ASC 718 Compliance: Ensuring Accurate Stock Compensation Reporting

Casey Fenton

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November 1, 2023

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In 2015, an emerging tech startup named Zenefits was skyrocketing toward success, amassing nearly 2,000 employees and raising over $500 million in funding. However, all was not as rosy as it seemed. An internal audit revealed that Zenefits had not complied with ASC 718 and had failed to expense millions in stock-based compensation correctly. The fallout was immediate and severe, with the company's valuation plummeting by a shocking 48%.

What happened to Zenefits serves as a stark reminder for businesses everywhere about the critical importance of ASC 718 compliance. This accounting standard, which regulates how companies report their employees' share-based payment transactions, may seem complex and perhaps overwhelming, but neglecting it can lead to serious consequences. 

As business leaders, startup founders, or employers, you must fully understand and adhere to ASC 718's rules. Doing so not only safeguards your business from potential pitfalls and regulatory repercussions but also reinforces the financial transparency and trustworthiness your stakeholders value. 

But What is ASC 718, Anyway?

The ASC 718, or Accounting Standards Codification Topic 718, is a standard released by the Financial Accounting Standards Board (FASB), the independent nonprofit organization responsible for establishing financial accounting and reporting standards in the United States.

Introduced in 2004 as SFAS 123(R) and later codified in 2009 as ASC 718, this standard revolutionized how companies account for share-based payments. Before its introduction, companies could choose to either recognize or disclose the expense of employee stock options in their financial statements. This often led to inconsistencies and a lack of transparency in financial reporting across companies.

To address this issue, ASC 718 was developed with the principle that transactions in which goods or services are the consideration received for the issuance of equity should be accounted for at fair value. This standard applies to virtually all share-based payment transactions, including stock options, restricted stock, stock appreciation rights, and employee stock purchase plans, among others.

The purpose of ASC 718 is to provide investors and other users of financial statements with more detailed and consistent information about the economic costs of share-based payment transactions, thereby increasing transparency in financial reporting.

In other words, ASC 718 promotes the idea that employee services received in exchange for equity instruments are valuable resources. Consequently, these transactions have an impact on the company's financial performance, which needs to be accurately reflected in the financial statements.

Through the implementation of ASC 718, companies can ensure that their financial statements provide a more realistic and comprehensive view of their financial position and performance, facilitating better decision-making for investors, creditors, and other stakeholders.

Significance of ASC 718 in Business

As you navigate the struggle that is running a business, you'll encounter various regulatory requirements. Among these, ASC 718 holds an essential place, especially if your compensation strategy includes equity-based components. The significance of ASC 718 extends far beyond mere compliance.

Accurate financial reporting is not just an administrative detail. It forms the backbone of your business' credibility and trustworthiness. When you embrace ASC 718, you showcase your commitment to transparency and accountability, directly impacting how investors, partners, and even employees perceive your business.

ASC 718 enables you to have a clear grasp of your company's financial health. It helps you understand the true cost of your equity-based compensation schemes by ensuring these costs are accounted for in your financial statements. This, in turn, supports effective strategic planning and decision-making.

Moreover, your employees, the recipients of these equity-based payments, are also significant stakeholders in your business. By adhering to ASC 718, you demonstrate a commitment to fair and transparent compensation practices. This can enhance employee satisfaction, motivation, and retention—key factors in your business’ success.

Finally, the value of equity-based compensation isn't just monetary—it's a symbol of shared ownership and trust between you and your employees. ASC 718 ensures that this value is recognized, not just internally, but by everyone who reviews your financial reports.

It’s just simple: ASC 718 is more than an accounting standard; it's a tool that shapes your business’s financial narrative, drives strategy, promotes transparency, and nurtures an environment of trust. Compliance is not merely about fulfilling a regulatory obligation, but about harnessing these benefits to fuel your business's growth and success.

Key Concepts of ASC 718

To properly navigate ASC 718, you need to understand its key concepts. The primary principle of ASC 718 is that the cost of employee services received in exchange for share-based payments should be recognized in financial statements.

Below are the components of ASC 718 for your guidance:

1. Fair Value Measurement

Under ASC 718, share-based compensation is measured based on its fair value at the grant date. For publicly-traded companies, this is typically determined by the market price of the shares. For private companies, however, determining fair value can be more complex and may require a valuation expert.

