4.13 Practical Expedients for Nonpublic Entities

4.13.1 Application

There are several practical expedients in ASC 718 that are available only to nonpublic entities. To apply them, an entity will need to first ensure that it meets the definition of a nonpublic entity as defined in ASC 718 (see Section 1.7).

4.13.1.1 Fair-Value-Based Measurement Exceptions

Two alternatives to fair-value-based measurement are available to nonpublic entities:

Calculated value — A nonpublic entity that cannot reasonably estimate the fair-value-based measure of its options and similar instruments (because it is not practicable to estimate the expected volatility of its stock price) should use the historical volatility of an appropriate industry sector index to calculate an award’s value. This amount is referred to as a calculated value. See Section 4.13.2 for a discussion of a nonpublic entity’s use of the historical volatility of an appropriate industry sector index in valuing a share-based payment award.
Intrinsic value — For liability-classified awards, nonpublic entities can elect as an accounting policy to measure all of their liability-classified awards at either intrinsic value or a fair-value-based measure. See Section 4.13.3 for additional information.

The table below summarizes the use of these measurement alternatives.

	Public Entities	Nonpublic Entities
Equity-classified awards	Fair-value-based measure	Either: Fair-value-based measure* Calculated value**
Liability-classified awards	Fair-value-based measure, remeasured in each reporting period until settlement	Either: Fair-value-based measure* (or a calculated value**), remeasured in each reporting period until settlement Intrinsic value, remeasured in each reporting period until settlement
* Expected volatility is based on the entity’s own share price or comparable public entities. ** Expected volatility is based on the historical volatility of an appropriate industry sector index; a calculated value is used when it is not practicable to estimate the expected volatility of an entity’s own share price.

4.13.1.2 Expected-Term Practical Expedient

A nonpublic entity may make an entity-wide accounting policy election to use a practical expedient to estimate the expected term of certain options and similar instruments. The practical expedient can be used only for awards that meet certain conditions. See Section 4.9.2.2.3 for additional information.

4.13.1.3 Practical Expedient for the Current Price Input for Equity Classified Awards

ASC 718-10

30-20C As a practical expedient, a nonpublic entity may use a value determined by the reasonable application of a reasonable valuation method as the current price of its underlying share for purposes of determining the fair value of an award that is classified as equity in accordance with paragraphs 718-10-25-6 through 25-18 at grant date or upon a modification. This practical expedient may not be used for awards classified as liabilities in accordance with paragraphs 718-10-25-6 through 25-18.

Nonpublic entities may elect to use a practical expedient to determine the current price input of equity-classified share-based payment awards issued to both employees and nonemployees on a measurement-date-by-measurement-date basis. The guidance in ASC 718-10-30-20G notes that a valuation performed in accordance with specified U.S. Treasury regulations related to IRC Section 409A is an example of a reasonable valuation method under the practical expedient. It also explicitly refers to other valuation approaches under IRC Section 409A that are presumed to be reasonable.

Unlike the transition guidance provided by the SEC for entities that elect the intrinsic value or calculated value practical expedients when changing from nonpublic to public entity status (see Section 4.13.4), there is no similar transition guidance related to the practical expedient for the current price input. Therefore, an entity that no longer meets the criteria to be a nonpublic entity would have to reverse the practical expedient’s effect in its historical financial statements. Consequently, before electing the practical expedient, nonpublic entities that could become public entities should carefully consider the potential future costs of having to perform such a reversal.

4.13.2 Calculated Value

ASC 718-10

Nonpublic Entity — Calculated Value for Nonemployee Awards

30-19A Similar to employee equity share options and similar instruments, a nonpublic entity may not be able to reasonably estimate the fair value of nonemployee awards because it is not practicable for the nonpublic entity to estimate the expected volatility of its share price. In that situation, the nonpublic entity shall account for nonemployee equity share options and similar instruments on the basis of a value calculated using the historical volatility of an appropriate industry sector index instead of the expected volatility of the nonpublic entity’s share price (the calculated value) in accordance with paragraph 718-10-30-20. A nonpublic entity’s use of calculated value shall be consistent between employee share-based payment transactions and nonemployee share-based payment transactions.

