ASC 718, also known as Compensation-Stock Compensation, is an essential accounting standard that governs the way companies report stock-based compensation in their financial statements. Stock compensation, such as stock options, restricted stock units (RSUs), and performance shares, is increasingly used by companies to attract and retain talent. 

However, without proper accounting, these equity-based rewards can create discrepancies in a company’s financial reporting. That’s where ASC 718 comes in, ensuring businesses record the fair value of stock compensation accurately and consistently. 

What is ASC 718 & Why is it Important?

ASC 718 is a standard issued by the Financial Accounting Standards Board (FASB) that sets out the rules for accounting for stock-based compensation, such as stock options and employee equity awards. 

It requires companies to recognize the fair value of stock compensation as an expense over the period in which employees earn the rewards (often called the vesting period). This ensures transparency and consistency in financial reporting.

Why is ASC 718 Important for Businesses?

Proper compliance with ASC 718 is crucial for maintaining accurate financial statements, especially for publicly traded companies, as misreporting stock compensation can lead to misleading financial results. 

For investors, transparent accounting of stock-based compensation provides a clearer picture of a company’s financial health and profitability.

Who Needs to Follow ASC 718?

ASC 718 applies to all companies—both public and private—that offer equity-based compensation to employees, consultants, or board members. 

Startups that use stock options to attract talent, as well as established businesses with complex stock compensation plans, must adhere to these guidelines to avoid accounting errors and ensure compliance with the U.S. Generally Accepted Accounting Principles (GAAP).

Types of Stock Compensation Covered Under ASC 718

ASC 718 covers a variety of stock compensation arrangements, and it’s essential to understand how each type is treated from an accounting perspective. The most common forms of stock-based compensation include employee stock options, restricted stock units (RSUs), and performance shares. 

1. Employee Stock Options

Employee stock options give employees the right to purchase company stock at a predetermined price, often called the exercise price or strike price

Under ASC 718, companies must recognize the fair value of the stock option on the grant date and record it as an expense over the option’s vesting period. 

This requires careful valuation, often using the Black-Scholes model or other complex financial methods, to ensure the stock option’s fair value is accurately reflected in the company’s financial statements.

2. Restricted Stock Units (RSUs)

RSUs are promises to deliver shares of company stock to employees once they meet specific conditions, such as completing a certain period of service. 

Unlike stock options, RSUs don’t require employees to purchase shares; instead, they receive the shares outright when the vesting conditions are met. 

ASC 718 requires companies to measure the fair value of RSUs on the grant date and recognize the expense over the vesting period, similar to stock options.

3. Performance Shares

Performance shares are equity awards that are granted based on the achievement of specific performance goals, such as meeting revenue targets or hitting profitability milestones. 

Since these awards are contingent on meeting certain performance criteria, they introduce additional complexities in accounting. Under ASC 718, performance shares are valued on the grant date. 

However, the actual expense recognition may vary depending on the likelihood of achieving the performance targets.

Impact on Financial Statements

All forms of stock-based compensation impact a company’s financial statements, particularly the income statement, balance sheet, and cash flow statement. 

Expenses related to stock compensation are recorded as operating expenses, reducing net income, while equity awards appear on the balance sheet as additional paid-in capital. 

Properly accounting for these awards is essential to providing an accurate picture of a company’s financial health.

Key Steps for ASC 718 Compliance

Complying with ASC 718 requires businesses to follow a series of steps to ensure that stock compensation is accurately recorded in their financial statements. Whether you’re managing stock options, restricted stock units (RSUs), or performance shares, adhering to the proper processes is essential for avoiding financial reporting errors and maintaining transparency. 

Here are the key steps to follow for ASC 718 compliance:

Step 1: Identify Stock-Based Compensation
Start by identifying all stock compensation arrangements, including stock options, RSUs, and performance shares. Review the terms, such as grant date and vesting period, to ensure accurate reporting.

Step 2: Measure Fair Value
Measure the fair value of the stock compensation on the grant date. Use models like Black-Scholes for stock options and market price for RSUs and performance shares, adjusting for performance conditions if necessary.

