Implementation of ASU 2022-03: Valuation of Restricted Securities

Background

In June 2022, the Financial Accounting Standards Board (“FASB”) issued amendments to Topic 820 – Fair Value Measurement of Equity Securities Subject to Contractual Sale Restrictions (the “ASU”). The FASB issued this ASU to clarify the guidance in Topic 820when measuring the fair value of an equity security subject to contractual restrictions that prohibit the sale of an equity security, to amend a related illustrative example, and to introduce new disclosure requirements. The ASU was issued to address the diversity in practice on whether the effects of a contractual restriction that prohibits the sale of an equity security should be considered in measuring that equity security’s fair value. Financial statement users asserted that Topic 820 contained conflicted guidance on what the unit of account is when measuring the fair value of an equity security. The ASU provides clarification within Topic 820 as it relates to this matter.   

Main Provisions and New Required Disclosure

The main provisions of the ASU clarify that a contractual restriction on the sale of an equity security is not considered part of the unit of account of the equity security, and thus is not considered in measuring fair value. The ASU also clarifies that an entity cannot, as a separate unit of account, recognize and measure a contractual sale restriction. A contractual sale restriction is a characteristic of a reporting entity holding the equity security rather than a characteristic of the asset, and therefore is not considered in measuring the fair value of an equity security.  The ASU requires entities to disclose the following for equity securities subject to contractual sale restrictions:

• The fair value of equity securities subject to contractual sale restrictions reflected in the balance sheet.
• The nature and remaining duration of the restriction(s).
• The circumstances that could cause a lapse in the restriction(s).

Examples

The following is an example for when a restriction is taken into account:

ABC Company issues Class A shares through a sale on a national securities exchange or an over-the-counter market as well as through a private placement transaction. Since 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 over-the-counter 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. Since that restriction would be included within 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 over-the-counter market when pricing the equity security; thus, 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 situation, 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 impact of the restriction.

The following is an example for when a restriction is not taken into account:

A reporting entity holds Class A shares of ABC Company that are eligible for sale on a national securities exchange or an over-the-counter 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 duration 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. In that case, the restriction is not included in the unit of account and therefore is not a characteristic of the asset. The equity security subject to the contractual sale restriction is identical to an equity security that is not subject to a contractual sale restriction. Thus, 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 the fair value should not be adjusted to reflect the reporting entity’s inability to sell the equity security on the measurement date.

Effective Date and Transition

The ASU is effective for public business entities for annual periods, including interim periods within those annual periods, beginning after December 15, 2023, and for private entities for annual periods, including interim periods within those annual periods, beginning after December 15, 2024.

For all entities, other than investment companies as defined under Topic 946, Financial Services – Investment Companies, the amendments in this ASU should be applied prospectively with any adjustments from the adoption of the amendments recognized in earnings and disclosed on the date of adoption. An entity that qualifies as an investment company under Topic 946 should apply the amendments in this ASU to an investment in an equity security subject to a contractual sale restriction that is executed or modified on or after the date of adoption. An investment company with an equity security subject to a contractual sale restriction that was executed before the date of adoption should continue to account for the equity security until the contractual restrictions expire or are modified using the accounting policy applied before the adoption of the amendments.