Nonpublic Entity — Calculated Value

30-20 A nonpublic entity may not be able to reasonably estimate the fair value of its equity share options and similar instruments because it is not practicable for it to estimate the expected volatility of its share price. In that situation, the entity shall account for its equity share options and similar instruments based on a value calculated using the historical volatility of an appropriate industry sector index instead of the expected volatility of the entity’s share price (the calculated value). Throughout the remainder of this Topic, provisions that apply to accounting for share options and similar instruments at fair value also apply to calculated value. Paragraphs 718-10-55-51 through 55-58 and Example 9 (see paragraph 718-20-55-76) provide additional guidance on applying the calculated value method to equity share options and similar instruments granted by a nonpublic entity.

Calculated Value for Certain Nonpublic Entities

55-51 Nonpublic entities may have sufficient information available on which to base a reasonable and supportable estimate of the expected volatility of their share prices. For example, a nonpublic entity that has an internal market for its shares, has private transactions in its shares, or issues new equity or convertible debt instruments may be able to consider the historical volatility, or implied volatility, of its share price in estimating expected volatility. Alternatively, a nonpublic entity that can identify similar public entities for which share or option price information is available may be able to consider the historical, expected, or implied volatility of those entities’ share prices in estimating expected volatility. Similarly this information may be used to estimate the fair value of its shares or to benchmark various aspects of its performance (see paragraph 718-10-55-25).

55-52 This Topic requires all entities to use the fair-value-based method to account for share-based payment arrangements that are classified as equity instruments. However, if it is not practicable for a nonpublic entity to estimate the expected volatility of its share price, paragraphs 718-10-30-19A through 30-20 require it to use the calculated value method. Alternatively, it may not be possible for a nonpublic entity to reasonably estimate the fair value of its equity share options and similar instruments at the date they are granted because the complexity of the award’s terms prevents it from doing so. In that case, paragraphs 718-10-30-21 through 30-22 require that the nonpublic entity account for its equity instruments at their intrinsic value, remeasured at each reporting date through the date of exercise or other settlement.

55-53 Many nonpublic entities that plan an initial public offering likely will be able to reasonably estimate the fair value of their equity share options and similar instruments using the guidance on selecting an appropriate expected volatility assumption provided in paragraphs 718-10-55-35 through 55-41.

55-54 Estimating the expected volatility of a nonpublic entity’s shares may be difficult and that the resulting estimated fair value may be more subjective than the estimated fair value of a public entity’s options. However, many nonpublic entities could consider internal and industry factors likely to affect volatility, and the average volatility of comparable entities, to develop an estimate of expected volatility. Using an expected volatility estimate determined in that manner often would result in a reasonable estimate of fair value.

55-55 For purposes of this Topic, it is not practicable for a nonpublic entity to estimate the expected volatility of its share price if it is unable to obtain sufficient historical information about past volatility, or other information such as that noted in paragraph 718-10-55-51, on which to base a reasonable and supportable estimate of expected volatility at the grant date of the award without undue cost and effort. In that situation, this Topic requires a nonpublic entity to estimate a value for its equity share options and similar instruments by substituting the historical volatility of an appropriate industry sector index for the expected volatility of its share price as an assumption in its valuation model. All other inputs to a nonpublic entity’s valuation model shall be determined in accordance with the guidance in paragraphs 718-10-55-4 through 55-47.

55-56 There are many different indexes available to consider in selecting an appropriate industry sector index. For example, Dow Jones Indexes maintain a global series of stock market indexes with industry sector splits available for many countries, including the United States. The historical values of those indexes are easily obtainable from its website. An appropriate industry sector index is one that is representative of the industry sector in which the nonpublic entity operates and that also reflects, if possible, the size of the entity. If a nonpublic entity operates in a variety of different industry sectors, then it might select a number of different industry sector indexes and weight them according to the nature of its operations; alternatively, it might select an index for the industry sector that is most representative of its operations. If a nonpublic entity operates in an industry sector in which no public entities operate, then it shall select an index for the industry sector that is most closely related to the nature of its operations. However, in no circumstances shall a nonpublic entity use a broad-based market index like the S&P 500, Russell 3000, or Dow Jones Wilshire 5000 because those indexes are sufficiently diversified as to be not representative of the industry sector, or sectors, in which the nonpublic entity operates.

