ASC 710, the FASB’s general compensation topic, tells employers to recognize the cost of wages, salaries, compensated absences, bonuses, and non-equity deferred pay in the period the employee performs the service that earns them, not the period the cash goes out. It is the default standard: if a form of employee compensation doesn’t have its own codification topic, ASC 710 governs when the expense hits the income statement and how the related liability is measured.
What ASC 710 Covers
ASC 710 applies to the general forms of pay an employer gives for employee services: regular salaries and hourly wages, vacation and sick-pay accruals, cash bonuses and incentive plans, sabbatical programs, and individual deferred compensation contracts. It works as the catch-all. Anything that isn’t captured by a more specialized topic falls here by default.
Several categories of employee cost sit outside ASC 710 and are worth naming, because assumptions about scope are where mistakes usually start:
- Stock-based compensation, including any award settled in equity instruments or measured against the employer’s share price, is governed by ASC 718.1Financial Accounting Standards Board (FASB). Accounting Standards Update 2021-07 – Compensation – Stock Compensation (Topic 718)
- Pensions and other post-retirement benefits fall under ASC 715.2Financial Accounting Standards Board. Compensation – Retirement Benefits (Topic 715) – ASU 2017-07
- One-time termination benefits offered as part of a specific exit or restructuring event are handled by ASC 420.
- Nonretirement postemployment benefits (ongoing severance plans, disability-related benefits, supplemental unemployment) are handled by ASC 712, which borrows ASC 710’s four-criteria accrual model for benefits that vest or accumulate.
The line between ASC 710 and ASC 420 catches people out on a regular basis. Severance flowing from a pre-existing ongoing benefit plan or an individually negotiated agreement is accounted for under ASC 710 or ASC 712, depending on timing. ASC 420 applies only to involuntary termination benefits created by a one-time plan established for a specific restructuring. Some restructurings involve both: the standard severance package runs through ASC 712 and any sweeteners beyond the plan’s terms get ASC 420 treatment.
The Core Accrual Principle
The foundational rule is that compensation cost is recognized as the employee earns it through service, regardless of when the payment is made. An employee who works in December and gets paid in January creates a December expense and a December liability. Waiting for the cash payment would understate cost in the period the work was performed and overstate it in the period the check cleared.
The liability sits on the balance sheet as accrued compensation payable; the offsetting debit is compensation expense. The accrued amount reflects what the employer expects to pay. For fixed-salary employees, this is arithmetic. For arrangements with variable components, the employer uses the best estimate available at the reporting date and updates that estimate as better information appears. The same earn-then-record logic runs through the topic’s sub-areas: compensated absences, bonuses, and deferred pay all anchor back to matching cost with service.
Compensated Absences
Compensated absences include any paid time off: vacation, holidays, sick leave, personal days, and sabbaticals. The question ASC 710 answers is whether the cost is booked as the time is earned or as the time is used. Under ASC 710-10-25-1, an employer accrues a liability for compensated absences only when all four of the following conditions are met:
- The employer’s obligation for the future absence relates to services already rendered by the employee.
- The rights vest (survive termination and require a payout even if the employee leaves) or accumulate (unused balances carry into future periods, even if capped).
- Payment is probable.
- The amount is reasonably estimable.
When all four are met, the liability is recognized in the period the time is earned, not the period it is used. The accrual should reflect estimated forfeitures from employee turnover when those forfeitures are reasonably estimable. Unlike pension obligations, the compensated-absences liability is generally not discounted. An employer may elect to discount, but if it does, the expected future payments should use the pay rates expected to be in effect when employees actually take the time off.
Vacation Pay
Vacation is the textbook case that satisfies all four criteria. Most employers either allow unused days to carry over or pay them out at termination, so rights either accumulate or vest. The cost is accrued as employees work through the year, and the liability grows on the balance sheet. When an employee takes a week of vacation, the liability comes down and cash goes out. If the employee leaves and gets paid for unused days, the same reduction happens.
Sick Pay
Sick leave often escapes accrual because of a specific carve-out. ASC 710-10-25-7 provides that an employer is not required to accrue a liability for nonvesting, accumulating sick-pay benefits. The FASB’s reasoning was that reliable estimates of future sick-pay usage would be too costly and uncertain to justify a mandatory accrual. The exception does not prohibit voluntary accrual if the employer wants to book one, as long as the four criteria are met.
