In the ever-changing business landscape, compensation has changed dynamically, and stock-based compensation is more important than ever in attracting top talent. ASC 718 is an extremely comprehensive framework that aims to ensure accurate financial reporting for all equity-based compensation.
ASC 718, also known as Accounting Standards Codification 718, is a set of guidelines established by the Financial Accounting Standards Board (FASB) for the accounting and reporting of stock-based compensation. It is essential for companies that offer employee compensation plans, as it outlines the measurement, recognition, and presentation of stock-based compensation expenses in financial statements.
In this blog, we will delve into the intricacies of ASC 718, providing a comprehensive understanding of its key components and implications for businesses.
ASC 718, also known as Accounting Standards Codification 718, is the single source of principles for the accounting and reporting of stock-based compensation. It provides guidance on the measurement, recognition, and presentation of stock-based compensation expenses in financial statements.
If you're a company that provides stock-based compensation to your employees, it's crucial to be well versed in ASC 718. This set of guidelines, established by the Financial Accounting Standards Board(FASB), governs the accounting and reporting of stock-based compensation, including stock options, restricted stock, and other equity-based compensation arrangements.
ASC 718 covers the reporting of stock-based compensation, including employee stock awards, on an income statement. It requires companies to report details such as the granting date, exercise prices of each share, the number of shares issued, and the fair value of the shares received. The reporting process consists of determining the value of options, allocating and amortizing expenses, and reflecting compensation expenses on the income statement.
The operational framework of ASC 718 revolves around fair value measurement and the subsequent recognition of compensation costs. Businesses are required to estimate the fair value of stock options using established models like the Black-Scholes model. For other equity instruments, the fair value is typically determined based on the market price of the company's stock on the grant date.
Recognition of compensation cost occurs over the vesting period, reflecting the time during which employees fulfill the service requirements tied to the granted equity instruments. It also addresses the potential impact of forfeitures, ensuring adjustments are made if actual forfeitures deviate from initial estimates.
When issuing stock options or restricted stock units (RSUs) to employees, companies must ensure that these equity grants are recorded as an expense on their financial statements. This is done through the application of ASC 718, which provides guidelines for expensing employee-stock-based compensation. The process of expensing stock options under ASC 718 consists of two main steps:
1. Calculating the fair value of the option and;
2. Allocating the expense over the option's useful economic life.
To calculate the fair value of an option, companies must input specific data points into a chosen valuation model. Key inputs include:
1. Strike price: The price at which the option can be exercised.
2. Price of the underlying security: The price assigned to the company's common stock as determined by an independent 409A valuation.
3. Term of the option: Its time to expiration.
4. Volatility of the price of the underlying security: The variance of the stock price over time.
5. Interest rate
These inputs help determine the fair value of the option, which represents the price at which the option would be purchased in an open market.
After determining the fair value of the option, the next step is to allocate the expense over the option's useful economic life. This is the period during which the option continues to incentivize and compensate the option holder. Most often, options vest over time, so their useful economic life generally aligns with their vesting period.
Under this method, the option is treated as a single expense and allocated on a straight-line basis over thefull-service period. For example, if a grant vests over four years, this method allocates 25% of the granteach year.
Alternatively, the FIN28 method treats each vesting increment as a separate award and expenses accordingly. For instance, if an equity grant vests over four years with the same number of shares vesting each year, the shares vesting in year one would be allocated over one year, the shares vesting in year two would be allocated over two years, and so on.
Upon completing both steps, the resulting compensation expenses are then reflected on the company's income statement.
As required by ASC 718, you will need to provide a detailed disclosure summary, which is essentially as tock option balance sheet for your company. This summary should include all information collected in the previous steps regarding active grants, such as options granted, exercised, forfeited, and expired.
ASC 718 imposes obligations for compliance regulations on private and public companies that issue stock-based awards. Public companies are to ensure they adhere to the standard of financial transparency, and though private companies are also to comply with regulations, they are provided with certain reporting exemptions. This enables companies to be held accountable for accurate financial reporting in the realm of stock-based compensation, regardless of their size or status.
Compliance with ASC 718 also involves robust disclosure practices- companies are duly obligated to disclose detailed information in their financial statements regarding the nature and extent of stock-based compensation plans. Disclosures must include the methodology used to determine fair value, the impact on financial statements and changes made in accounting policies regarding stock-based awards.
To achieve thorough compliance with ASC 718, companies must continuously assess their stock-based compensation programs, ensuring they align with the necessary principles. Key considerations involve regular evaluations of the fair value determination methods, keeping regular disclosure updates and maintaining transparency with stakeholders. By prioritizing these considerations, companies could easily navigate through the complexities of the ASC 718.
In conclusion, ASC 718 is a vital set of guidelines that govern the accounting and reporting of stock based compensation. Whether you're a public or private company, understanding the key components of ASC 718, such as valuation of options, grant date determination, and expense allocation, is essential for accurate financial reporting and compliance with accounting standards. By familiarizing yourself with ASC 718 and its reporting requirements, you can ensure that your company remains compliant and well prepared for various financial transactions and audits