55-57 A nonpublic entity shall use the selected index consistently, unless the nature of the entity’s operations changes such that another industry sector index is more appropriate, in applying the calculated value method in both the following circumstances:

For all of its equity share options or similar instruments
In each accounting period.

55-58 The calculation of the historical volatility of an appropriate industry sector index shall be made using the daily historical closing values of the index selected for the period of time prior to the grant date (or service inception date) of the equity share option or similar instrument that is equal in length to the expected term of the equity share option or similar instrument. If daily values are not readily available, then an entity shall use the most frequent observations available of the historical closing values of the selected index. If historical closing values of the index selected are not available for the entire expected term, then a nonpublic entity shall use the closing values for the longest period of time available. The method used shall be consistently applied (see paragraph 718-10-55-27). Example 9 (see paragraph 718-20-55-77) provides an illustration of accounting for an equity share option award granted by a nonpublic entity that uses the calculated value method.

As discussed in Section 4.12, nonpublic entities should try to use a fair-value-based measure to value their equity-classified awards. However, there may be instances in which a nonpublic entity may not be able to reasonably estimate the fair-value-based measure of its options and similar instruments because it is not practicable for it to estimate the expected volatility of its share price. In these cases, the nonpublic entity should substitute the historical volatility of an appropriate industry sector index for the expected volatility of its own share price. In assessing whether it is practicable to estimate the expected volatility of its own share price, the entity should consider the following factors:

Whether the entity has an internal market for its shares (e.g., investors or employees can purchase and sell shares).
Previous issuances of equity in a private transaction or convertible debt provide indications of the historical or implied volatility of the entity’s share price.
Whether there are similarly sized public entities (including those within an index) in the same industry whose historical or implied volatilities could be used as a substitute for the nonpublic entity’s expected volatility.

If, after considering the relevant factors, the nonpublic entity determines that estimating the expected volatility of its own share price is not practicable, it should use the historical volatility of an appropriate industry sector index as a substitute in estimating the fair-value-based measure of its awards.

An appropriate industry sector index would be one that is narrow enough to reflect the nonpublic entity’s nature and size (if possible). For example, the use of the Philadelphia Exchange (PHLX) Semiconductor Sector Index is not an appropriate industry sector index for a small nonpublic software development entity because it represents neither the industry in which the nonpublic entity operates nor the size of the entity. The volatility of an index of smaller software entities would be a more appropriate substitute for the entity’s expected volatility of its own share price.

Under ASC 718-10-55-58, an entity that uses an industry sector index to determine the expected volatility of its own share price must use the index’s historical volatility (rather than its implied volatility). However, ASC 718-10-55-56 states that “in no circumstances shall a nonpublic entity use a broad-based market index like the S&P 500, Russell 3000, or Dow Jones Wilshire 5000” (emphasis added).

A nonpublic entity’s conclusion that estimating the expected volatility of its own share price is not practicable may be subject to scrutiny. We would typically expect that a nonpublic entity that can identify an appropriate industry sector index would be able to identify similar entities from the selected index to estimate the expected volatility of its own share price and would therefore be required to use the fair-value-based measurement method.