There is a carve-out within the carve-out. If employees can cash out unused sick days before retirement, or if the employer routinely pays sick benefits without requiring an illness-related absence, the payments look more like compensation than insurance. In that case, the benefit has effectively vested and the liability should be accrued.
Sabbatical Leave
Sabbatical accounting depends on the purpose of the leave. If the sabbatical exists so the employee can perform research or public service that benefits the employer, the compensation is not attributable to services already rendered, and no advance accrual is needed. The cost is expensed during the sabbatical.
If the sabbatical is unrestricted paid time off granted as a reward for long service, the cost is accrued ratably over the service period the employee must complete to become eligible. A sabbatical that requires seven years of service and provides no incremental benefit for additional years is treated as an accumulating right under ASC 710-10-25-5, so the expected cost is spread across those seven years.
Bonuses and Incentive Compensation
Cash bonuses fall into two categories under ASC 710, and the accounting is meaningfully different for each.
Performance-Based Bonuses
When a bonus depends on hitting a defined target, the employer accrues the cost over the service period as long as payment is probable and the amount is reasonably estimable. “Probable” carries the same meaning as in ASC 450’s contingency guidance: the future event is likely to occur, not merely possible.
The estimate has to be updated at each reporting date. If the probability of meeting the target changes, the accrual changes with it. Two approaches are acceptable. The first is a cumulative catch-up: the accrual is adjusted to what would have been recorded from inception under the current probability assessment, with the remaining cost spread over the rest of the service period. The second is purely prospective: the total estimated compensation now assessed as probable is allocated over the remaining service period with no look-back adjustment. Either is acceptable, but the choice should be applied consistently.
If the target is ultimately missed, any previously accrued liability is reversed and the reversal reduces compensation expense in the period the determination is made.
Discretionary Bonuses
A discretionary bonus carries no enforceable obligation until the employer formally declares it. There is no pre-established formula, and the employee has no right to payment based on performance. Because no obligation attaches to prior service, there is nothing to accrue during the service period. The full expense hits the income statement in the period the board or management commits to the payment.
The practical risk is misclassification. If the company calls a bonus “discretionary” but pays it every year at roughly the same percentage of salary, an auditor may conclude that a constructive obligation exists and require accrual over the earning period. Economic substance controls, not the label on the plan document.
Non-Equity Deferred Compensation
Non-equity deferred compensation arrangements promise an employee a future cash payment earned through current service. No stock is involved. An executive might, for example, earn a contractual right to annual payments starting at age 65, based on years of service completed today. Because the cash outflow is years or decades away, the time value of money is central to the accounting.
Accrual Over the Service Period
ASC 710-10-25-9 requires the cost of deferred compensation to be accrued over the employee’s service period in a systematic and rational manner. The goal is to have the present value of the obligation fully accrued by the date the employee reaches full eligibility. Two methods are in common use:
- Under the sinking fund method, the employer calculates fixed periodic charges that, together with imputed interest, will accumulate to the total payment by the eligibility date. Annual expense increases over time because the interest component grows as the liability balance rises.
- Under the equal annual accrual method, the total estimated payment is divided by the number of service periods through the eligibility date. Discounting is ignored, and the annual charge stays the same each year.
The sinking fund method is more theoretically sound because it reflects the time value of money. The equal annual method is simpler and still acceptable. The choice affects the pattern of expense recognition, not the total cost over the life of the arrangement.
Measuring the Liability at Present Value
Under the sinking fund approach, the deferred compensation liability appears on the balance sheet at its discounted present value rather than the full nominal amount the employee will eventually receive. The liability grows each period through accretion, which represents the interest cost of deferring the payment. By the eligibility date, the accreted balance equals the total obligation.
The discount rate matters. One accepted approach borrows from ASC 715’s pension guidance: use the rate of return on high-quality fixed-income investments whose cash flows match the timing and amount of expected benefit payments, where “high quality” means rated Aa or higher by a recognized agency. For arrangements that resemble long-term payables, an entity-specific credit-adjusted rate may be appropriate. A lower discount rate produces a higher initial liability and front-loads more cost into the early service years; a higher rate defers more cost into later accretion.
Rabbi Trusts
Many employers fund deferred compensation obligations through rabbi trusts, which are irrevocable trusts that remain subject to the claims of the employer’s general creditors in bankruptcy. Under ASC 710-10-45-1, the assets of a rabbi trust are consolidated with the employer’s financial statements, whether or not the trust qualifies as a variable interest entity under ASC 810.
