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lotter on DSK11XQN23PROD with RULES1

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Federal Register / Vol. 86, No. 228 / Wednesday, December 1, 2021 / Rules and Regulations
minimum information needed to achieve the Topics disclosure objectives.52 Under that guidance, Company B is required to disclose the expected volatility and the method used to estimate it.53 Accordingly, the staff expects that, at a minimum, Company B
would disclose in a footnote to its financial statements how it determined the expected volatility assumption for purposes of determining the fair value of its share options in accordance with FASB ASC Topic 718. For example, at a minimum, the staff would expect Company B to disclose whether it used only implied volatility, historical volatility, or a combination of both, and how it determined any significant adjustments to historical volatility.
In addition, Company B should consider the requirements of Regulation SK Item 303b3 regarding critical accounting estimates in MD&A. A
company should determine whether its evaluation of any of the factors listed in Questions 2 and 3 of this section, such as consideration of future events in estimating expected volatility, resulted in an estimate that involves a significant level of estimation uncertainty and has had or is reasonably likely to have a material impact on the financial condition or results of operations of the company.
Facts: Company C is a newly public entity with limited historical data on the price of its publicly-traded shares and no other traded financial instruments.
Company C believes that it does not have sufficient company-specific information regarding the volatility of its share price on which to base an estimate of expected volatility.
Question 6: What other sources of information should Company C
consider in order to estimate the expected volatility of its share price?
Interpretive Response: FASB ASC
Topic 718 provides guidance on estimating expected volatility for newlypublic and nonpublic entities that do not have company-specific historical or implied volatility information available.54 Company C may base its estimate of expected volatility on the historical, expected or implied volatility of similar entities whose share or option prices are publicly available. In making its determination as to similarity, Company C would likely consider the industry, stage of life cycle, size and financial leverage of such other entities.55
52 FASB
53 FASB

ASC paragraph 71810501.
ASC subparagraph 71810502f 2

ii.
54 FASB ASC paragraphs 718105525 and 718
105551.
55 FASB ASC paragraph 718105525.

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The staff would not object to Company C looking to an industry sector index e.g., NASDAQ Computer Index that is representative of Company Cs industry, and possibly its size, to identify one or more similar entities.56
Once Company C has identified similar entities, it would substitute a measure of the individual volatilities of the similar entities for the expected volatility of its share price as an assumption in its valuation model.57 Because of the effects of diversification that are present in an industry sector index, Company C
should not substitute the volatility of an index for the expected volatility of its share price as an assumption in its valuation model.58
After similar entities have been identified, Company C should continue to consider the volatilities of those entities unless circumstances change such that the identified entities are no longer similar to Company C. Until Company C has sufficient information available, the staff would not object to Company C basing its estimate of expected volatility on the volatility of similar entities for those periods for which it does not have sufficient information available.59 Until Company C has either a sufficient amount of historical information regarding the volatility of its share price or other traded financial instruments are available to derive an implied volatility to support an estimate of expected volatility, it should consistently apply a process as described above to estimate expected volatility based on the volatilities of similar entities.60
2. Expected Term FASB ASC paragraph 718105529
states, The fair value of a traded or transferable share option is based on its contractual term because rarely is it economically advantageous to exercise, 56 If a company operates in a number of different industries, it could look to several industry indices.
However, when considering the volatilities of multiple companies, each operating only in a single industry, the staff believes a company should take into account its own leverage, the leverages of each of the entities, and the correlation of the entities stock returns.
57 FASB ASC paragraph 718105551.
58 FASB ASC paragraph 718105525.
59 FASB ASC paragraph 718105537. The staff believes that at least two years of daily or weekly historical data could provide a reasonable basis on which to base an estimate of expected volatility if a company has no reason to believe that its future volatility will differ materially during the expected or contractual term, as applicable, from the volatility calculated from this past information. If the expected or contractual term, as applicable, of a share option is shorter than two years, the staff believes a company should use daily or weekly historical data for at least the length of that applicable term.
60 FASB ASC paragraph 718105540.

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rather than sell, a transferable share option before the end of its contractual term. Employee share options generally differ from transferable or tradable share options in that employees cannot sell or hedge their share optionsthey can only exercise them; because of this, employees generally exercise their options before the end of the options contractual term. Thus, the inability to sell or hedge an employee share option effectively reduces the options value compared to a transferable option because exercise prior to the options expiration terminates its remaining life and thus its remaining time value.
Accordingly, FASB ASC Topic 718
requires that when valuing an employee share option under the Black-ScholesMerton framework the fair value of employee share options be based on the share options expected term rather than the contractual term.
FASB ASC paragraph 718105529A
states, On an award-by-award basis, an entity may elect to use the contractual term as the expected term when estimating the fair value of a nonemployee award to satisfy the measurement objective in paragraph 71810306. Otherwise, an entity shall apply the guidance in Topic 718 in estimating the expected term of a nonemployee award, which may result in a term less than the contractual term of the award. If an entity does not elect to use the contractual term as the expected term, similar considerations discussed in paragraph 718105529, such as the inability to sell or hedge a nonemployee award, apply when estimating its expected term.
The staff believes the estimate of expected term should be based on the facts and circumstances available in each particular case. Consistent with our Topic 14 introductory guidance regarding reasonableness, the fact that other possible estimates are later determined to have more accurately reflected the term does not necessarily mean that the particular choice was unreasonable. The staff reminds registrants of the expected term disclosure requirements described in FASB ASC subparagraph 7181050
2f2i.
Facts: Company D utilizes the BlackScholes-Merton closed-form model to value its share options for the purposes of determining the fair value of the options under FASB ASC Topic 718.
Company D recently granted share options to its employees. Based on its review of various factors, Company D
determines that the expected term of the options is six years, which is less than the contractual term of ten years.

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