In measuring awards, a nonpublic entity should switch from using a calculated value to using a fair-value-based measure when it (1) can subsequently estimate the expected volatility of its own share price or (2) becomes a public entity. ASC 718-10-55-27 states, in part, that the “valuation technique an entity selects [should] be used consistently and [should] not be changed unless a different valuation technique is expected to produce a better estimate” of a fair-value-based measure (or, in this case, a change to a fair-value-based measure). The guidance goes on to state that a change in valuation technique should be accounted for as a change in accounting estimate under ASC 250 and should be applied prospectively to new awards. Therefore, for existing equity-classified awards (i.e., unvested equity awards that were granted before an entity switched from the calculated value method to a fair-value-based measure), an entity would continue to recognize compensation cost on the basis of the calculated value determined as of the grant date unless the award is subsequently modified. An entity should use the fair-value-based method to measure all awards granted after it switches from the calculated value method.

ASC 718 provides the example below of when it may be appropriate for a nonpublic entity to use the calculated value method.

ASC 718-20

Example 9: Share Award Granted by a Nonpublic Entity That Uses the Calculated Value Method

55-76 This Example illustrates the guidance in paragraphs 718-10-30-19A through 30-20.

55-76A This Example (see paragraphs 718-20-55-77 through 55-83) describes employee awards. However, the principles on how to account for the various aspects of employee awards, except for the compensation cost attribution and certain inputs to valuation, are the same for nonemployee awards. Consequently, an entity should substitute the historical volatility of an appropriate industry sector index for expected volatility in accordance with paragraph 718-10-30-20 when measuring the grant-date fair value of nonemployee awards with similar facts and circumstances (that is, an entity has determined that it is not practicable for it to estimate the expected volatility of its share price), as illustrated in paragraphs 718-20-55-77 through 55-80. Therefore, the guidance in those paragraphs may serve as implementation guidance for similar nonemployee awards.

55-76B Compensation cost attribution for awards to nonemployees may be the same as or different from that which is illustrated in paragraph 718-20-55-81 for employee awards. That is because an entity is required to recognize compensation cost for nonemployee awards in the same manner as if the entity had paid cash in accordance with paragraph 718-10-25-2C. Additionally, valuation amounts used in this Example could be different because an entity may elect to use the contractual term as the expected term of share options and similar instruments when valuing nonemployee share-based payment transactions.

55-77 On January 1, 20X6, Entity W, a small nonpublic entity that develops, manufactures, and distributes medical equipment, grants 100 share options to each of its 100 employees. The share price at the grant date is $7. The options are granted at-the-money, cliff vest at the end of 3 years, and have a 10-year contractual term. Entity W estimates the expected term of the share options granted as 5 years and the risk-free rate as 3.75 percent. For simplicity, this Example assumes that no forfeitures occur during the vesting period and that no dividends are expected to be paid in the future, and this Example does not reflect the accounting for income tax consequences of the awards.

55-78 Entity W does not maintain an internal market for its shares, which are rarely traded privately. It has not issued any new equity or convertible debt instruments for several years and has been unable to identify any similar entities that are public. Entity W has determined that it is not practicable for it to estimate the expected volatility of its share price and, therefore, it is not possible for it to reasonably estimate the grant-date fair value of the share options. Accordingly, Entity W is required to apply the provisions of paragraph 718-10-30-20 in accounting for the share options under the calculated value method.

55-79 Entity W operates exclusively in the medical equipment industry. It visits the Dow Jones Indexes website and, using the Industry Classification Benchmark, reviews the various industry sector components of the Dow Jones U.S. Total Market Index. It identifies the medical equipment subsector, within the health care equipment and services sector, as the most appropriate industry sector in relation to its operations. It reviews the current components of the medical equipment index and notes that, based on the most recent assessment of its share price and its issued share capital, in terms of size it would rank among entities in the index with a small market capitalization (or small-cap entities). Entity W selects the small-cap version of the medical equipment index as an appropriate industry sector index because it considers that index to be representative of its size and the industry sector in which it operates. Entity W obtains the historical daily closing total return values of the selected index for the five years immediately before January 1, 20X6, from the Dow Jones Indexes website. It calculates the annualized historical volatility of those values to be 24 percent, based on 252 trading days per year.

55-80 Entity W uses the inputs that it has determined above in a Black-Scholes-Merton option-pricing formula, which produces a value of $2.05 per share option. This results in total compensation cost of $20,500 (10,000 × $2.05) to be accounted for over the requisite service period of 3 years.

