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Federal Register / Vol. 86, No. 228 / Wednesday, December 1, 2021 / Rules and Regulations change in the valuation technique or model used to meet the fair value measurement objective would not be considered a change in accounting principle.23 As such, a company would not be required to file a preferability letter from its independent accountants as described in Rule 1001b6 of Regulation SX when it changes valuation techniques or models.
However, the staff would not expect that a company would frequently switch between valuation techniques or models, particularly in circumstances where there was no significant variation in the form of share-based payments being valued. Disclosure in the footnotes of the basis for any change in technique or model would be appropriate.24
Question 4: Must every company that issues share options or similar instruments hire an outside third party to assist in determining the fair value of the share options?
Interpretive Response: No. However, the valuation of a companys share options or similar instruments should be performed by a person with the requisite expertise.

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D. Certain Assumptions Used in Valuation Methods FASB ASC Topic 718s CompensationStock Compensation Topic fair value measurement objective for equity instruments awarded to grantees for goods or services is to estimate the grant-date fair value of the equity instruments that the entity is obligated to issue when grantees have delivered the good or rendered the service and satisfied any other conditions necessary to earn the right to benefit from the instruments.25 In order to meet this fair value measurement objective, management will generally be required to develop estimates regarding 1 the expected volatility of its companys share price; 2 the expected term of the option, taking into account both the contractual term of the option and the effects of grantees expected exercise and post-vesting termination behavior; and 3 the determination of the current price of the underlying share. The staff is providing guidance in the following sections related to the technique or model meets the fair value measurement objective. For example, changing a technique or model from period to period for the sole purpose of lowering the fair value estimate of a share option would not meet the fair value measurement objective of the Topic.
23 FASB ASC paragraph 718105527.
24 See generally FASB ASC paragraph 71810
501.
25 FASB ASC paragraph 71810306. FASB ASC
paragraph 71810301 states that this guidance applies equally to awards classified as liabilities.

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expected volatility, expected term and current share price assumptions to assist public entities in applying those requirements.
1. Expected Volatility FASB ASC paragraph 718105536
states, Volatility is a measure of the amount by which a financial variable, such as share price, has fluctuated historical volatility or is expected to fluctuate expected volatility during a period. Option-pricing models require an estimate of expected volatility as an assumption because an options value is dependent on potential share returns over the options term. The higher the volatility, the more the returns on the share can be expected to varyup or down. Because an options value is unaffected by expected negative returns on the shares, other things being equal, an option on a share with higher volatility is worth more than an option on a share with lower volatility.
Facts: Company B is a public entity whose common shares have been publicly traded for over twenty years.
Company B also has multiple options on its shares outstanding that are traded on an exchange traded options.
Company B grants share options on January 2, 20X6.
Question 1: What should Company B
consider when estimating expected volatility for purposes of measuring the fair value of its share options?
Interpretive Response: FASB ASC
Topic 718 does not specify a particular method of estimating expected volatility. However, the Topic does clarify that the objective in estimating expected volatility is to ascertain the assumption about expected volatility that marketplace participants would likely use in determining an exchange price for an option.26 FASB ASC Topic 718 provides a list of factors entities should consider in estimating expected volatility.27 Company B may begin its process of estimating expected volatility by considering its historical volatility.28
However, Company B should also then consider, based on available information, how the expected volatility of its share price may differ from historical volatility.29 Implied volatility 30 can be useful in estimating 26 FASB

ASC paragraph 718105535.
ASC paragraph 718105537.
28 FASB ASC paragraph 718105540.
29 Ibid.
30 Implied volatility is the volatility assumption inherent in the market prices of a companys traded options or other financial instruments that have option-like features. Implied volatility is derived by entering the market price of the traded financial instrument, along with assumptions specific to the financial options being valued, into a model based 27 FASB

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expected volatility because it is generally reflective of both historical volatility and expectations of how future volatility will differ from historical volatility.
The staff believes that companies should make good faith efforts to identify and use sufficient information in determining whether taking historical volatility, implied volatility or a combination of both into account will result in the best estimate of expected volatility. The staff believes companies that have appropriate traded financial instruments from which they can derive an implied volatility should generally consider this measure. The extent of the ultimate reliance on implied volatility will depend on a companys facts and circumstances; however, the staff believes that a company with actively traded options or other financial instruments with embedded options 31
generally could place greater or even exclusive reliance on implied volatility.
See the Interpretive Responses to Questions 3 and 4 below.
The process used to gather and review available information to estimate expected volatility should be applied consistently from period to period.
When circumstances indicate the availability of new or different information that would be useful in estimating expected volatility, a company should incorporate that information.
Question 2: What should Company B
consider if computing historical volatility? 32
Interpretive Response: The following should be considered in the computation of historical volatility:
1. Method of Computing Historical Volatility The staff believes the method selected by Company B to compute its historical volatility should produce an estimate that is representative of a marketplace participants expectations about Company Bs future volatility over the expected if using a Black-ScholesMerton closed-form model or contractual if using a lattice model on a constant volatility estimate e.g., the BlackScholes-Merton closed-form model and solving for the unknown assumption of volatility.
31 The staff believes implied volatility derived from embedded options can be utilized in determining expected volatility if, in deriving the implied volatility, the company considers all relevant features of the instruments e.g., value of the host instrument, value of the option, etc.. The staff believes the derivation of implied volatility from other than simple instruments e.g., a simple convertible bond can, in some cases, be impracticable due to the complexity of multiple features.
32 See FASB ASC paragraph 718105537.

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