Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 718 governs the accounting treatment of all share-based payment transactions in which a company acquires goods or services by either (1) issuing company stock or (2) incurring liabilities that are based on the fair value of the company’s stock or settled by issuing company stock.
ASC Topic 718 requires both publicly-traded and private companies that grant long-term incentive awards to recognize the fair value of the awards as compensation cost in their financial statements. Fair value is the valuation standard for financial reporting under US Generally Accepted Accounting Principles (“US GAAP”) and is distinguishable from fair market value, which is the standard on which the Internal Revenue Service relies for tax purposes. Fair value is intended to measure the value of an award on the grant date, assuming that the grantee will fulfill all of the award’s conditions.
On August 17, 2020, the Financial Accounting Standards Board (FASB) issued a draft of a proposed Accounting Standards Update (“ASU”), in which FASB proposes to amend ASC 718 to simplify the determination of the fair value of a private company stock option on the grant date or date the award is modified.
The proposed ASU would allow private companies to determine the current price of a share underlying a stock option using a valuation method performed in accordance with Treasury Regulation Section 1.409A-1(b)(5)(iv)(B)(2). Accordingly, private companies would be permitted to use any of the following valuation methods:
- A valuation determined by an independent appraisal within the 12 months preceding the grant date or modification 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 start-up corporation (as defined in the Treasury Regulations).
Private companies would have to satisfy the detailed requirements set out in the Treasury Regulations to use the valuation methods. This would allow private companies to satisfy the requirements of both ASC 718 and Section 409A with a single valuation.
FASB is accepting comments on the proposed ASU until October 1, 2020.
Patrick Ellis is a Traverse City-based attorney counseling business across numerous industries and stages of maturity regarding corporate formations and governance, commercial and strategic transactions, real estate, and day-to-day, operational and legal matters. If you have any questions about the issues addressed in this post, or if you would like a copy of any of the materials mentioned in it, please contact: