ASU 2021-07: Equity-classified share-based award measurement
ASU in a minute
- The Financial Accounting Standards Board (FASB) has issued a new Accounting Standards Update (ASU) that allows a nonpublic entity to elect a practical expedient to determine the current price of a share underlying an equity-classified share-based award using the reasonable application of a reasonable valuation method.
- The characteristics of the reasonable application of a reasonable valuation practical expedient are the same as those used in the U.S. Department of the Treasury regulations for tax purposes.
- As a result, a valuation performed in accordance with the Treasury regulations, such as a Section 409A valuation, is an example of a way to achieve the practical expedient.
- The practical expedient in this ASU aligns Topic 718 and Section 409A, which allows nonpublic entities to obtain a single valuation to satisfy the requirements of both Topic 718 and Section 409A.
- The ASU is effective prospectively for all qualifying awards granted or modified during fiscal years beginning on or after Dec. 15, 2021, and interim periods within fiscal years beginning after Dec. 15, 2022. Early adoption is permitted.
- Nonpublic entities are allowed to apply the practical expedient in this ASU on a measurement-date-by-measurement-date basis. This means that the practical expedient must be applied to all share-based awards having the same underlying share and the same measurement date.
Why the ASU?
On Oct. 25, 2021, the FASB issued ASU 2021-07, “Compensation – Stock Compensation (Topic 718): Determining the Current Price of an Underlying Share for Equity-Classified Share-Based Awards (a Consensus of the Private Company Council),” in response to feedback from private company stakeholders indicating that determining the fair value of private company share-based awards within the scope of Topic 718, namely, the current price input, is often costly and complex. Thus, the Private Company Council reached a consensus to provide a practical expedient for private companies for all equity-classified share-based awards within the scope of Topic 718, to lower the cost and complexity of applying measurement guidance.
The ASU simplifies the application of Topic 718 by allowing nonpublic entities the option of applying a practical expedient to determine the current price input of equity-classified share-based awards. The practical expedient uses the same characteristics as those in Treasury regulations related to Section 409A of the U.S. Internal Revenue Code (Section 409A). Therefore, a valuation performed in accordance with Section 409A is an example of a way to achieve the practical expedient prescribed in this ASU. This allows nonpublic entities to obtain a single valuation to satisfy both the book and tax requirements.
What are the main provisions?
The main provisions of this ASU include the following:
Scope of the practical expedient
The practical expedient can be adopted by nonpublic entities and applied to their equity-classified share-based awards that are within the scope of Topic 718.
The practical expedient may not be used for awards classified as liabilities in accordance with Topic 718.
The practical expedient
The practical expedient, if elected, allows nonpublic entities to determine the current price input for their equity-classified share-based awards using the reasonable application of a reasonable valuation method.
Reasonable application of a reasonable valuation method
The reasonable application of a reasonable valuation method includes the following characteristics:
- The date on which the valuation’s reasonableness is evaluated is the measurement date.
- The following factors are considered under a reasonable valuation method:
- The value of tangible and intangible assets of the entity
- The present value of the anticipated future cash flows of the entity
- The market value of stock or equity interests in similar entities engaged in trades or businesses substantially similar to those engaged in by the entity for which stock is to be valued
- Recent arm’s-length transactions involving the sale or transfer of such stock or equity interests
- Other relevant factors such as control premiums or discounts for lack of marketability and whether the valuation is used for other purposes that have a material economic effect on the entity, its stockholders, or its creditors
- The entity’s consistent use of a valuation method to determine the value of its stock or assets for other purposes
- The scope of information to be considered in a reasonable valuation is all information material to the value of the entity.
- The criteria to be met for the use of a previously calculated value to be considered reasonable are the following:
- The value is calculated no more than 12 months earlier than the date for which the value is being used.
- The value is updated for any information available after the date of calculation that may materially affect the value of the entity.
Methods presumed to result in a reasonable valuation
Any of the following three methods is presumed to result in a reasonable valuation under Section 409A, provided the detailed requirements for use of each method are satisfied:
- A valuation determined by an independent appraisal within the 12 months preceding the grant date
- A valuation based on a formula that, if used as part of a nonlapse restriction with respect to the share, would be considered the fair market value of the share
- A valuation made reasonably and in good faith and evidenced by a written report that considers the relevant factors of the illiquid stock of a startup corporation (as defined in the Treasury regulations)
Methods that satisfy the practical expedient criteria
It is expected that an independent appraisal (as per method number one under Section 409A) will often be the method used by nonpublic entities electing the practical expedient in this ASU because of the presumption of reasonableness associated with that method for tax purposes, as well as the requirements associated with and limiting availability of other methods that achieve the presumption of reasonableness.
Other valuations, including internal valuations, can also have the characteristics described in the practical expedient.
Required disclosure
Per Accounting Standards Codification (ASC) 718-10-50-2(f)(2)(vi), a nonpublic entity that elects to apply the practical expedient shall disclose that election.
Benefits of the ASU
Currently, some nonpublic entities may obtain separate external valuations to satisfy the requirements of both Topic 718 and Section 409A. The practical expedient in this ASU allows these entities to use a Section 409A valuation to satisfy both requirements.
In addition, some nonpublic entities may issue multiple grants within a 12-month period. The practical expedient in this ASU allows such entities to consider using one Section 409A appraisal, provided there are no material changes to the business.
When does this take effect?
The amendments in this ASU are effective as follows:
Effective date
Fiscal years beginning after Dec. 15, 2021, and interim periods within fiscal years beginning after Dec. 15, 2022
Nonpublic entities are allowed to apply the practical expedient in this ASU prospectively, on a measurement-date-by-measurement-date basis, for all equity-classified share-based awards granted or modified after the effective date. The practical expedient must be applied to all share-based awards within the scope of the practical expedient having the same underlying share and the same measurement date.
Early adoption is permitted for both interim and annual financial statements that have not yet been issued or made available for issuance as of Oct. 25, 2021.
What do you need to think about?
While the practical expedient can lower the cost and complexity for nonpublic entities of applying valuation guidance to equity-classified share-based awards within the scope of Topic 718, the following key consideration is noted:
Word of caution
The practical expedient provided by this ASU is for nonpublic entities. If, after application of the practical expedient, a nonpublic entity becomes a public business entity, the effects of the practical expedient likely will need to be unwound to comply with guidance applicable for public business entities.