2. Expense Recognition

The total compensation cost, determined by the fair value of the share-based payments, should be recognized over the period in which the employee services are rendered—typically, the vesting period.

3. Classifications

Share-based payments are classified as either equity or liabilities. How they're classified affects how they're measured and reported on financial statements.

How is Stock Compensation Treated Under ASC 718?

With ASC 718, stock compensation is considered an expense. Therefore, it directly impacts your company's income statement. When you grant a stock option to an employee, the fair value of that option is recognized as an expense over the vesting period.

The key point to remember is that stock compensation isn't a one-time event for financial reporting—it's an ongoing process that continues until all the granted stock options have vested or expired.

How to Implement ASC 718 in Your Business Operations

To smoothly implement ASC 718 in your operations, follow these steps:

Step 1: Engage Experts

Because of the complexity of the ASC 718, it’s advisable to work with accounting professionals who have expertise in this area.

Step 2: Fair Value Determination

Accurately determine the fair value of the share-based payments you’re offering. You may need a valuation expert for this step, particularly if you’re a private company.

Stage 3: Expense Tracking

Track the expenses associated with share-based payments over the vesting period, ensuring that these expenses are accurately represented in your financial statements.

Stage 4: Continuous Review

Be prepared for ongoing compliance. As your company’s situation changes, your approach to ASC 718 might also need to change.

Implications of Non-compliance with ASC 718

Non-compliance with ASC 718 isn't something to be taken lightly. It comes with various implications that can negatively impact your business in several ways. Some of the potential consequences include:

Legal Consequences

Regulatory bodies may impose penalties and sanctions, ranging from fines and lawsuits to requiring financial restatements. In the worst-case scenario, your business could even face criminal charges.

Investor Relations

Investors rely on the accuracy of their financial reports. Non-compliance can significantly damage their trust, potentially making it harder for you to secure necessary capital in the future.

Reputation Damage

In our connected world, non-compliance can quickly become public knowledge, tarnishing your brand's image. This reputational damage can lead to a loss of customers, partners, and possibly employees.

Internal Disruptions

Misreported financials can distort your understanding of the company's financial health, leading to flawed strategic decision-making. Furthermore, the costs of equity compensation that aren't appropriately accounted for can lead to significant discrepancies between your perceived and actual financial status.

Employee Satisfaction

Stock compensation is a contract of trust between you and your employees. Inaccurate reporting of these benefits can lead to employee dissatisfaction, decreased motivation, and potentially, talent attrition.

The message is clear: as a business leader, ensuring full compliance with ASC 718 isn't optional—it's vital to protect your business from these serious risks.

Never Be Fine with Being Fined for Non-Compliance

The role of ASC 718 in your business operations is not just about regulatory compliance—it's about creating a framework of transparency, fairness, and accountability. When it comes to stock options and Restricted Stock Units (RSUs), ASC 718 ensures these equity-based compensations are accurately reported and valued in your financial statements. This not only enhances financial integrity but also reinforces your commitment to your employees by acknowledging their contributions and potential.

Stock options and RSU are more than just part of a compensation package—they represent a shared success between you and your team. With strict adherence to ASC 718, you're not just avoiding regulatory pitfalls; you're strengthening your company's financial credibility, supporting informed decision-making, and ultimately, fostering a culture of trust and shared success. So whether you're a startup founder launching your first compensation plan or a seasoned business owner revising your strategy, complying with ASC 718 in your business operations is a step toward long-term success. 

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ABOUT THE AUTHOR

Casey Fenton

Founder, Upstock & Couchsurfing, AI and Equity Innovator

Casey Fenton, the founder of Upstock & Couchsurfing and an AI and equity innovator, has revolutionized how we perceive and implement equity in the workplace. His foresight in creating platforms that not only connect people but also align their interests towards communal and corporate prosperity has established him as a pivotal figure in technology and community building. Casey speaks worldwide on topics including ownership mindset, worker equity, With Upstock and Couchsurfing, he has demonstrated an unparalleled expertise in harnessing technology for the betterment of community interaction and organizational benefits.

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