Contractual Sale Restrictions and The Use of Fair Value (ASC 820)

Fair value is used to measure a variety of assets and liabilities in U.S. GAAP; therefore it is a key concept, or as the FASB refers to it, a “broad transaction” that is defined by a single standard, ASC 820. ASC 820 defines fair value and provides a framework for measuring fair value. However, there are lots of nuances in this framework, many of which are addressed in the “Implementation and Illustration Guidance” section of ASC 820.

One of those nuances involves contractual restrictions on the sale of an asset. This post will explore the guidance surrounding this topic.

Example: Contractual sale restrictions and the use of fair value

Gose cannot include a discount to reflect the effect of contractual sale restrictions when determining the fair value of such investments!

ASC 820 accounting guidance

ASC 820 states that a “contractual sale restriction prohibiting the sale of an equity security is a characteristic of the reporting entity holding the equity security” and, therefore, the entity should not consider the contractual sale restriction when measuring the equity security’s fair value, meaning the entity should not apply a discount related to the contractual sale restriction.

Therefore, Gose should measure the fair value of such investments using the price of an identical security in its principal market and is not subject to such a contractual sale restriction (i.e., price x quantity).

Security-specific vs. entity-specific characteristics

With respect to restrictions on the sale of equity securities, the guidance within ASC 820 has always stated that if the restriction was security-specific, meaning the restriction would transfer to a market participant, then the effect of the restriction should be considered when determining fair value.

ASC 820 recently added an example of a security-specific restriction involving shares issued through a private placement that are not registered and are legally restricted from being sold on a national securities exchange or over-the-counter market.

Conversely, the effects of entity-specific restrictions are not reflected in a fair value measurement since such restrictions would not transfer to a market participant. However, there was diversity in practice on whether the effects of a contractual restriction that prohibits the sale of an equity security, such as the one in our example, should be considered in measuring that equity security’s fair value.

ASC 820 recently clarified 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. Examples of such restrictions include lock-up agreements and market standoff agreements that are often found in capital-raising and other transactions such as business combinations.

Other clarifications

ASC 820 includes several new disclosures related to equity securities that are subject to contractual sale restrictions, such as:

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

If you’re looking for more information, check out our Fair Value: Restrictions on the Sale of Assets microlearning or visit our Fair Value Measurements topic page!

About GAAP Dynamics
We’re a DIFFERENT type of accounting training firm. We view training as an opportunity to empower professionals to make informed decisions at the right time. Whether it’s U.S. GAAP, IFRS, or audit training, we’ve trained thousands of professionals since 2001, including at some of the world’s largest firms. Our promise: Accurate, relevant, engaging, and fun training. Want to know how GAAP Dynamics can help you? Let’s talk!

Disclaimer
This post is for informational purposes only and should not be relied upon as official accounting guidance. While we’ve ensured accuracy as of the publishing date, standards evolve. Please consult a professional for specific advice.