ASC 718 Explained: Key Considerations for Expensing Stock Compensation

Last Updated: May, 2026

ASC 718 is the FASB (Financial Accounting Standards Board) accounting standard that governs how US companies recognize and report equity-based compensation expenses. It applies to both public and private companies following US GAAP and covers stock options, RSUs, phantom stock, and other equity awards.

Key Takeaways

Standard Authority	FASB ASC 718 is the sole authoritative source for equity compensation accounting under US GAAP
Fair Value	Must be measured at grant date using BSM, lattice, or Monte Carlo models
Recent Updates	ASU 2016-09, ASU 2018-07, and ASU 2021-07 made significant changes to implementation
ISO Tax	Both a 2-year grant holding period AND 1-year exercise holding period required; AMT may apply at exercise
Private Companies	PCC alternatives and ASU 2021-07 practical expedient can reduce complexity and cost
Attribution Methods	Straight-line for cliff vesting; graded vesting attribution method for multi-tranche schedules

What is ASC 718?

ASC 718 (Accounting Standards Codification) is a set of accounting standards and principles developed by the Financial Accounting Standards Board (FASB), a non-governmental body.

It requires companies to:

• Measure the fair value of equity awards at the grant date.
• Recognize the expense over the vesting period.
• Disclose the impact on financial statements.

Types of Equity Compensation Covered Under ASC 718

Award Type	Description
Stock Options (ISOs & NSOs)	Right to purchase shares at a fixed price
Restricted Stock Units (RSUs)	Shares granted upon meeting vesting conditions
Performance Share Units (PSUs)	Shares tied to performance metrics
Phantom Stock	Cash-settled awards that mirror stock value
Profit Interest Units (PIUs)	Partnership equity commonly used by LLCs
Employee Stock Purchase Plans (ESPPs)	Discounted stock purchase programs

Why is ASC 718 important?

Among several reasons, the primary role of ASC 718 is related to ensuring accurate financial reporting and compliance for stock-based compensation. Below we added few points highlighting the importance:

• Fair Value measurement – This requires companies to measure the FV of equity awards at grant date and recognize its value over vesting period, which helps to provide a picture of a company’s financial health.
• Transparency and disclosure – Crucial for investors and analysts to know the impact of equity compensation on a company’s financial position and performance.
• Regulatory compliance – Compliance with ASC 718 is crucial for public and private companies seeking to adhere to GAAP and to prepare for IPO or funding rounds.
• Complex transaction guidance – Helps companies to overcome difficult situations of stock-based compensation and ensure compliance, and minimize financial reporting errors.
• Standardization of accounting practices – This helps to ensure the consistency in financial reporting across different companies, making it easier for investors and stakeholders to compare financial statements.

This is why ASC 718 implementation is so important. It is a comprehensive guideline that helps address all the questions and many more across various business structures.

ASC 718 Subtopics: Complete Breakdown

There are six subtopics that comprises ASC 718, each addressing a specific aspect of equity compensation:

• 718-10 Overall – This subtopic gives general guidance on share-based payment arrangements with employees.
• 718-20 Awards Classified as Equity – Under this subtopic, it focuses and gives guidance on share-based payment awards that are classified as equity.
• 718-30 Awards Classified as Liabilities – As compared to 718-20, this subtopic gives guidance share-based payment awards that are classified as liability.
• 718-40 Employee Stock Ownership Plans – For employee stock ownership plans, ASC 718-40 offers guidance and notes the purposes for entities using these plans.
• 718-50 Employee Share Purchase Plans – Under this subtopic, entities have to first determine whether the plan is either compensatory or non-compensatory. Guidance is provided to entities that have employee share purchase plans.
• 718-740 Income Taxes – This subtopic specifically addresses the accounting for current and deferred income taxes that resulted from share-based payment arrangements, including employee stock ownership plans.

Recent FASB Updates to ASC 718 (2016–2024)

The following updates significantly changed ASC 718 implementation and must be considered for full compliance.

