Share-based payment – Reporting and everything you should know
This article aims to provide in-depth knowledge of share-based payment.
When it comes to initiating payments for business transactions, traditional methods rely on the use of cash, cheque, or bank transfers. Along with improved technical developments, there has been a shift towards a more effective form of payment called share-based payment. They are similar to traditional payments in the sense that it is still traded between two parties. However, it involves the use of equity instruments of the company as a means of payment. The purpose of share-based payment is to facilitate the transmission of equity instruments in a transparent and efficient manner. It provides a viable alternative to cash and cheques, making the exchange of equity instruments completely mobile. This article aims to provide in-depth knowledge of share-based payment.
Share-based payment and reporting
Companies issue share-based payments in exchange for goods/services or even as compensation for employees, known as stock-based compensation. It is governed by a set of rules and specific regulations in regard to all the transactions. Equity instruments are classified according to their functions and then further classified into shares or options. The Financial Accounting Standards Board (FASB) requires businesses to report share-based payment transactions according to specific guidelines.
As such, the requirements for Share-based payment reporting are to disclose the information on the number of shares or options issued, their fair market values, and trading volumes. It has proven to be a great tool for companies to acquire goods or services from other parties. This can be traded over the counter and have a wide range of uses within the company. Therefore, it is essential for companies to adopt ASC 718 reporting for their share-based payments in a timely and accurate manner.
What is share-based payment?
Share-based payment is a contractual payment exchange between two parties for goods or services where the payment is made using equity instruments. It is transacted over the counter and is usually governed by a set of rules and regulations. Typically, the equity instruments used for share-based payments include shares or options, each of which has a specific role in the transaction. As such, the fair market value of the equity instrument plays a major role in the share-based payment.
It is important for companies to be up to date with the latest guidelines and regulations in relation to the share-based payment. Therefore, it is a powerful mechanism for companies to acquire goods or services from other parties.
How does Share-based payment work?
Share-based payment offers a seamless and transparent exchange of equity instruments by using shares or options. Basically, it is a transaction where a company issues shares or options to the supplier on an agreed basis and in exchange for either goods or services. The process of share-based payment is a highly regulated process and requires the use of specific accounting and financial reporting guidelines. This is due to the fact that equity instruments are highly liquid, which means that they can be easily exchanged and traded.
As such, it is imperative that share-based payment reporting follow the established set of rules and regulations. While the working of share-based payment is straightforward, either simply transferring of equity takes place or the entity receives goods or services based on the price or value of equity instruments. It is an effective way to acquire goods or services while improving operational efficiency by reducing cash-based payments and eliminating costly bank processing fees.
Types of share-based payment
While the main overview of share-based payment has been provided, there are three types of share-based payment. Following are the three types:
- Equity payment – Equity-based payments involve the issuance of shares or options to suppliers in exchange for goods or services. The companies would then record the transaction by recognizing liability for the shares or options issued to the supplier when the goods or services are received. Share-based payment reporting obligations should be met by the company issuing the instruments at the time of granting the shares or options.
- Cash payment – Cash-based payments are usually made for goods and services based on the price or value of those equity instruments. In other words, when an entity was to issue equity instruments for cash, but rather than getting cash in lieu of equity instruments, they can receive the goods or services contracted in the share-based payment. In this regard, determining the fair market value of the equity instruments is crucial under the cash-based payment as the amount of goods or services is totally dependent on the price of the equity instruments.
- Share-based payment with cash alternatives – This type of share-based payment is a hybrid between cash-based and equity-based payments. In this case, the entity can receive goods or services by choosing either cash-settled or equity-settled share-based payment. It gives the flexibility to the entity to receive either cash or equity instruments based on their needs.
How to decide the value of the share-based payment?
The value of an equity instrument is the selling price that would be received if the company were to sell those instruments. In other words, the amount at which the company could potentially liquidate those instruments to a third party or in a stock market. Therefore, using fair market value and intrinsic value is the best way to determine the value of those instruments. Here is a brief guide on how to determine the value of share-based payment:
- Calculate fair market value – Since equity is a tradable asset, its fair market value can be determined by applying the principles of valuation. In the case of privately listed companies, 409A valuation is used to determine fair market value. While in the case of publicly listed companies, the company’s share price is used to determine fair market value. Be aware of the facts that affect the price of publicly traded instruments, such as an increase or decrease in a company’s market value, industry outlook, and the impact of actions on stock prices.
