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July062022

Restricted Securities – FMV No Longer Discounted for Contractual Restriction

Bonnie Mann Falk, CPA, Partner

07.06.22 | Assurance Chat

What’s New?

Good news! We no longer need to factor in a contractual restriction prohibiting the sale of an equity security when estimating the fair value of that security.

Let’s take a closer look at ASU 2022-03, Fair Value Measurement (Topic 820), Fair Value Measurement of Equity Securities Subject to Contractual Sale Restrictions.

The Why

The FASB issued ASU 2022-03 to address inconsistency in practice of estimating the FMV of a restricted security if it is restricted due to a contractual prohibition on selling that equity security. Some discounted the value, while others did not. Eliminating this inconsistency will result in decreased costs and complexity in measuring FV and increased comparability across entities.

The When and How

ASU 2022-03 has the following effective dates and transition requirements:

Type of EntityEffective DateEarly AdoptionTransition
Public business entities, except investment companiesFiscal years beginning after December 15, 2023, and interim periods within those fiscal yearsPermitted for both interim and annual financial statements that have not yet been issued or made available for issuanceApplied prospectively, with adjustments from the adoption recognized in earnings and disclosed on the date of adoption
Investment companies under Topic 946Fiscal years beginning after December 15, 2023, and interim periods within those fiscal yearsPermitted for both interim and annual financial statements that have not yet been issued or made available for issuanceApplied to equity security subject to contractual restriction executed or modified on or after the date of adoption. For those acquired pre-adoption, follow the previous policy until the contractual restriction expires or is modified
All other entitiesFiscal years beginning after December 15, 2024, and interim periods within those fiscal yearsPermitted for both interim and annual financial statements that have not yet been issued or made available for issuanceApplied prospectively, with adjustments from the adoption recognized in earnings and disclosed on the date of adoption

Bottom Line

The FASB clarified that if a restriction is part of the unit of account of the equity security, it is a characteristic of the security and should be considered in the FMV calculation. I look at these types of restrictions as applicable to any party who holds the equity security under the same circumstances. In contrast, a contractual sales restriction is not considered part of the equity security and thus, should not be part of the FMV calculation, nor should an entity recognize and measure the restriction. I look at these types of restrictions as ones that are unique to the party holding the equity security.

Due to the uniqueness, the information regarding the contractual restriction is important to share, so ASU 2022-03 calls for new disclosures, including:

  • FV of equity securities in the balance sheet that are subject to contractual sale restrictions
  • Nature and remaining duration of the restriction(s)
  • When or how a restriction could lapse

Let’s look at two examples:

Restriction Taken into Account (ASC 820-10-55-52) – not uniqueRestriction Not Taken into Account (ASC 820-10-55-52A) - unique
Company X issues Class A shares through a sale on a national securities exchange or an OTC market as well as through a private placement transaction. Because the Class A shares issued through the private placement are not registered and are legally restricted from being sold on a national securities exchange or an OTC market until the shares are registered or the conditions necessary for an exemption from registration have been satisfied, a market participant would sell the private placement Class A shares in a different market than the market used for registered Class A shares on the measurement date. Because that restriction would be included with the unit of account of the equity security, a market participant would consider the inability to resell the security on a national securities exchange or an OTC market when pricing the equity security; therefore, the reporting entity that holds the Class A shares acquired through a private placement transaction would consider that restriction a characteristic of the asset. In that case, the reporting entity should measure the fair value of the equity security on the basis of the market price of the similar unrestricted equity security adjusted to reflect the effect of the restriction. The adjustment will vary depending on all of the following:

  1. The nature and remaining duration of the restriction
  2. The extent to which buyers are limited by the restriction (for example, there might be a large number of qualifying investors)
  3. Qualitative and quantitative factors specific to both the instrument and the issuer.
A reporting entity holds Class A shares of Company X that are eligible for sale on a national securities exchange or an OTC market. Separately, the reporting entity enters into a contractual arrangement in which it agrees that it will not sell the Class A shares for a certain period of time. That arrangement may be referred to as a lock-up agreement or a market standoff agreement or may be the result of a provision within a separate agreement between certain shareholders (that is, separate from the legal documents that establish the rights and obligations of all holders of a particular class of stock). In that instance, the restriction is not included in the unit of account and therefore is not a characteristic of the asset. The equity security subject to a contractual sale restriction is identical to an equity security that is not subject to a contractual sale restriction. Therefore…the fair value of the equity security subject to the contractual sale restriction should be measured on the basis of the market price of the same equity security without the contractual sale restriction and should not be adjusted to reflect the reporting entity’s inability to sell the equity security on the measurement date.

Questions? I can be reached at 516.806.1193 | BMannFalk@berdonllp.com or reach out to your Berdon Advisor.

Bonnie Mann Falk is a Partner in the Quality Control (QC) Department of Berdon LLP with over 30 years of experience in public accounting and expertise in a variety of areas including quality management, compliance, and risk management. As a QC Partner, Bonnie advises the Firm on policies and procedures to enhance quality, increase efficiency, and elevate communication.

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