ASU 2016-09: Effective Date starts from fiscal years beginning after December 15, 2016 (public entities)

Key changes introduced:

• Excess tax benefits and deficiencies are now recognized in the income statement rather than in APIC.
• Companies may now elect to account for forfeitures as they occur rather than estimating them upfront.
• Excess tax benefits are now classified as operating activities in the cash flow statement.
• Simplified tax withholding rules for net settlement of awards

ASU 2018-07: Effective Date starts from fiscal years beginning after December 15, 2018 (public entities)

Key changes introduced:

• Aligned nonemployee award accounting with employee award accounting under ASC 718
• Prior to this update, awards to nonemployees (consultants, vendors) were governed by ASC 505-50 and required remeasurement until vesting.
• Awards to nonemployees are now measured at grant date fair value, consistent with employee awards.
• Simplified the accounting for equity-classified nonemployee awards significantly

ASU 2021-07: Fiscal years beginning after December 15, 2021

Key changes introduced:

• Private companies can now use a practical shortcut by applying a reasonable valuation method under IRS Section 409A to determine the share price for option pricing.
• Reduces the burden of obtaining a new 409A valuation for every reporting period
• Applies only to liability-classified awards in private companies
• Allows the use of valuations performed within 12 months of the financial reporting date if no material changes have occurred

How does ASC 718 Work? A Step-by-Step Process

When you follow ASC 718, you must take the following three steps:

Step 1: Business valuation (409A Valuation)

In the US, when you issue equity compensation, the Internal Revenue Service (IRS) requires you to get a business valuation compliant with Section 409A of the Internal Revenue Code (IRC), i.e. a 409A valuation. Through a 409A valuation, you will know your company’s Fair Market Value (FMV), i.e. the price that would be fair in a market where your company’s key details are known and understood. The exercise price must be set as per the FMV.

To have the best shot at tax compliance, you must qualify for safe harbor status, for which there are three routes:

• Illiquid startup presumption
• Independent appraisal presumption
• Binding formula presumption

Step 2: Calculating the expenses to the company

Since stock options vest over a schedule, they cannot be recorded all at once. In this regard, the accounting treatment of stock options is similar to that of depreciation. If a stock option has a vesting schedule of 5 years, it will be recorded over 5 years. Under ASC 718, two ways to calculate the amount of stock options to be recorded are:

Method 1: Straight-line method

In the straight-line method, we divide the stock options by years in the vesting schedule. This is the number of stock options to be recorded each year in the vesting schedule.

Suppose SEMyx Laboratories issues 100,000 stock options to Gary McAllister that will vest over the next 5 years.

Then, the number of stock options to be recorded each year for 5 years = 100,000/5 = 20,000

Method 2: FIN28 method

Under the FIN28 method, every vesting increment is treated as a separate award and expense. This is not as complicated as it seems. Let us understand this through an example. Suppose SEMyx is still issuing 100,000 stock options to Gary McAllister with a vesting schedule of 5 years. But this time, they want to use the FIN28 method. So, the calculations for this will look like this:

Calculating stock options vested each year:

Particulars	Amount
Total stock options	100,000
Vesting schedule	5
Stock options vested each year (A/B)	20,000

Calculating the percentage of stock options from each award to be recorded each year:

For every nth award, 1/n of stock options must be recorded until 100% of the stock options in the award are recorded.

Particulars	Vested in year 1	Vested in year 2	Vested in year 3	Vested in year 4	Vested in year 5
First award	100%	0%	0%	0%	0%
Second award	50%	50%	0%	0%	0%
Third award	33%	33%	33%	0%	0%
Fourth award	25%	25%	25%	25%	0%
Fifth award	20%	20%	20%	20%	20%

Calculating stock options expense to be recorded each year:

Particulars	Year 1	Year 2	Year 3	Year 4	Year 5
First award	20,000	0	0	0	0
Second award	10,000	10,000	0	0	0
Third award	6,666.67	6,666.67	6,666.67	0	0
Fourth award	5,000	5,000	5,000	5,000	0
Fifth award	4,000	4,000	4,000	4,000	4,000
Total stock options to be recorded	45,666.67	25,666.67	15,666.67	9,000	4,000

Step 3: Disclosing the expenses in financial statements

Now that you have calculated the stock options to be recorded each year, all you need to do is disclose these details in your financial statements. ASC 718 requires the following disclosures in financial statements:

• Nature and terms of share-based payment arrangements
• Method and assumptions used to estimate fair value
• Compensation cost recognized during the period
• Unrecognized compensation cost and expected recognition period
• Cash flow effects of share-based payment arrangements
• Impact on income tax expense

Calculating Fair Value Pricing Models

ASC 718 calculations are pretty complex and require experienced professionals to regularly track and manage the entire process. Though the expensing rules are standard, now and then some amendments are introduced to improve the process. Based on all these variations, FMV being the cornerstone of this process, the following two methods of pricing are most commonly used:

