ASC 718 – Stock Option Expense for Series A Funded Companies
In this article, we will look at ASC 718 and how Series A funded company should account for stock option expenses.
Stock options in private companies are a way to incentivize employees by giving them the opportunity to buy shares in the company after a certain period of time at a set price. However, the expense associated with stock options is something that should be accounted for under the financial statements. Here, ASC 718 addresses the accounting for stock option expenses. Generally, as the company grows and raise more capital, these type of responsibilities and obligations often increases. But, what is ASC 718? How do stock options expense for series A funded companies work? What is the procedure of accounting for stock option expenses? In this article, we will look at ASC 718 and how Series A funded company should account for stock option expenses.
ASC 718 for Series A Companies
To understand ASC 718 in detail, it is essential to look at what is Series A funding, what are Series A funded companies, and what does stock options work in private companies? Well, to begin with, Series A funding is the process of raising capital during the initial stages, usually after the venture has demonstrated progress in developing its business plan and the potential to grow and generate revenue. In this regard, as the name implies, Series A funded companies are generally startups that have successfully completed their Series A financing.
As a result, companies that are Series A funded are likely to have a number of stock-based compensation plans in place including stock options, ESOPs, or ESPP. Now, stock options are forms of equity compensation that enable employees and other service providers, such as executives, advisors, or consultants to acquire stock in a company over time at a predetermined price. Stock options are popular among startups because it is considered as a powerful tool to retain, motivate, and recruit top employees, advisors and consultants.
In such conditions, it becomes important for a company to determine how to account for stock options expenses. Therefore, under ASC 718, corporations are required to follow the principles of fair value measurement when measuring the expense associated with equity-related instruments and report the same in the financial statements.
How does ASC 718 impact Series A funded companies?
Accounting Standards Codification or ASC 718 is a set of statements issued by the Financial Accounting Standards Board (FASB) in 2009 to account for equity compensation-related instruments. The FASB uses the principles-based approach for the accounting and reporting of stock options but provides few specific rules and guidance on how to account for stock options as part of a company’s equity compensation.
As a matter of fact, the impact of ASC 718 for series A funded companies is limited to the extent of the guidance and rules given to companies. In general, ASC 718 requires that all stock options that are granted in form of equity must be reported on the income statement as a non-cash expense. Therefore, ASC 718 ensures that the stock option transactions are recorded and the reporting is fair, objective and accurate.
What is ASC 718 used for?
The main objective of ASC 718 is to provide consistent treatment on how a company accounts for its stock options in the financial statements. It ensures the classification of stock options or any other equity compensation as part of the financial statements, these are being reported on the income statement. The following are a few of the reasons why ASC 718 is used:
- Accurate reporting of expenses – The stock compensation expenses recorded in the financial statements will have a direct impact on the business valuation of the companies. In order to gauge the fair value of the company, it is important to have an accurate representation of the expenses. Thus, ASC 718 provides a uniform reporting of the stock compensation expenses.
- Compliance with regulations – Financial data must be recorded and stored according to ASC 718 due to the fact that the government will be able to assess if the companies are abiding by the stock-based compensation rules and regulations. This will guarantee the companies’ creditability and raise their market value.
- Protection of your business – Protecting the legal rights of businesses and employees is crucial. Companies can keep the terms in place throughout the stock-based compensation process with the help of ASC 718. The terms and conditions of the stock-based compensation must be outlined in detail by ASC 718 in order to comply with laws and regulations.
Accounting for stock option expensing for series A companies
Well, ASC 718 sets the framework for the accounting of stock option expenses. When the employees acquire legal ownership of the shares, the expense of stock options must be mentioned in the financial statements under ASC 718. This expense is basically a non-cash expense to the financial statements (income statement) as the transfer of equity takes place instead of cash. In simple words, these shares will be expensed as non-cash after the employees receive them in accordance with ASC 718. Thus, accounting for stock option expensing for series A companies is essentially the process of recording the stock options expenses in the income statement.
How do you calculate the stock option expense of a Series A company?
Now that you have a fair idea of how to account for the stock option expenses let’s find out how the stock option expense is calculated. Basically, you need to multiply the number of stock options that are granted by the fair market value (FMV) of the share on the grant date to determine the total stock compensation expenditure. Further, divide the total stock compensation expense amount by the number of vesting years to get the amount to record for each annual period.
To better understand the concept, let’s take a look at a hypothetical example. For instance, if 10,000 shares are granted under stock options on a date when the fair market value of the share is $12 per share, the total stock compensation expense will be $120,000. Assuming that the vesting period is of three years; then $120,000 is divided by three which results in an annual expense of $40,000 for stock compensation. This is the expense that the company will be recording in their financial statements.
How to get started with ASC 718 compliance for your Series A company
Companies are required to comply with the rules and regulations of ASC 718. In order to ensure that they are fully compliant with the FASB, they need to consider certain aspects which are as follows:
- Calculate the fair value – The first step in accounting for stock option expensing is to calculate the fair value of the share at the time of granting the options. This can be done by conducting 409A valuation which is used as a reference for pricing the strike price or exercise price. You might be wondering what 409A valuation and strike price is? Well, 409A valuation is used to determine the FMV of shares in private companies, and the strike price is the price at which the shares are purchased.
- Allocate cost period-wise – After determining the fair market value, it must be spread out over several years due to the fact that the stock compensation expenses of the company must be spread out over the vesting period. You must ascertain the stock option’s lifespan or the number of years the fair market value would be allocated in order to do this. This idea is comparable to figuring out the usable life of a physically depreciable item, such as a piece of equipment.
- Regularly determine cost – You are required to enter the transactions in the income statement as well as the company’s balance sheet. In the case of an early-stage startup with uncertain earnings, you may not want to begin issuing an annual portion of the fair value of your options. However, deferring long-term spending is risky, especially if your company begins raising funds through Series A funding. Thus, you must adopt a regular process to track the fair value with the passage of time.
- Seek help from experts – You can avail of the services of experts like Eqvista who are conversant with accounting for stock option expensing. The rules and regulations set by ASC 718 may sound difficult to comprehend especially for startups and small businesses in their initial stages of operation. Thus, it is advisable that you seek assistance from professionals who can help you get started with this process.
- Use automation – The software and approach you choose to track these transactions must be well-designed in order to achieve the desired objective of accounting for stock option expensing. You must carefully evaluate the options available in the market and choose the software that offers customization, flexibility, and control over your data. Eqvista offers the latest automation for accounting for stock option expensing and tracking.
- Plan strategically – In order to achieve accounting for stock option expensing, you need to plan accordingly, from the time you start granting options to your employees till the time when you begin recording them in the financial statements. You must be clear about what you are required to do so that your startup can comply with FASB and other regulations. This will help you make a much smoother transition to ASC 718 in future.
Have your ASC 718 expense reporting done by Eqvista!
Are you looking for ways to address the challenge of accounting for stock option expensing? Do you feel that the details of stock option expensing are still a bit confusing and complicated? You can try to get help from Eqvista who provides professional guidance for accounting for stock option expensing. We offer the latest technology and expertise to help you get started with ASC 718 expense reporting. Our experts are well-versed with the latest accounting standards and can help you with the entire process of accounting for stock option expensing. Thus, you need not worry about being fully compliant with the FASB and other regulations, as we will make sure that you meet every deadline and deliver the reports on time. Contact us today!