FASB Considers New Provision for Private Companies

By Sandy Carter. Less costly? Less complex? And authored by FASB?  Inquiring minds at private companies want to know how suggested changes in measuring equity, as well as liability-classified awards, might make their lives easier.

The Private Company Council (PCC), advisory body to the FASB representing the interests of privately-held companies with respect to U.S. GAAP, influenced the Board in October 2014, to add a “Simplification” project to its agenda.  Among its requests, PCC asked the Board to evaluate a provision allowing ‘non-public’ companies to measure both equity and liability awards using the intrinsic value method. If the FASB adopts this new provision, it will offer this opportunity only to entities which do not meet the definition of a public entity as defined under ASC 718.

The Board agreed to consider the provision allowing private companies a one-time opportunity to move from measuring liability-classified awards at fair value to measuring these awards at intrinsic value, but moved consideration for valuing equity-classified awards to a future project.

Currently under ASC 718, private companies must elect by policy to measure all their liability awards either by intrinsic value or fair value, but many such entities are not aware of this provision.  If the FASB approves this new expedient, private companies may make a one-time move from measuring liability awards at fair value, a more complex process, to using the simpler intrinsic value method.

But which measurement yields the most accurate result?  The fair value method, using the Black-Scholes calculation for measuring fair value, uses a dividend yield, volatility rate and risk-bigstock_Close_up_of_Business_people_di_36469429free interest rate in an attempt to take the mystery out of valuing options. But how well do these factors apply to private companies?  Attempting to estimate and apply these variables is a daunting task.   Originally the authors designed the Black-Scholes method for European style grants which cannot be exercised until the options expire, i.e. at expiration date.  In the U.S., participants may exercise options at various vesting dates, making the Black-Scholes calculation of fair value for U.S. style grants an ‘educated guess.’

In addition, where private company equity awards are considered, there is frequently no market for the shares.  These grants often expire unexercised.  One PCC member argued that most private company participants face great uncertainties and, in the end, realize little or no value from their stock options and awards.  Valuing the grants at current market value less grant price, where there is little volatility in price, may prove the more accurate measure.

If the FASB adopts this new provision, it will offer this opportunity only to entities which do not meet the definition of a public entity as defined under ASC 718, which states, “An entity that meets any of the following criteria: a) Has equity securities that trade in a public market, either on a stock exchange (domestic or foreign) or in an over-the-counter market, including securities quoted only locally or regionally b) Makes a filing with a regulatory agency in preparations for the sale of any class of equity securities in a public market    c) Is controlled by an entity covered by the preceding criteria. That is a subsidiary of a public entity is itself a public entity.  An entity that has only debt securities trading in a public market (or that has made a filing with a regulatory agency in preparation to trade only debt securities is not a public entity).”

Bottom line, thanks to the PCC, FASB is including provisions to simplify accounting for private companies alongside a broader ‘simplification’ project affecting public companies, keeping Big GAAP (public) and Little GAAP (private) working together. Among these considerations, private companies may eventually save cost and complexity by using the intrinsic value method rather than the fair value calculation for valuing their liability awards and in the future their equity-classified awards, too.

If you are interested in streamlining and simplifying your equity compensation reporting, check out Certent’s comprehensive web-based platform which ensures ASC 718 regulatory compliance and automates reporting for equity compensation.

Sandy Carter Banner