Private companies only have to use a single method for valuing stock-based compensation awards under a change made by the Financial Accounting Standards Board (FASB) last week.
Private companies today sometimes use separate valuation methods to meet generally accepted accounting principles (GAAP) and IRS “presumption of reasonableness” standards when valuing stocks tied to equity-based compensation.
To reduce the compliance burden, the new standard, which FASB classifies as a “practical expedient,” allows companies that value their shares using the IRS rules to also satisfy GAAP Topic 718 standards at the same time. The new standard takes effect at the end of this year.
The change “eliminates, albeit rare, those instances where a company got multiple valuations,” FASB board member Susan Cosper said at the organization's meeting last week.
Importantly, if a company’s auditor takes issue with the accuracy of the valuation based on the IRS standard, the company would still need to do a separate valuation.
“Even if a company opts for the practical expedient, if its auditor were to conclude that the value estimate for tax purposes is not a reliable fair value estimate, then they would still need to follow appropriate audit procedure,” said FASB board member Christine Botosan. That “could include requiring a second valuation.”
The IRS presumption of reasonableness rules, under Section 409A of the tax code, lays out three ways a company can determine the fair market value of share-based compensation awards: 1) independent appraisal, 2) formula, and 3) a written report that considers the relevant factors of the illiquid stock of a start-up corporation.
In their analysis of the issue, FASB staff say the independent appraisal is the way most companies value their shares. As private companies, their shares aren't actively traded, so there’s no market mechanism to set valuation.
Whichever method is used, unless the auditor uncovers a valuation problem, the IRS method will satisfy the Topic 718 GAAP standard.
Finance leaders will need to stay on top of any changes to IRS rules on its presumption of reasonableness standards, though; if there are changes, they’ll need to keep that in mind for purposes of meeting GAAP.
“The only thing I know about the tax code is it changes,” said FASB Chair Richard Jones. “Hopefully [there are no] significant changes in the future, but that’s something practitioners will need to watch out for, both in preparing as well as in auditing those estimates.”