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The FASB on Aug. 17, 2020, issued a proposal to simplify the way privately owned companies determine the current price input associated with a traditional share-option award, a change drawn to reduce costs in financial reporting.

The proposal would provide a practical expedient that enables private companies to leverage the valuation method used under Internal Revenue Code Section 409A to determine the fair value of shares underlying a stock-option award on its grant date or modification date. A practical expedient is a more cost-effective way of achieving the same or a similar accounting or reporting objective.

“Members of the [Private Company Council] conveyed concerns that current guidance on determining fair value for these shares creates unnecessary cost and complexity for some stakeholders,” FASB Chairman Richard Jones said in a statement. “The proposed ASU puts forth a potential solution to this issue, and we look forward to hearing what our stakeholders think about it,” he said.

Most private companies obtain two independent valuations – one for GAAP and one for tax requirements – and under the changes they would be able to obtain just one to satisfy both purposes, thereby cutting costs, the proposal states. Valuations by independent appraisal that satisfy Section 409A are valid for 12 months unless determined to be “grossly unreasonable.” This could potentially reduce the number of valuations that a private company would have to obtain, the board said.

The proposal was not unanimously endorsed by the full board.

FASB member, Christine Botosan, the academic on the board, wrote a dissent on the issuance of the change on grounds that: the cost saving would be meager and therefore do not justify the optional public-private differences introduced in GAAP; it would not have a significant impact on valuation processes and procedures presently applied to private companies; and the audit costs are unlikely to be significantly reduced.

Botosan said she “supports alternatives for private companies within GAAP when there is an opportunity to reduce cost and complexity for private companies while at least maintaining the usefulness of information for typical users of private company financial statements.” In this instance, however, the proposed amendment will yield “insufficient cost savings to justify creating another optional public-private difference within GAAP,” she said.

The proposal was issued as 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.

Companies have until Oct. 1 to submit comments.

Nitty gritty of the issue

The proposal said it seeks to address concerns that trying to figure out the fair value of traditional private company share-option awards is often costly and complex.

This is primarily because the private company equity shares underlying the share option often are not actively traded and, therefore, observable market prices for those shares or similar shares do not exist, the proposal explains.

When determining the fair value of those awards, a valuation technique such as an option pricing model is typically used. An option-pricing model requires various inputs, including the fair value of the equity shares underlying a share-option award (referred to as the current price input).

The FASB’s Private Company Council (PCC) told the board it received feedback that the current price input is typically the most difficult input for private companies to estimate and substantiate to their auditors, primarily because of the lack of observable prices for private company equity shares.

Because the measurement objectives of Topic 718, Compensation—Stock Compensation, and Section 409A are generally aligned, it is expected that the current price value determined using a valuation method satisfying the “presumption of reasonableness” requirements of Section 409A “will be consistent with the value that would have been determined using a valuation method that is compliant with Topic 718,” the proposal states.

Costs would be reduced for private companies, and documentation and audit procedures needed to substantiate the current price input should decrease under the proposal practical expedient.

“The PCC proposal responds to an area that private company stakeholders have said they think can be improved,” PCC Chair Candace Wright said in a statement. “We encourage them to review the proposed ASU and share their views on it.”

For more information on this topic, or to learn how Baker Tilly accounting and assurance specialists can help, contact our team.

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