- Calculate intrinsic value – Intrinsic value refers to the economic value of a company’s assets. The most commonly used models to calculate intrinsic value include the discounted cash flow method and the asset-based approach. Thus, with the required data, your equity instruments’ fair value can be determined. Knowing the fair market and intrinsic value of an equity instrument is vital in order to make a sound decision. But when does Share-based payment apply?
When do companies consider share-based payment?
In today’s world, share-based payment is considered to be an excellent alternative to other forms of cash flow financing. As the economy continues to evolve and improve, companies are looking for new ways to cut costs while increasing overall productivity. Given that it allows companies to utilize their equity instruments in order to buy goods or services, it is a highly attractive option for most companies, even though it adds a significant amount of share-based payment reporting to the accounting department.
Additionally, companies can adopt share-based payment awards as a way to attract and retain top talent, while it is referred to as stock-based compensation. In this regard, ASC 718 reporting is very important in calculating and reporting share-based payment awards. It states that the non-cash expense, such as the issuance of stock-based compensation, should be included in the income statement. Hence, share-based payment reporting compliance is crucial to any company’s operations.
Tax implications for share-based payment
Because of its significant impact on the company’s financial well-being, it is vital that share-based payment management is done correctly in order for companies to avoid penalties and fines. While at the time of the stock being appreciated, the company becomes subject to tax on the appreciation of their share. Usually, in the case of employee share-based payment, the taxation policy is treated as part of salary and is accordingly taxed.
As such, share-based payment for acquiring goods or services may have different tax implications. However, the taxation of share-based payment for selling stocks must be done carefully in order for companies to avoid penalties and fines. Therefore, it is imperative that companies appoint a tax advisor who can help them prepare taxes on a regular basis. Well, how to report share-based payment?
Reporting and accounting for share-based payment
Under ASC 718 reporting, it is necessary for companies to report the share-based payments when granted to employees as a part of compensation on their financial statements as a non-cash expense. However, in the case of share-based payment for goods or services, the company is usually required to record a liability in its financial statements. Under the ASC 718 accounting policies, companies are required to make a reasonable estimate of the fair market value of their equity instruments and expense those instruments accordingly. Hence, the disclosure of share-based payments is crucial for companies in order to prepare a complete financial statement.
Accounting standards for share-based payment
It is mandated for an entity to recognize share-based payment transactions, including shares that are granted, share options, or share appreciation rights in its financial statements. In addition, the transactions with employees or other parties are to be settled in the entity’s cash, other assets, or equity instruments. ASC 718 reporting policies must be carefully followed by each entity in order to create a complete financial statement for each period.
Therefore, the Financial Accounting Standards Board (FASB), the International Accounting Standards Board (IASB), and the Securities Exchange Commission are some regulatory bodies overseeing share-based payment transactions.
How does ASC 718 reporting work for share-based payment?
In order for an entity to disclose its share-based payment transactions, the ASC 718 reporting mandated that each entity must follow certain accounting policies. All transactions with employees or other parties must be accounted for by the entity under non-cash expenses. Following are the main mandatory accounting policies for the reporting of share-based payment transactions:
- Identify the scope of stock-based payment – ASC 718 mandates that when granting share-based payment, each entity must describe the number of shares, the exercise price, and the vesting details of the share-based payment in their financial statements by classifying it as a non-cash expense.
- Classified stock-based payment into equity and liability – After the equity instruments are issued, they must be classified into either equity or liability and included in the entity’s financial statements. If the stock-based payment is made for the purpose of the acquisition of goods or services, the company must record a liability, while for the purpose of stock awards, it must be classified as equity.
- Estimate secondary transaction – In order to give a complete picture of the financial transactions that have been made and their cost, companies must be able to estimate the secondary transaction.
What else do you need for ASC reporting for your stock-based payment?
In order for companies to report their share-based payments, they must carefully follow the ASC 718 reporting policies outlined. From identifying the date of reporting to the classification of equity instruments to the estimation of cost and fair value, companies must follow every step provided in order to create a complete financial statement that is accurate and transparent. Therefore, be sure to consult with a professional who can advise you on the best methods of share-based payment reporting for your organization.
How can Eqvista help with your stock-based payment ASC reporting?
The importance of managing share-based payments is crucial for each company. It is essential to report all transactions in a transparent way in order for companies to prepare accurate financial statements. We highly recommend companies to consult with a certified professional who can help them manage their share-based payment transactions to avoid potential penalties. Eqvista can help you receive the benefits of managing your share-based payments in a clear and systematic manner. The team at Eqvista is dedicated to assisting your organization in all its share-based payment reporting needs. Get in touch with Eqvista now!
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