If you own a company, you might be searching for more information on ASC718. Here is everything you need to know.
Running a company can be difficult when it comes to all the papers and forms you need to know about. One of the forms you might be searching for more information on is the ASC718. The ASC718 can help you with expenses and income statements.
ASC718 is how you will expense your employee stock based compensation on their income statements. Expense accounting also falls under ASC718 as are equity awards.
Expense accounting can be complicated when you’re new to it. This article will cover all the most important things to know when it comes to ASC718 and help you to know when you should start expensing employer options.
When Should I Start Expensing Employee Options?
Some private companies don’t begin to offer expensing employee options until they begin to receive larger funding rounds. At some point, though, a company will need to become GAAP compliant. This means they are audited against the generally accepted accounting principles.
If your company has large investors, you will want to make sure you have a third party sign off on all financials so that they trust your company.
All ASC718 operations and guidelines are regulated by the Financial Accounting Standards Board. This board also developed the Accounting Standards Codification, which is what ASC718 falls under.
What Does The ASC718 Entail?
The ASC718 puts certain reporting obligations to each company. There are certain guidelines and standards that you will need to follow, including calculating the fair value of the option and spreading the reporting of the expense that is associated with the option.
You will also need to recognize that expenses are employee compensation that will show on income statements. This can all sound confusing when you aren’t sure how to get started. That’s why this guide will go more in-depth about all the steps.
Calculate The Fair Value Of The Option
To make the most out of accounting when it comes to the ASC718- you should establish fair value as soon as you can, such as when you first begin to build your company.
Waiting too long might cause you more problems reporting in the future. Reporting from the beginning will allow you to have a better idea of how much the option is worth and how it can be represented on an income statement.
If you have a startup, you might have some assets that are not easily converted into cash. So, trying to figure out how much they might be worth will not be as easy. Since you can’t determine their value in the open market, you will need to evaluate them using a formal valuation model.
Many of these models are available and businesses can choose whichever one they want to use. Just make sure you are always using the same one as switching back and forth can make it harder to determine values.
Once you have the model you want to choose, make sure you have all the variables to plug in such as interest rate, dividend yield, strike price, expected term, volatility, and underlying value. When you have all the right variables, you will be able to see the values per option through the model, which allows you to move on to the next step below.
Spreading The Expenses
You will need to spread expenses associated with the option across the economic life. You have to pay attention to how the GAAP outlines rules for this so that you do not mess anything up. If you have an option that will last for five years, you will be able to report the expense related to it for each of the years separately.
So, if you have an employee that was granted 100,000 options and you value the options at $0.20, the employee will be able to receive 20% of his options at the end of each year. This means you can use an expense of $4,000 for each of the five years.
In the above example, the expenses are spread out evenly over the five years. However, this is not always how it happens in real life. You might find that the expenses are better suited to be spread out differently each year.
According to the GAAP, both of these options are okay as long as you show the expense every year rather than just a total for the end of the year.
When Everything Adds Up
When everything goes according to plan, the information in this article can be easily used to make sure that you have everything required by the ASC718. However, there is always a possibility of something being disturbed that can change how everything works. When there is a disruption, you need to be able to change the way you report things so that it doesn’t happen again.
You also need to be able to fix it easily so that it doesn’t ruin too much of your time. One example of this is when a company needs to reprice items. If you want to make the price lower than what is considered a fair market value, you will need to make sure your accounting is modified so that it’s still compliant with the GAAP.
Your accounting department will need to add in the extra incremental expenses and measure the values of the option both before and after the change. This process can become complicated when there is more than one repricing or when you have too many modifications at one time.
Also, you might have some disruptions depending on when your company started to record the employee options. For example, startups might have chosen not to record their employee options, but they will have to once funding rounds, and the sums that are part of them begin to grow. This is because they need to start recording options in order to become GAAP compliant.
Using A Professional
Since ASC718 reporting can become complex, it might be a good idea for your company to consider bringing in a professional to help with the tasks. The earlier you bring in someone to help, the easier it will be to get the options and expenses sorted.
If you decide to go with a professional, you might want to check their experience and make sure they know all the guidelines of GAAP compliance. You also want to make sure they can grow with your company. This means they don’t just track things on a spreadsheet. They will be able to make sure all your expenses and grants can be valued and inserted into their formula.
You also want to make sure they are accurate with all their match and modeling systems. Finding the fair value can be difficult, which is why professionals are often used since they can most likely find values much quicker than the average person. Most professionals also use software that takes away human error.
The right professional will also be cost-effective. Using outside help can seem daunting sometimes because you might not have the budget for it. However, there are many software choices out there that are low-cost and still effective. Just make sure to read reviews.
A Few More Details
The main reason you need ASC718 reporting is because there are very complex rules about equity awards and options for expenses when it comes to income. Employee stock ownership plans need to have the proper rules and regulations in place to make sure your company and employees are doing everything properly. It also determines the fair market value of stocks before you issue them to create fairness.
When reporting with the ASC718, there are a few things you need. One is the date of the grant. Every time you get a stock or grant, make sure you keep all the paperwork. You will also need the price per share and the number of shares or units granted. You also need the ASC718 fair value of the received consideration.
When preparing an expense report, you usually need about 10 to 20 business days for it to be completed, but it depends on the size of your company. In some cases, it can take up to 30 days. The expense report will include the stock option grants and all secondary transactions.
In Closing
As you can probably tell by now, ASC718 is essential for your company when it comes to reporting expense options as part of income statements. You will need to take the proper steps and protocols to make sure it’s done correctly. Bringing in outside help can help with this and make sure all the components are GAAP compliant.
While you might not be reporting as a startup, as your company grows and you receive larger funding, you will have to begin reporting expenses to avoid being audited. The steps of the procedure are not too hard, but reviewing this guide from time to time will ensure you have all the right steps in place.
Shawn Manaher is a former financial advisor, has founded 5 online businesses, and is a coach, speaker, podcast host, and author. He’s been featured on Forbes, The Consults Corner on TAE Radio, The Writing Biz, What’s Your Story, and more.
