FASB Simplifies Valuing Share-Based Compensation

ASU 2021-07: Streamlined Approach for Companies Valuing Share-Based Awards

In late October, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2021-07, Compensation – Stock Compensation (Topic 718).  With the new guidance, the FASB offers private companies a practical expedient to make the valuation of share-based compensation more streamlined and straight forward.

Many companies make equity-classified, share-based awards to employees and non-employees alike as a form of compensation. To appropriately record these awards, companies are required to determine the value of these awards at the grant date. This process can be complex and burdensome; many of the inputs of the calculation, such as the current price of the underlying share, are subject to significant uncertainty caused by the lack of observable market price data.

New ASU Aligns with Current Valuation Requirements for IRC Section 409A

Under existing Generally Accepted Accounting Principles (“GAAP”), share-based awards are measured at fair value, and accordingly, the current input price is measured at fair value. The new ASU provides private companies with a practical expedient option to determine the current price input using the reasonable application of a reasonable valuation method. This aligns GAAP with the current valuation requirements prescribed by Internal Revenue Code Section 409A and related Tax Regulations.

The practical expedient also describes the characteristics of the reasonable application of the reasonable valuation method:

1. The date on which the valuation’s reasonableness is evaluated is the measurement date.
2. The following factors should be considered in a reasonable valuation:
   • The value of the 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 interest 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 the stock or equity interest of the entity.
   • 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.
3. The scope of information to be considered in a reasonable valuation is all information material to the value of the entity.
4. The following criterial must be met for the use of a previously calculated value to be considered reasonable:
   • The value is updated for any information available after the date of calculation that may materially affect the value of the entity.
   • The value is calculated no more than 12 months earlier than the date for which the value is being used.

Effective Dates

The practical expedient can be elected for share-based awards that are classified as equity, but may not be applied to liability-classified awards. The standard is effective for periods beginning after December 15, 2021, but may be early adopted.

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