Private company equity shares underlying a share option often are not actively traded, and thus, observable market prices for those shares or similar shares do not exist. Therefore, determining the fair value of private company share-option awards at grant date or upon a modification to an award often can be costly and complex. In response to this complexity, the Financial Accounting Standards Board (FASB) recently issued Accounting Standards Update (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).
ASU 2021-07 provides a practical expedient whereby a nonpublic entity is allowed to determine the current price input of equity-classified share-based awards issued to both employees and nonemployees using the reasonable application of a reasonable valuation method. The practical expedient describes the characteristics of the reasonable application of a reasonable valuation method including (a) the date on which a valuation’s reasonableness is evaluated, (b) the factors that a reasonable valuation should
consider, (c) the scope of information that a reasonable valuation should consider, and (d) the criteria that should be met for the use of a previously calculated value to be considered reasonable. The same characteristics are used in the regulations of the U.S. Department of the Treasury related to Section 409A of the U.S. Internal Revenue Code to describe the reasonable application of a reasonable valuation method for income tax purposes. A reasonable valuation performed in accordance with these Treasury Regulations is an example of a way to achieve the practical expedient.
Nonpublic entities are allowed to apply the practical expedient on a measurement-date-by-measurement-date basis to equity-classified share-based awards within the scope of FASB Accounting Standards Codification Topic 718. The practical expedient is not available for liability-classified awards.
ASU 2021-07 is effective prospectively for all qualifying awards granted or modified during fiscal years beginning after December 15, 2021, and interim periods within fiscal years beginning after December 15, 2022. Early application, including application in an interim period, is permitted for financial statements that have not yet been issued or made available for issuance as of October 25, 2021.
