FASB ASU No. 2022-03
Fair Value Measurement of Equity Securities Subject to Contractual Sale Restrictions
The amendments in ASU No. 2022-03 (1) clarify the guidance in Topic 820, Fair Value Measurement, when measuring the fair value of an equity security subject to contractual restrictions that prohibit the sale of an equity security, (2) amend a related illustrative example, and (3) introduce new disclosure requirements for equity securities subject to contractual sale restrictions that are measured at fair value in accordance with Topic 820. This Update affect all entities that have investments in equity securities measured at fair value that are subject to a contractual sale restriction.
ASU No. 2022-03 clarifies 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, therefore, is not considered in measuring fair value. The amendments also clarify that an entity cannot, as a separate unit of account, recognize and measure a contractual sale restriction. The amendments also require the following disclosures for equity securities subject to contractual sale restrictions: 1) The fair value of equity securities subject to contractual sale restrictions reflected in the balance sheet; 2) The nature and remaining duration of the restriction(s); and 3) The circumstances that could cause a lapse in the restriction(s).
The FASB emphasized that ASU No. 2022-03 does not change the principles of fair value measurement. The amendments seek to clarify those principles when measuring the fair value of an equity security subject to a contractual sale restriction and improve current GAAP by reducing diversity in practice as well as the cost and complexity in measuring fair value, and increasing comparability of financial information across reporting entities that hold those investments. Below are two examples, adapted from ASU No. 2022-03, to illustrate the guidance.
Example 1 – Restriction on Equity Security Reflected in Fair Value Measurement
Class A shares are sold on a national securities exchange, an over-the-counter market, as well as through a private placement transaction. The Class A shares issued through a 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.
Because 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; 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.
Example 2 – Restriction on Equity Security Not Reflected in Fair Value Measurement
A reporting entity holds Class A shares 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 time period. 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 the 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.
Effective Dates: For public business entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2023, and interim periods within those fiscal years. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2024, and interim periods within those fiscal years. Early adoption is permitted for both interim and annual financial statements that have not yet been issued or made available for issuance.
For all entities except investment companies as defined under Topic 946, Financial Services—Investment Companies, the amendments in this Update 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 Update 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 (that is, if an investment company was incorporating the effects of the restriction in the measurement of fair value, it would continue to do so).