application of a reasonable method,” Vice Chair James Kroeker said. “I think we have to be clear in the ‘basis’ that that is as of the date of endorsement or date of issuance – some date approximate to now, because we don’t know what changes may or may not occur in future,” he said.

The board’s decisions relate to Proposed Accounting Standards Update (ASU) No. 2020-200 Compensation—Stock Compensation (Topic 718): Determining the Current Price of an Underlying Share for Equity-Classified Share-Option Awards, a proposal of the PCC, issued in August 2020 for public comment.

The practical expedient takes an approach that is slightly different than the proposal, which directly deferred to a paragraph of the treasury regulations, according to the discussions. The PCC in its redeliberations made the change in response to comment letter feedback, indicating that such a direct reference could result in automatic changes to GAAP and that more guidance was needed to evaluate when a previously calculated value would qualify for the practical expedient.

Not Getting a Safe Harbor

The PCC, which pushed for the rules, said private companies would save cost from a potential reduction in the number of valuations they are required to obtain. In limited circumstances cost reduction would arise because private companies currently obtaining two independent valuations – one for GAAP and one for tax requirements – would be able to obtain just one to satisfy both purposes; and because an acceptable practice for determining the current price input using only one valuation would be codified in GAAP.

FASB member Christine Botosan, the board’s academic, said the “basis for conclusions” section of the standard should also make it clear that the practical expedient does not change the measurement objective, and does not provide a safe harbor from having to get a second valuation if necessary to achieve the measurement objective.

“I’m also wanting to point out that the practical expedient states that a company can use a value determined by a reasonable application of a reasonable valuation method and then goes on to describe what that is, and I don’t think we’re doing anything new in there that is inconsistent with what would be allowed under the existing guidance, and I think that is true whether an entity issues an equity award or a liability award under existing guidance,” said Botosan.

“So for this reason I continue to be concerned with the statement that the practical expedient ‘may not be used for awards classified as liabilities’ is going to be very confusing for those trying to apply our guidance,” she said. “It implies that entities were not allowed to use ‘a reasonable application of a reasonable valuation method’ to determine the fair value of the current price input for liability awards [and…] I think that’s going to be confusing.”


This article originally appeared in the August 5, 2021 edition of Accounting & Compliance Alert, available on Checkpoint.

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