Black-Scholes method

Otherwise known as BSM, this formula helps in the accurate calculation of FMV at any given time. It also estimates the market price a buyer would be willing to pay in the present time. The accuracy of this method is based on the following assumptions:

• The market is fluid. This means that stock trading remains continuous and regular predictions of market direction or fluctuations in stock price are not required.
• If dividends are regularly paid, BSM subtracts the discount value of a possible dividend from the present stock price.
• Stocks are normally sold in sets of 100. This means BSM allows securities to be divisible.
• No commissions are charged. Usually, share transactions are required to pay a commission to trade in the market.
• Interest rates are constant and ‘risk-free’ as stated in the US Government Treasury Bills.

The mathematical formula used in the Black Scholes model is complicated. Thankfully automated programs and online options calculators are available that enable experts to simply key in the values and get the results. However, here is the actual formula:

Where:

• C – Call option price – Actual price of the option in future after all variations are accounted for
• S – Current stock price – This is the fair market value of the stock determined by a 409A valuation of the company
• K – Strike price – This is the price at which the call option can be exercised.
• r – Risk-free interest rate – This is the interest rate at which one can lend money. Usually, the rate prescribed on the US Treasury Website is used as a reference
• t – Time to maturity – This is the period over which options would vest incrementally until all the stocks are vested
• σ – Volatility – This is the estimated variance the stock price would undergo during the entire grant period. It is difficult to estimate this variance for private companies. Hence public company trends are used as a reference
• N – Normal distribution – A statistical measure (normal distribution) corresponding to the probability that the call option will be exercised at the expiration

Lattice-based model

This model can also be used for ASC 718 implementation. It is similar to the Black-Scholes method and uses almost similar categories of input. But in addition, this method also allows volatility in dividends and the contractual terms of the equity rewards. Lattice-based models are used to value derivatives that help determine the underlying stock price. This model uses a binomial tree that plots the possible changes in the stock price over the entire period of the derivative’s life.

Since Lattice-based models are better at accounting for the volatility factor, they are considered a better options pricing model in comparison to Black-Scholes Method in markets prone to fluctuations. This is especially helpful for small businesses in the growth phase. They are the ones with the highest chances of fluctuating stock prices. While the Black-Scholes method with its constant volatility factor is better suited for mature companies, the Lattice-based models favor the startups.

Tax considerations for stock options

When tax considerations come into play, employee stock options are categorized into two – Statutory Stock Options or Incentive Stock Option (ISO) and Non-Statutory Stock Options or Non-Qualified Stock Options. Here is how tax implications are different for these two:

Incentive Stock Options

The grant of an ISO does not incur taxes. For an ISO disposition to qualify for long-term capital gains treatment, the employee must satisfy both of the following holding periods simultaneously.

Period 1	More than 2 years	From the grant date
Period 2	More than 1 year	From the exercise date

Non-Qualified Stock Options

The grant of NSO however is taxed at three levels. First during the grant (provided the fair market value of the stock can be determined, else no tax at this stage), second at the time of exercise, and third during the sale.

FAQs

Here we added some most commonly asked questions of ASC 718

Does ASC 718 apply to private companies?

Yes. ASC 718 applies to all entities that issue equity-based compensation and report under US GAAP, including private companies. However, private companies have access to simplified accounting alternatives through the Private Company Council (PCC).

Can companies change their attribution method?

Changing accounting methods requires justification as a preferable accounting policy change and must be applied consistently. Companies should select the appropriate method for implementation.

How often should a 409A valuation be updated?

At a minimum, annually, and within 12 months of any material event, such as a new funding round, a significant change in business prospects, or M&A activity.

What happens if ASC 718 is not properly implemented?

Non-compliance can result in financial restatements, SEC comments (for public companies), penalties, delays in audit completion, and complications in funding rounds or IPO preparation.

Looking for expert guidance on ASC 718

ASC 718 requires companies to recognize the fair value of stock-based compensation as an expense on their income statements during the awards’ vesting period. Issuing, tracking, and managing equity in an expanding business is a daunting task, so many companies engage Eqvista’s experts to assist with valuation, accounting, and reporting requirements.

Eqvista is an expert in this process. We know proper implementation is crucial for financial reporting accuracy and regulatory compliance. ASC 718 implementation is one of our celebrated strengths. Here is a snapshot of all our services. For further information reach us today!