FASB Proposes a Practical Expedient for Determining the Share Price Input for Measuring Equity-Classified Share-Option Awards for Private Companies
On August 17, 2020, the FASB issued for public comment a proposed ASU1 that would allow private companies2 to use a practical expedient to determine the current market price of the underlying share of equity-classified share-option awards issued to grantees. Under the practical expedient, private companies would make this determination by using a valuation that such companies have performed to comply with the “presumption of reasonableness” requirements in Section 409A of the U.S. Internal Revenue Code.
The practical expedient is intended to reduce the cost and complexity of financial reporting while continuing to give private-company stakeholders useful information on which to base investment decisions. Comments on the proposed ASU are due by October 1, 2020. For ease of reference, the proposal’s questions for respondents are reprinted in the appendix of this Heads Up.
Background and Main Provisions of the Proposed Changes
ASC 7183 currently requires nonpublic entities to measure equity-classified share-based payment awards by using either a fair-value-based measure or, in circumstances in which such entities cannot reasonably estimate the expected volatility of their own share prices, a calculated value.
In determining the fair value of an equity-classified share option, private companies often use an option-pricing model under which various inputs are required, including the fair value of the equity shares underlying the share option. However, because of the nature of private companies, observable market prices generally do not exist for the equity shares of private companies; accordingly, they often use either a market approach or an income approach (or both), which may be costly and complex.
Since private companies often perform a valuation of their shares to meet the Section 409A requirements, many use that valuation as an input to measure their equity-classified share-option awards issued as compensation. But because those assessments are performed for tax purposes, private companies would need to carefully consider whether they are also appropriate for measuring equity-classified share-option awards under ASC 718.
The proposed ASU is based on decisions by the Private Company Council (PCC) to provide a practical expedient that permits a private company to use the valuation it prepares for Section 409A compliance purposes when valuing the underlying share of equity-classified share-option awards issued to grantees, which would be factored into the company's option-pricing model to determine the awards’ fair-value-based measurement under ASC 718.
The FASB subsequently endorsed the PCC’s decisions and issued the proposed ASU.
Comments on the proposed ASU are due by October 1, 2020. A company may elect to apply the final guidance on an award-by-award basis prospectively from the date of adoption. The PCC will determine the effective date after considering stakeholder feedback on the proposed guidance. Early application would be permitted.
Once the PCC considers the feedback on the proposal, any changes will be subject to a final vote by the PCC before a final proposal is sent to the FASB for endorsement.
Appendix — Questions for Respondents
The proposed ASU’s questions for respondents are reproduced below for reference.
Question 1: Is the practical expedient as drafted in this proposed Update operable? If not, please explain why.
Question 2: The practical expedient in this proposed Update is applicable only for equity-classified share-option awards. Should the scope of the practical expedient in this proposed Update be expanded to include other equity-classified share-based compensation arrangements (for example, nonvested shares)? Please explain why or why not.
Question 3: Will the proposed practical expedient reduce costs, including audit costs or fees, associated with the current price input? Please explain why or why not.
Question 4: Do you or your clients obtain separate valuations to satisfy GAAP requirements (Topic 718) and tax regulations (Section 409A)?
Question 5: Do you agree with allowing the proposed practical expedient to be elected on an award-by-award basis?
Question 6: Will the proposed practical expedient compromise the decision usefulness of information related to equity-classified share-option awards? If yes, please explain how.
Question 7: Do you agree with the proposed prospective transition requirements? If not, please explain why.
FASB Proposed Accounting Standards Update (ASU), Determining the Current Price of an Underlying Share for Equity-Classified Share-Option Awards.
The amendments in the proposed ASU would affect all nonpublic entities (as defined in the FASB Accounting Standards Codification (ASC) master glossary). See paragraph BC5 of the proposed ASU.
FASB Accounting Standards Codification Topic 718, Compensation — Stock Compensation.