In the United States, your financials are audited to ensure they comply with GAAP (Generally Accepted Accounting Principles) requirements. Financials that are clean, audited, and compliant make scaling to subsequent stages simpler. They assist you in completing due diligence and closing finance. ASC 718 is the stock-based reporting standard that every founder needs to know and follow. ASC 718 is utilized to expense the fair market value of these awards in your income statement as compensation when you give equity to your workers, advisers, and other stakeholders. In this article, we discuss further on ASC 718 and why it is important for every business owner.
ASC 718 and its reporting
Employee stock-based compensation is expensed on an income statement in accordance with ASC 718. Equity awards are a type of remuneration that is subject to a set of accounting standards known as ASC 718 that corporations must adhere to. Expense accounting was previously known as FAS 123 (r), but it is now governed by ASC 718.
Understand ASC 718 and ASC 718 reporting
In corporate accounting, ASC 718 concerns the correct reporting of stock-based remuneration. ASC 718 stands for Accounting Standards Codification Topic No. 718. It is widely accepted as the norm for expensing equity payments to both workers and non-employees by businesses.
Types of ASC 718
ASC 718 is divided into six subtopics, each of which is described below :
- 718-10 Overall – The Overarching Subtopic provides broad information on employee share-based payment agreements.
- 718-20 Awards Classified as Equity – ASC 718-20 states that it provides advice for equity-classified share-based payment awards. It’s also “interrelated with Subtopic 718-10, which provides advice for instruments categorized as either equity or liabilities issued in share-based payment transactions”.
- 718-30 Awards Classified as Liabilities – ASC 718-30 states that it provides guidelines for share-based payment awards that are categorized as liabilities, but it is also linked to ASC 718-10, which covers both liabilities and equity awards.
- 718-40 Employee Stock Ownership Plans – Employee stock ownership plans are addressed in ASC 718-40, which lists the following reasons for businesses that use these plans: A matching program must be funded to support a sponsor’s 401(k) savings plan, formula-based profit-sharing plan, and other employee benefits. To raise fresh funds or to establish a market for existing stock.
- 718-50 Employee Share Purchase Plans – Employee Share Purchase Programs is a subtopic offering advice to companies implementing employee stock purchase plans.
- 718-740 Income Taxes – A state’s franchise tax legislation was altered to include a tax on income that was allocated to the state based on the federal tax return. On January 1, 1992, the new tax went into force.
Why do companies need ASC 718?
The valuation of equity-based employee pay is required for financial reporting purposes. A firm that pays its workers stock-based compensation must account for the fair value of such awards in its financial reporting, according to ASC 718. The cost of stock-based remuneration is amortized over the employee’s service duration of the vesting period. Independent third-party value specialists can perform valuations and provide support for the amount to be expensed. Employees that get stock or stock options as a form of pay rather than cash are said to be on a stock-based compensation plan. Because they don’t have enough money to pay people competitively, most startups adopt stock compensation.
When should companies prepare for ASC 718 reporting?
Most businesses publish financial statements, but this isn’t always the case for early-stage, privately-held businesses that aren’t yet profitable. When a company incorporates external parties, such as institutional investors, it must submit conventional financial reporting on a regular basis (usually annually or quarterly). These financial reports allow investors to reduce risk by keeping track of and managing the firm’s transactions in which they have invested. The ASC 718 report is a tiny but crucial part of the financials that are a requirement of the investor’s information rights. After funding a Series A or B, most firms will prepare financials (including an ASC 718 report) for the first time. It’s also about this time in a company’s existence that it starts to make revenue. Once a firm has generated income, it is typical for it to undergo an external audit by an accountant, which will require submitting an ASC 718 report.
ASC 718 setup
Under current accounting rules, an employer must estimate forfeitures (resulting from failure to provide the required service) when recognizing compensation expenditures for all share-based payments (equity or liability). Under the new rules, a corporation can decide whether to estimate the number of awards that will vest or to account for forfeitures on an enterprise-wide basis.
ASC implementation when considering expensing employee options
Companies must account for the fair value of those awards in their financial statements under ASC 718, which normally begins on the date the awards are issued. This article addresses the most important accounting features of ASC 718, focusing on employee rewards given by public businesses. SC 6 discusses additional considerations for employee incentives given by non-public businesses. SC 7 deals with the accounting for rewards given to non-employees.
What does the ASC 718 report include?
In corporate accounting, ASC 718 concerns the correct reporting of stock-based remuneration. It’s ASC 718, which stands for Accounting Standards Codification Topic No. 718. It is widely accepted as the norm for expensing equity payments to both workers and non-employees by businesses.
- Valuation – A valuation is the process of assessing the fair worth of an asset or a company. In general, a company’s worth may be determined on an absolute or relative basis compared to other similar firms or assets.
- Legal terms – A lawsuit is a legal action brought in a court of law to resolve a disagreement between two people or organizations. Liability awards are valued at each reporting date, whereas equity awards are valued at the grant date.
- Expense report – An expense report is a list of expenses that were incurred on behalf of the company that is classified and itemized. This report assists the employer or finance team in determining how much money was spent, what was purchased, and how much of the cost was reimbursed.
- Financial information – Financial data is information on a person’s or company’s monetary transactions. Creditors and lenders use this information to calculate credit risk assessments.
- Disclosure summary – In this section of the report, the disclosure summary gives an in depth methodology of how you obtained your option valuation. It also displays your company’s projected expenses. In other words, the disclosure summary is a balance sheet of your company’s option and restricted stock award.
How to calculate ASC 718 expense?
The total stock compensation expenditure is computed by multiplying the number of stock options given by the grant date’s fair market value.
Black schooled method
Black-Scholes is a pricing model that uses six factors to calculate a call or put option’s fair price or theoretical value, including volatility, option type, underlying stock price, time, strike price, and the risk-free rate. The Black-Scholes model, commonly known as the Black-Scholes-Merton (BSM) model, is one of the most fundamental concepts in current financial theory.
A lattice-based model
A binomial tree is used to determine the many pathways the price of an underlying asset, such as a stock, may follow during the life of the derivative in a lattice-based model. A binomial tree visually depicts the various potential values that option prices might have across various time periods.
Important tax considerations to follow for stock options
During our engagements, we’ve seen that organizations frequently underestimate the entire expense of granting share-based compensation. The timing and quantity of option expenditure can be affected by various terms and conditions. The number of awards made might raise the valuation expenses as well as the accounting work required to comply with ASC 718. Compensation committees can better align the costs and benefits of share-based compensation programs.
Why choose Eqvista to maintain accurate ASC 718 reporting?
With all of the information on how options should be expensed and what the ASC 718 is all about, you can now pick one of the employee stock plans from the list and start issuing them to your workers. However, make sure you have your cap table ready to keep track of all the shares that are coming in and going out of your firm. Eqvista can help you with your ASC 718 reporting. Interested to learn more? Contact us today!