55-81 For each of the 3 years ending December 31, 20X6, 20X7, and 20X8, Entity W will recognize compensation cost of $6,833 ($20,500 ÷ 3). The journal entry for each year is as follows.

55-82 The share option award granted by a nonpublic entity that used the calculated value method is as follows.

55-83 Assuming that all 10,000 share options are exercised on the same day in 20Y2, the accounting for the option exercise will follow the same pattern as in Example 1, Case A (see paragraph 718-20-55-10) and will result in the following journal entry.

At exercise the journal entry is as follows.

4.13.3 Intrinsic Value

ASC 718-30

Nonpublic Entity

30-2 A nonpublic entity shall make a policy decision of whether to measure all of its liabilities incurred under share-based payment arrangements (for employee and nonemployee awards) issued in exchange for distinct goods or services at fair value or at intrinsic value. However, a nonpublic entity shall initially and subsequently measure awards determined to be consideration payable to a customer (as described in paragraph 606-10-32-25) at fair value.

Nonpublic Entity

35-4 Regardless of the measurement method initially selected under paragraph 718-10-30-20, a nonpublic entity shall remeasure its liabilities under share-based payment arrangements at each reporting date until the date of settlement. The fair-value-based method is preferable for purposes of justifying a change in accounting principle under Topic 250. Example 1 (see paragraph 718-30-55-1) provides an illustration of accounting for an instrument classified as a liability using the fair-value-based method. Example 2 (see paragraph 718-30-55-12) provides an illustration of accounting for an instrument classified as a liability using the intrinsic value method. A nonpublic entity shall subsequently measure awards determined to be consideration payable to a customer (as described in paragraph 606-10-32-25) at fair value.

Nonpublic entities can make a policy election to measure all liability-classified awards (not including awards determined to be consideration payable to a customer under ASC 606) at intrinsic value (instead of at their fair-value-based measure or calculated value) as of the end of each reporting period until the award is settled. However, it is preferable for an entity to use the fair-value-based method to justify a change in accounting principle under ASC 250 (see Section 4.13.4 for a discussion of how to record the effects of the change when a nonpublic entity becomes a public entity). Therefore, a nonpublic entity that has elected to measure its liability-classified awards at a fair-value-based measure (or calculated value) would not be permitted to subsequently change to the intrinsic-value method.

The example below illustrates the application of the intrinsic value method for liability-classified awards granted by a nonpublic entity.

ASC 718-30

Example 2: Award Granted by a Nonpublic Entity That Elects the Intrinsic Value Method

55-12 This Example illustrates the guidance in paragraphs 718-30-35-4 and 718-740-25-2 through 25-4.

55-12A This Example (see paragraphs 718-30-55-13 through 55-20) describes employee awards. However, the principles on how to account for the various aspects of employee awards, except for the compensation cost attribution and certain inputs to valuation, are the same for nonemployee awards. Consequently, a nonpublic entity can make the accounting policy election in paragraph 718-30-30-2 to change its measurement of all liability-classified nonemployee awards from fair value to intrinsic value and remeasure those awards each reporting period as illustrated in this Example. Therefore, the guidance in this Example may serve as implementation guidance for similar liability-classified nonemployee awards.

55-12B Compensation cost attribution for awards to nonemployees may be the same or different for liability-classified employee awards. That is because an entity is required to recognize compensation cost for nonemployee awards in the same manner as if the entity had paid cash in accordance with paragraph 718-10-25-2C. Additionally, valuation amounts used in this Example could be different because an entity may elect to use the contractual term as the expected term of share options and similar instruments when valuing nonemployee share-based payment transactions.

