Prerequisites for ASC 718

This guide assumes familiarity with basic accounting principles, access to cap table software (e.g., Carta, Pulley), and recent 409A valuation reports.

Overview

75 min
Calculation Time
Expert
Difficulty
Quarterly
Review Frequency

What You’ll Learn

  • How to determine the fair value of stock options and RSUs
  • Methods for recognizing compensation expense over the vesting period
  • Impact of forfeitures and modifications on expense recognition
  • Best practices for managing equity-related disclosures

1. Preparation Steps

Before calculating compensation expense, ensure you have these key inputs:

Key Data Inputs

  • Valuation report (e.g., 409A valuation)
  • Cap table details (equity grants, vesting schedules)
  • Employee roster with hire/termination dates
  • Grant date stock prices (for options)

Critical Documentation

  • Equity Incentive Plan documents
  • Board approval minutes for grants
  • Auditor’s ASC 718 policy memo (if applicable)
  • Legal opinions on equity grants

2. Valuation and Expense Methods

You have primary considerations for determining fair value and expense recognition.

Method A: The Black-Scholes Model

This is the standard model for valuing stock options.

Pros:
  • Widely accepted for options.
  • Provides a robust fair value estimate.
  • Essential for public companies.
Cons:
  • Requires complex inputs (volatility, dividend yield).
  • Sensitive to assumptions.
  • Not applicable for RSUs.

Method B: Intrinsic Value / Market Price

Used for RSUs and simpler equity instruments, or simplified methods for options.

Expert Tip: For most startups, the Black-Scholes model is the standard for stock options, while market price at grant date is used for RSUs. Ensure your 409A valuation supports these valuations.

3. High-Level ASC 718 Workflow

Here is a simplified workflow for recording stock-based compensation.

Here is a sample code block to show how an equity grant record might look.

{
  "grant_id": "EQG-20250101-001",
  "employee_id": "EMP-007",
  "grant_type": "Stock Option",
  "grant_date": "2025-01-01",
  "num_shares": 10000,
  "exercise_price": 1.50,
  "fair_value_per_share": 0.75,
  "vesting_schedule": "4-year, 1-year cliff"
}

4. Recording Compensation Expense

  1. 1

    Determine Fair Value

    Obtain a recent 409A valuation. Calculate option fair value (e.g., Black-Scholes) or use market price for RSUs at the grant date.

  2. 2

    Calculate Total Compensation Cost

    Multiply the fair value per share by the number of shares granted. This total cost is recognized over the vesting period.

  3. 3

    Book Journal Entries

    Debit Stock-Based Compensation Expense and Credit Additional Paid-in Capital (APIC) for the portion earned each reporting period.

  4. 4

    Manage Forfeitures

    Reverse previously recognized expense for unvested shares if an employee departs before full vesting. Adjust APIC accordingly.

Common Error: Inconsistent Vesting Schedules

Ensure your cap table software’s vesting schedules precisely match the grant agreements and internal records. Discrepancies lead to incorrect expense recognition and reconciliation issues.

5. Reporting & Disclosure

Key Disclosure Checklist

  • Prepare summary of options outstanding and exercisable
  • Disclose assumptions used in Black-Scholes model
  • Reconcile compensation expense to income statement
  • Detail changes in equity accounts and APIC

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