ASC 718 expense reporting is an important aspect of financial reporting for public companies that issue equity-based compensation. Investors and analysts must have timely access to accurate information on the fair value of stock-based compensation to make informed decisions about the state of a company’s finances. Companies must adhere to best practices when disclosing expenses associated with equity-based compensation since compliance with ASC 718 can be a difficult undertaking.
The best practices for ASC 718 expense reporting will be covered in this article, including the significance of avoiding manual processes, planning for scalability, getting expert guidance, and timely expense reporting. Companies can improve the accuracy and transparency of their financial reporting and maintain compliance with generally accepted accounting standards (GAAP) by implementing these best practices into effect. This can help organizations gain the trust of stakeholders and investors.
What is ASC 718?
ASC 718 is an accounting standard that outlines the rules for how businesses should account for equity-based remuneration in their financial statements. The Financial Accounting Standards Board (FASB) issued the regulation in 2004, and it applies to all publicly traded businesses that provide equity-based compensation to their staff.
It is designed to make sure that businesses appropriately disclose the cost of equity-based remuneration in their financial statements. Before the adoption of ASC 718, businesses could choose to either report the cost of equity-based compensation or make it known in the financial statements’ footnotes. Due to this, investors and other stakeholders found it challenging to compare the financial results of businesses that employ various techniques to account for equity-based remuneration.
It requires companies to calculate the fair value of equity-based compensation when it is granted and then recognize the expense over the vesting period of the awards. This permits more precise financial analysis and comparison and assures that the cost of equity-based remuneration is reflected in the company’s financial statements.
How does ASC 718 work?
Under ASC 718, companies are required to measure the fair value of equity awards on the grant date, using an appropriate valuation method. The fair value of the equity awards must subsequently be recorded as an expense in the income statement over the award’s vesting period. The corporation must modify the expenditure recognition if an employee forfeits an equity award before it vests. The fair value must also be recalculated in the event of a modification, and any changes in fair value must be recorded in the income statement. The impact of equity awards on the income statement and balance sheet, as well as the fair value of awarded equity awards and the assumptions used to determine the fair value, have to be disclosed in detail by companies in their financial statements.
Benefits of ASC 718
There are several benefits of ASC 718 for companies and stakeholders, including:
- Improved financial reporting: The framework for accounting for equity-based compensation programs provided by ASC 718 is consistent and transparent, which enhances the accuracy and dependability of financial reporting. This aids in the decision-making process for investors and other stakeholders regarding the financial stability of a company.
- Alignment of employee and shareholder interests: Employees are encouraged to work toward raising the company’s stock price through equity-based compensation programs like stock options and RSUs, which align their interests with those of shareholders.
- Attraction and retention of talent: Employees may find equity-based compensation plans to be enticing since they offer the chance for substantial financial gain. This can assist businesses in luring and keeping top people, which is crucial in competitive industries.
- Reduced cash flow impact: Other kinds of compensation, such as cash bonuses, may require more cash than equity-based compensation programs do. The management of cash flow and resource allocation can be improved as a result.
What does ASC 718 reporting include
ASC 718 reporting typically includes the following:
- Options valuation – Companies must appropriately record the value of the options they have granted under ASC 718 reporting requirements. Companies use models to ascertain the “fair value” of an option grant since market forces cannot ascertain the genuine value of an option at a private corporation. The Black-Scholes model determines the value of an option based on six predefined inputs, including the option strike price, the fair market value, the anticipated term of the grant, the volatility of the option price, and the risk-free interest rate over the grant period. The Black-Scholes model or the binomial option-pricing model is the model that is most frequently used for this purpose.
- Expense report – The vesting schedule and expiration date must be taken into account to report option grants’ fair values correctly. The expense is determined by multiplying the fair value of the option by the number of options that vested during the time of generating the ASC 718 report. But, future costs must take into consideration the likelihood of employee termination as well as any cash flow brought on by option exercises or forfeitures. Given that some employees may quit the company before their options vest or forfeit them, not all issued options will incur costs. To effectively report the fair value of option grants, it is vital to have a detailed understanding of the vesting schedule and expiration date, as well as the possibility of employee termination and cash flow from option exercises or forfeitures.
- Disclosure – The disclosure summary is a complete list that illustrates how the ASC 718 report preparation goes about obtaining option valuation data. It contains details on current grants, such as granted, exercised, forfeited, and expired options. The summary aids in assessing future expenses that are anticipated for the business. Fundamentally, it acts as the company’s balance sheet for options and restricted stock awards. The disclosure summary enables stakeholders to comprehend the impact of equity compensation on the company’s financials by giving a thorough breakdown of active awards and their corresponding fair values. For investors, analysts, and other interested parties to make knowledgeable decisions regarding the company, this information is essential.
Best practices of ASC 718 reporting
There are some best practices of ASC 718 reporting which will be discussed below.
- Avoid manual process – Equity compensation reporting can be laborious and error-prone when done manually. Utilizing automated processes and software can dramatically reduce the chance of errors while also saving time. These systems can track stock options and vesting schedules, calculate fair value automatically, and offer reporting and compliance capabilities. Companies can increase the accuracy of their financial statements and guarantee compliance with ASC 718 reporting requirements by avoiding manual operations. Additionally, automated systems can develop to support a rising workforce and minimize the workload for employees, allowing them to concentrate on their primary duties.
- Plan for scale – The process of planning for scale entails developing a system that can manage the escalating workload as your business expands and the number of employees and equity compensation plans increase. A scalable process needs to be built to support expansion and be adaptable enough to deal with changes. Using automated tools and software that can process higher volumes of data and deliver real-time analytics can help with this. To manage the growing workload and stay up with regulatory changes, it is also crucial to have a workforce with the right expertise. Scale planning properly can assist prevent expensive errors and guarantee adherence to ASC 718 reporting requirements.
- Get professional advice – Additionally, consulting a professional can assist guarantee that your ASC 718 reporting complies with regulatory requirements. Experts can also help identify any issues or risks that can occur as well as offer insightful information about the valuation process. It is important to work with a reputable and experienced firm to ensure that you receive accurate and reliable guidance on ASC 718 reporting.
When should you report ASC 718 expenses?
Once a company has third-party stakeholders, including institutional investors, who demand regular financial reporting, they should report ASC 718 expenses. This usually happens following the completion of a Series A or B fundraising round, at which stage the business is also likely to start making money. An external audit by a certified public accountant, which would include an ASC 718 report, can also be necessary after the business starts bringing in money. In the end, the timing of ASC 718 reporting will depend on the particulars of the organization, but it’s crucial to remember that it’s a requirement for businesses with stock compensation plans.
ASC 718 reporting is an important aspect of financial reporting, particularly for startups that offer equity compensation plans to their employees. While the reporting process can be complex and challenging, seeking professional advice from an accounting or legal firm can help ensure compliance and accuracy.
Article contributed by: https://eqvista.com