55-13 On January 1, 20X6, Entity W, a nonpublic entity that has chosen the accounting policy of using the intrinsic value method of accounting for share-based payments that are classified as liabilities in accordance with paragraphs 718-30-30-2 and 718-30-35-4, grants 100 cash-settled stock appreciation rights with a 5-year life to each of its 100 employees. Each stock appreciation right entitles the holder to receive an amount in cash equal to the increase in value of 1 share of Entity W’s stock over $7. The awards cliff-vest at the end of three years of service (an explicit and requisite service period of three years). For simplicity, the Example assumes that no forfeitures occur during the vesting period and does not reflect the accounting for income tax consequences of the awards.

55-14 Because of Entity W’s accounting policy decision to use intrinsic value, all of its share-based payments that are classified as liabilities are recognized at intrinsic value (or a portion thereof, depending on the percentage of requisite service that has been rendered) at each reporting date through the date of settlement; consequently, the compensation cost recognized in each year of the three-year requisite service period will vary based on changes in the liability award’s intrinsic value. As of December 31, 20X6, Entity W stock is valued at $10 per share; hence, the intrinsic value is $3 per stock appreciation right ($10 – $7), and the intrinsic value of the award is $30,000 (10,000 × $3). The compensation cost to be recognized for 20X6 is $10,000 ($30,000 ÷ 3), which corresponds to the service provided in 20X6 (1 year of the 3-year service period). For convenience, this Example assumes that journal entries to account for the award are performed at year-end. The journal entry for 20X6 is as follows.

55-15 As of December 31, 20X7, Entity W stock is valued at $8 per share; hence, the intrinsic value is $1 per stock appreciation right ($8 – $7), and the intrinsic value of the award is $10,000 (10,000 × $1). The decrease in the intrinsic value of the award is $20,000 ($10,000 – $30,000). Because services for 2 years of the 3-year service period have been rendered, Entity W must recognize cumulative compensation cost for two-thirds of the intrinsic value of the award, or $6,667 ($10,000 × 2/3); however, Entity W recognized compensation cost of $10,000 in 20X5. Thus, Entity W must recognize an entry in 20X7 to reduce cumulative compensation cost to $6,667.

55-16 As of December 31, 20X8, Entity W stock is valued at $15 per share; hence, the intrinsic value is $8 per stock appreciation right ($15 – $7), and the intrinsic value of the award is $80,000 (10,000 × $8). The cumulative compensation cost recognized as of December 31, 20X8, is $80,000 because the award is fully vested. The journal entry for 20X8 is as follows.

55-17 The share-based liability award at intrinsic value is as follows.

55-18 For simplicity, this Example assumes that all of the stock appreciation rights are settled on the day that they vest, December 31, 20X8, when the share price is $15 and the intrinsic value is $8 per share. The cash paid to settle the stock appreciation rights is equal to the share-based compensation liability of $80,000.

55-19 At exercise the journal entry is as follows.

55-20 If the stock appreciation rights had not been settled, Entity W would continue to remeasure those remaining awards at intrinsic value at each reporting date through the date they are exercised or otherwise settled.

4.13.4 Transition From Nonpublic to Public Entity Status

SEC Staff Accounting Bulletins

SAB Topic 14.B, Transition From Nonpublic to Public Entity Status

Facts: Company A is a nonpublic entity4 that first files a registration statement with the SEC to register its equity securities for sale in a public market on January 2, 20X8. As a nonpublic entity, Company A had been assigning value to its share options5 under the calculated value method prescribed by FASB ASC Topic 718, Compensation — Stock Compensation,6 and had elected to measure its liability awards based on intrinsic value. Company A is considered a public entity on January 2, 20X8 when it makes its initial filing with the SEC in preparation for the sale of its shares in a public market.

Question 1: How should Company A account for the share options that were granted prior to January 2, 20X8 for which the requisite service has not been rendered by January 2, 20X8?

Interpretive Response: Prior to becoming a public entity, Company A had been assigning value to its share options under the calculated value method. The staff believes that Company A should continue to follow that approach for those share options that were granted prior to January 2, 20X8, unless those share options are subsequently modified, repurchased or cancelled.7 If the share options are subsequently modified, repurchased or cancelled, Company A would assess the event under the public company provisions of FASB ASC Topic 718. For example, if Company A modified the share options on February 1, 20X8, any incremental compensation cost would be measured under FASB ASC subparagraph 718-20-35-3(a), as the fair value of the modified share options over the fair value of the original share options measured immediately before the terms were modified.8

Question 2: How should Company A account for its liability awards granted prior to January 2, 20X8 that are fully vested but have not been settled by January 2, 20X8?

