Private companies only need to use one method to assess stock-based compensation awards under a change made by the Financial Accounting Standards Board (FASB) last week.
Today, private companies sometimes use separate valuation methods to adhere to generally accepted accounting principles (GAAP) and IRS ‘presumption of reasonableness’ standards when valuing compensation-related actions. action-based.
To reduce the burden of compliance, the new standard, which the FASB classifies as a “practical expedient,” allows companies that assess their actions using IRS rules to also meet GAAP Topic 718 at the same time. time. The new standard will come into effect at the end of this year.
The change “eliminates, albeit rare, instances where a company has received multiple reviews,” FASB board member Susan Cosper said at the organization’s meeting last week.
It is important to note that if a company’s auditor disputes the accuracy of the IRS-based assessment, the business will still need to conduct a separate assessment.
“Even if a company opts for the practical expedient, if its auditor concludes that the estimate of value for tax purposes is not a reliable estimate of fair value, then it should still follow the procedure. appropriate audit, ”said Christine Botosan, FASB board member. . This “could include the requirement for a second assessment”.
The IRS presumption of reasonableness rules, under Section 409A of the Tax Code, set out three ways for a company to determine the fair market value of stock-based compensation awards: 1) independent valuation, 2) formula and 3) a written report that considers the relevant factors of a start-up company’s illiquid stock.
In their analysis of the matter, FASB staff say independent valuation is how most companies evaluate their stocks. As private companies, their shares are not actively traded, so there is no market mechanism to set the valuation.
Whichever method is used, unless the auditor discovers a valuation problem, the IRS method will meet Topic 718 GAAP.
Financial executives will, however, need to stay abreast of any changes to the IRS rules on its presumption of standards of reasonableness; if there are any changes, they will have to take them into account to comply with GAAP.
“The only thing I know about the tax code is that it is changing,” said FASB chairman Richard Jones. “With a bit of luck [there are no] important changes in the future, but this is something practitioners will need to watch out for, both when preparing and verifying these estimates. “