The Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2021-07, Compensation-Stock Compensation (Topic 718) titled “Determining the Current Price of an Underlying Share for Equity-Classified Share-Based Awards.”

The amendments in this update affect all nonpublic entities that issue equity-classified share-based awards and elect the practical expedient in this update.

What’s in the Update?

A nonpublic entity can now 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 characteristics of the reasonable application of a reasonable valuation method. These include:

  1. The date on which a valuation’s reasonableness is evaluated
  2. The factors that a reasonable valuation should consider
  3. The scope of information that a reasonable valuation should consider
  4. The criteria that should be met for the use of a previously calculated value to be considered reasonable

These characteristics are the same as those identified by the Internal Revenue Service for income tax purposes that results in a valuation commonly referred to as a “409A report.” And the update specifies that an analysis that complies with IRS rules will also achieve this practical expedient. Examples of what can be used include:

  1. A valuation determined by an independent appraisal within the 12 months preceding the grant date
  2. A valuation based on a formula that, if used as part of a non-lapse restriction with respect to the shares, would be considered the fair market value of the shares
  3. A valuation made reasonably and in good faith that is evidenced by a written report that considers the relevant factors with respect to the illiquid stock of a start-up corporation, as defined in the regulations

The update is effective for fiscal years beginning after December 15, 2021, and it can be adopted earlier.

What This Means for Technology Start-Ups

Before this ASU, accountants and auditors were required, in some cases, to perform significant additional analysis and assessments above and beyond 409A reports to ensure the current value input used to calculate stock option expense was reasonable. Now, this is not necessary. This change will allow virtually all 409A Reports to be used to determine the current value input when calculating stock option expense with little additional analysis.

Have questions on how the update may affect your organization? Contact a Clark Nuber professional to discuss further.

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