Interpretive Response: As a nonpublic entity, Company A had elected to measure its liability awards subject to FASB ASC Topic 718 at intrinsic value.9 When Company A becomes a public entity, it should measure the liability awards at their fair value determined in accordance with FASB ASC Topic 718.10 In that reporting period there will be an incremental amount of measured cost for the difference between fair value as determined under FASB ASC Topic 718 and intrinsic value. For example, assume the intrinsic value in the period ended December 31, 20X7 was $10 per award. At the end of the first reporting period ending after January 2, 20X8 (when Company A becomes a public entity), assume the intrinsic value of the award is $12 and the fair value as determined in accordance with FASB ASC Topic 718 is $15. The measured cost in the first reporting period after December 31, 20X7 would be $5.11

Question 3: After becoming a public entity, may Company A retrospectively apply the fair-value-based method to its awards that were granted prior to the date Company A became a public entity?

Interpretive Response: No. Before becoming a public entity, Company A did not use the fair-value-based method for either its share options or its liability awards. The staff does not believe it is appropriate for Company A to apply the fair-value-based method on a retrospective basis, because it would require the entity to make estimates of a prior period, which, due to hindsight, may vary significantly from estimates that would have been made contemporaneously in prior periods.12

Question 4: Upon becoming a public entity, what disclosures should Company A consider in addition to those prescribed by FASB ASC Topic 718?13

Interpretive Response: In the registration statement filed on January 2, 20X8, Company A should clearly describe in MD&A the change in accounting policy that will be required by FASB ASC Topic 718 in subsequent periods and the reasonably likely material future effects.14 In subsequent filings, Company A should provide financial statement disclosure of the effects of the changes in accounting policy. In addition, Company A should consider the requirements of Item 303(b)(3) of Regulation S-K regarding critical accounting estimates in MD&A.

______________________________

4 Defined in the FASB ASC Master Glossary.

5 For purposes of this staff accounting bulletin, the phrase “share options” is used to refer to “share options or similar instruments.”

6 FASB ASC paragraph 718-10-30-20 requires a nonpublic entity to use the calculated value method when it is not able to reasonably estimate the fair value of its equity share options and similar instruments because it is not practicable for it to estimate the expected volatility of its share price. FASB ASC paragraph 718-10-55-51 indicates that a nonpublic entity may be able to identify similar public entities for which share or option price information is available and may consider the historical, expected, or implied volatility of those entities’ share prices in estimating expected volatility. The staff would expect an entity that becomes a public entity and had previously measured its share options under the calculated value method to be able to support its previous decision to use calculated value and to provide the disclosures required by FASB ASC subparagraph 718-10-50-2(f)(2)(ii).

7 This view is consistent with the FASB’s basis for rejecting full retrospective application of FASB ASC Topic 718 as described in the basis for conclusions of Statement 123R, paragraph B251.

8 FASB ASC paragraph 718-20-55-94. The staff believes that because Company A is a public entity as of the date of the modification, it would be inappropriate to use the calculated value method to measure the original share options immediately before the terms were modified.

9 FASB ASC paragraph 718-30-30-2.

10 FASB ASC paragraph 718-30-35-3.

11 $15 fair value less $10 intrinsic value equals $5 of incremental cost.

12 This view is consistent with the FASB’s basis for rejecting full retrospective application of FASB ASC Topic 718 as described in the basis for conclusions of Statement 123R, paragraph B251.

