March 28, 2011 – Journal of Accountancy
FinREC Releases Working Draft of Revised “Cheap Stock” Practice Aid
The AICPA’s Financial Reporting Executive Committee (FinREC) on Monday released a working draft of the revised practice aid Valuation of Privately Held Company Equity Securities Issued as Compensation, also known as the “Cheap Stock” practice aid. This is an update of the practice aid, which was originally issued in April 2004.
The working draft, developed by the Equity Securities Task Force, is posted here.
The practice aid provides nonauthoritative guidance and illustrations for valuation specialists, preparers, auditors and other interested parties regarding the valuation and disclosures related to privately held company equity securities issued as compensation. There were numerous reasons for updating the original practice aid. Since the publication of the original practice aid, FASB issued several accounting standards that introduced key changes relating to valuation practices for early stage companies. The broad use of the practice aid has also revealed topics that the original practice aid did not cover or that were not completely clear.
One of the threshold accounting issues that is addressed in the revised document is the interaction between FASB Statement no. 123(R), Share-Based Payment (revised 2004), and FASB Statement no. 157, Fair Value Measurements.
FASB Statement no. 123(R) (now incorporated in FASB Accounting Standards Codification (ASC) Topics 718 and 505-50) requires fair-value-based valuation for share-based payments. FASB Statement no. 157 (ASC Topic 820) establishes a framework for measuring fair value and is applicable whenever other standards require or permit fair value measurements. However, FASB Statement no. 157 specifically scopes out FASB Statement no. 123(R) due to some exceptions to fair value permitted under 123(R). The task force updating the practice aid believes that, despite the scope exception, FASB Statement no. 157 contains some concepts practitioners may find helpful when determining fair value in connection with share-based payment transactions. As a result, the revised practice aid recommends following the measurement guidance in FASB Statement no. 157 (ASC Topic 820) when accounting for share-based payment transactions unless such guidance is inconsistent with the guidance in ASC Topic 718 or 505-50.
Other accounting-related changes reflected in the revised practice aid include:
- The example of financial statement and management’s discussion and analysis (MD&A) disclosures have been updated to reflect the latest GAAP and SEC requirements.
- Views on contemporaneous versus retrospective valuations and related disclosures have been reconsidered. The revised practice aid eliminates suggested disclosure differences when a contemporaneous versus retrospective valuation was performed. As a result, recommended disclosures will now be the same regardless of whether a company obtained a contemporaneous or retrospective valuation.
In addition to accounting changes, since 2004 there have been advances in the theory and practice of valuation for early stage companies and the revised practice aid was updated to describe some of the “best practices” that have evolved in recent years. With respect to valuation approaches and methods, the revised practice aid has been updated to include the “backsolve” method, which is a method within the market approach under which the implied value of equity is derived from a recent transaction in the company’s own securities.
In terms of methods of allocating equity value, the revised practice aid clarifies the probability-weighted expected return method (or PWERM) and the option-pricing method (or OPM) and will provide additional examples. Also, the revised practice aid includes a newly added discussion of the backsolve method for PWERM and OPM and introduces hybrid methodologies that combine the PWERM and OPM methodologies.
The revised practice aid also addresses control and marketability issues related to premiums and discounts. There is significant diversity in practice in this area, and, to assist practitioners, the revised practice aid includes a new chapter discussing the circumstances in which a discount for lack of marketability or control may be applied and how the discount (or premium) could be measured.
Other changes include:
- A newly added discussion on determining the fair value of debt for purposes of valuing equity
- Updates for AICPA Statement on Standards for Valuation Services (SSVS) no. 1, Valuation of a Business, Business Ownership Interest, Security, or Intangible Asset
- New and updated statistical material and other references
Interested parties are encouraged to review the working draft and provide feedback. All comments will be kept confidential and will not be posted on the AICPA website. Email comments to Yelena Mishkevich at ymishkevich@aicpa.org by May 31, or send them by mail to Yelena Mishkevich, Accounting Standards, AICPA, 1211 Avenue of the Americas, 19th Floor, New York, NY 10036.
The final document is expected to be published by the end of 2011. However, the timing will depend on the number and extent of comments received on the working draft.