Step 3: Recognize Expense Over the Vesting Period
Recognize the stock compensation expense over the vesting period, spreading the cost over the time employees earn their rights to the awards.

Step 4: Disclosure Requirements
Meet disclosure requirements by reporting the nature, valuation, and expense of stock compensation in your financial statements to ensure transparency for investors and regulators.

Valuation Techniques Under ASC 718

Valuing stock-based compensation under ASC 718 can be a challenging but essential part of financial reporting. Companies must use accurate models and assumptions to ensure fair value calculations are compliant with the standard. 

Choosing the right valuation method depends on the type of compensation and the complexities involved, such as performance conditions or market volatility.

  • Black-Scholes Model: Best for straightforward stock options, considering factors like stock price, volatility, and interest rates.
  • Monte Carlo Simulation: Ideal for complex awards with performance conditions, running multiple scenarios for future stock prices.
  • RSUs and Performance Shares: Generally valued at the stock’s market price on the grant date, with performance shares requiring additional considerations for meeting targets.
  • Key Assumptions: Include stock price volatility, the expected life of the options, and market trends that impact the valuation.
  • Compliance: Proper valuation ensures transparent financial reporting and adherence to ASC 718 guidelines.

Differences Between ASC 718 and ASC 505 (Equity)

While both ASC 718 and ASC 505 deal with equity compensation, they apply to different types of transactions and have distinct accounting treatments. 

Understanding the differences is important for companies to ensure proper financial reporting and compliance with the correct standard.

Scope: ASC 718 covers stock compensation granted to employees, such as stock options, RSUs, and performance shares, while ASC 505 focuses on equity transactions with non-employees, like consultants or service providers.

Valuation: Under ASC 718, employee stock compensation is valued based on the grant date, whereas ASC 505 often requires fair value measurement at the time services are performed or the equity is issued.

Expense Recognition: For ASC 718, expenses are recognized over the vesting period, aligning with the employee’s service. In ASC 505, the expense recognition is more flexible, depending on when the service is provided or the equity is issued.

Disclosure Requirements: ASC 718 has stricter disclosure requirements, particularly for publicly traded companies, compared to ASC 505, which may involve fewer detailed disclosures.

Common Mistakes in ASC 718 Reporting

Accounting for stock-based compensation under ASC 718 can be complex, and companies often make avoidable mistakes that can lead to financial reporting errors or audit issues. 

  • Inaccurate Fair Value Measurement
  • Incorrect Expense Timing
  • Neglecting Performance Conditions
  • Insufficient Disclosures
  • Inconsistent Assumptions

By addressing these common errors, companies can ensure their ASC 718 reporting is accurate and compliant with FASB guidelines.

Best Practices for Implementing ASC 718

To ensure smooth compliance with ASC 718, companies should adopt several best practices that streamline the accounting process and reduce the risk of errors. These practices help businesses stay consistent, transparent, and compliant in their financial reporting.

  • Automate Valuation and Reporting: Use financial software tools to automate the valuation of stock compensation and track expense recognition over the vesting period. Automation reduces manual errors and simplifies complex calculations.
  • Regularly Review Stock Compensation Plans: Periodically review and update your stock compensation plans to reflect any changes in accounting standards or company policies. This helps maintain compliance and ensure the accuracy of financial reporting.
  • Stay Informed About FASB Updates: Keep up with any changes or updates from FASB regarding ASC 718 to ensure that your company’s practices are current and compliant with the latest standards.
  • Educate Stakeholders: Ensure that all involved parties—HR, accounting teams, and leadership—understand the financial and legal implications of stock-based compensation. Proper education helps align everyone with the compliance process.
  • Work with Financial Advisors: Engage experienced accountants or financial advisors specializing in stock compensation accounting to navigate the complexities of ASC 718 and avoid potential pitfalls.

Summary

ASC 718 ensures accurate reporting of stock-based compensation, such as stock options, RSUs, and performance shares, in financial statements. Compliance is key to maintaining transparency with investors. By identifying stock compensation, using appropriate valuation models, and following best practices like automating processes and ensuring proper disclosures, companies can avoid common mistakes and audit issues. Implementing ASC 718 effectively helps businesses manage their equity awards and maintain financial clarity.