13 FASB ASC Section 718-10-50.

14 See Item 303 of Regulation S-K.

The calculated value and intrinsic value measurement alternatives available to a nonpublic entity are no longer appropriate once the entity is considered a public entity.11 In addition, public entities use the expected-term practical expedient (for determining the expected term of certain options and similar instruments) differently than nonpublic entities. To estimate the expected term as a midpoint between the requisite service period and the contractual term of an award, entities will need to comply with the requirements of the SEC’s simplified method (see Section 4.9.2.2.2).

In SAB Topic 14.B, the SEC discusses various transition issues associated with the valuation of share-based payment awards related to an entity that becomes a public entity (e.g., when it files its initial registration statement with the SEC), including the following:

If a nonpublic entity historically measured equity-classified share-based payment awards at their calculated value, the newly public entity should continue to use that approach for share-based payment awards granted before the date on which it becomes a public entity unless those awards are subsequently modified, repurchased, or canceled, in which case the entity would assess the event under the public company provisions of ASC 718.
If a nonpublic entity historically measured liability-classified share-based payment awards on the basis of their intrinsic value and the awards are still outstanding, the newly public entity should measure those liability awards at their fair-value-based measurement upon becoming a public entity.
Upon becoming a public entity, the entity is prohibited from retrospectively applying the fair-value-based method to measure its awards if it used calculated value or intrinsic value before the date on which it became a public entity.
Upon becoming a public entity, the entity should clearly describe in its MD&A the change in accounting policy that will be required by ASC 718 in subsequent periods and any reasonably likely material future effects of the change.

SAB Topic 14 does not provide transition guidance for entities that are changing from nonpublic to public entity status and have applied the practical expedient for determining the current price of their underlying shares (see Section 4.13.1.3). Thus, an entity that no longer meets the criteria to be a nonpublic entity would have to reverse the practical expedient’s effect in its historical financial statements.

In addition, the SEC’s guidance does not address how an entity should account for a change from the intrinsic value method for measuring liability-classified awards to the fair-value-based method. In informal discussions, the SEC staff indicated that it would be acceptable to record the effect of such a change as compensation cost in the current period or to record it as the cumulative effect of a change in accounting principle in accordance with ASC 250. While the preferred approach is to treat the effect of the change as a change in accounting principle under ASC 250, with the cumulative effect of the change recorded accordingly, recording it as compensation cost is not objectionable given the SEC’s position. Under either approach, entities’ financial statements should include the appropriate disclosures.

ASC 250-10-45-5 states, in part, that an “entity shall report a change in accounting principle through retrospective application of the new accounting principle to all prior periods, unless it is impracticable to do so.” Retrospective application of the effects of a change from intrinsic value to fair value would be impracticable because objectively determining the assumptions an entity would have used for the prior periods would be difficult without the use of hindsight. Therefore, the change would be recorded as a cumulative-effect adjustment to retained earnings and applied prospectively, as discussed in ASC 250-10-45-6 and 45-7. This conclusion is consistent with the guidance in SAB Topic 14.B that states that entities changing from nonpublic to public status are not permitted to apply the fair-value-based method retrospectively.

The example below illustrates how to record the effects of a change from the intrinsic value method to the fair-value-based method.

Example 4-9

Company A (with a calendar year-end) uses the intrinsic value method to account for its liability-classified SARs, which are fully vested on December 31, 20X6. On February 15, 20X7, A files its initial registration statement with the SEC for an IPO. Assume the following intrinsic values and fair values:

In its financial statements included in the initial registration statement, A should use the intrinsic value method to account for the SARs. As a result of filing its initial registration statement with the SEC, A must change its method for valuing its SARs from the intrinsic value method to the fair-value-based method. For the period from January 1, 20X7, through February 15, 20X7, A should therefore record compensation cost of $3 under the intrinsic value method and should record $2 as either an adjustment to retained earnings or compensation cost to account for the change from the intrinsic value method to the fair-value-based method.

Footnotes

The definition of a “public entity” in ASC 718 includes an entity that “[m]akes a filing with a regulatory agency in preparation for the sale of any class of equity securities in a public market.” The definition therefore includes an entity that has filed its initial registration statement with the SEC before the effective date of an IPO.

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.