One point catches people out. Trust assets cannot be netted against the deferred compensation liability. Because the assets remain available to general creditors if the employer becomes insolvent, they are still assets of the reporting entity, and the liability still stands separately. Earnings on trust investments flow through the employer’s income statement as investment return and are not offset against compensation expense. Employer stock held by the trust is classified as equity in a manner similar to treasury stock.
Section 409A Tax Compliance
ASC 710 governs the financial reporting side of nonqualified deferred compensation. IRC Section 409A governs the tax side, and the two do not always line up. Any employer maintaining a nonqualified deferred compensation arrangement needs to understand 409A because a plan that violates it triggers severe tax consequences for the employee.
Section 409A permits distributions only on one of six triggering events:3Office of the Law Revision Counsel. 26 U.S. Code 409A – Inclusion in Gross Income of Deferred Compensation Under Nonqualified Deferred Compensation Plans
- Separation from service, with a six-month delay for specified employees of publicly traded companies.
- Disability, meaning unable to engage in substantial gainful activity for at least 12 months.
- Death.
- A specified time or fixed schedule established at the time of deferral.
- Change in ownership or control of the corporation.
- Unforeseeable emergency, limited to the amount needed to address the hardship.
If a plan fails these distribution rules or other 409A requirements, the consequences fall on the participant. All previously deferred compensation not subject to a substantial risk of forfeiture becomes immediately includible in the participant’s gross income. On top of ordinary income tax, the participant faces a 20 percent additional tax on the included amount, plus interest at the federal underpayment rate plus one percentage point, running back to the year the compensation was first deferred.4Office of the Law Revision Counsel. 26 USC 409A – Inclusion in Gross Income of Deferred Compensation Under Nonqualified Deferred Compensation Plans
For financial reporting, the question is whether a 409A failure creates additional compensation expense or requires adjustment to the deferred compensation liability. If the employer is obligated to make the participant whole for the tax penalties, that gross-up obligation itself needs to be recognized under ASC 710’s general accrual principles.
Disclosures Actually Required
ASC 710’s disclosure requirements are narrower than many preparers assume. The topic does not mandate extensive stand-alone disclosures about compensation policies or deferred compensation arrangements. The most specific requirement relates to compensated absences: if the employer meets the first three accrual conditions (services rendered, rights vest or accumulate, payment is probable) but cannot reasonably estimate the amount, that fact must be disclosed in the notes rather than left unsaid.
For deferred compensation, there are no Topic 710-specific disclosure mandates, but other areas of GAAP fill the gap when the arrangements are material:
- ASC 235 requires description of the accounting policy for deferred compensation, including how any rabbi trust consolidation is handled.
- ASC 850 requires disclosure of the dollar amounts of related party transactions for each income statement period presented.
- ASC 325 requires disclosure of the purpose, significant terms, and accounting policies for both the insurance assets and the compensation liability when deferred compensation is funded through corporate-owned life insurance.
SEC registrants face additional requirements through Regulations S-K and S-X, including related-party disclosures, MD&A discussion of material future funding commitments, and the Compensation Discussion and Analysis section. Those requirements can be more demanding than the GAAP disclosure rules themselves.
Where Application Typically Goes Wrong
The recurring problems with ASC 710 involve judgment more than mechanics. Misclassifying a de facto formula bonus as discretionary is probably the most frequent issue. If the company has paid a “discretionary” year-end bonus at roughly the same percentage of salary for the past five years, the argument that no constructive obligation exists gets hard to sustain. Auditors and regulators look at the pattern of behavior, not the label.
Compensated-absence accruals go wrong when companies fail to track accumulated balances accurately or ignore the forfeiture estimate. An employer with high turnover among junior employees who forfeit unvested vacation at departure will overstate the liability if it accrues the full balance without adjusting for expected forfeitures. Conversely, expensing vacation only when taken will understate expense in the earning period.
For deferred compensation, the discount rate is the most consequential choice. Two employers with identical payment obligations can report materially different annual compensation expenses simply by picking different rates. Auditors expect the rate to be supportable by observable market data, not reverse-engineered to produce a desired expense pattern. Document the rate at inception and update only when circumstances genuinely change.
Finally, a single workforce action can pull in several standards at once. One restructuring can involve ASC 420 for one-time severance offered to a group, ASC 712 for benefits under the pre-existing severance plan, ASC 710 for individually negotiated separation agreements, and ASC 718 for modifications to unvested equity awards. Getting the scope boundaries right at the start prevents reclassification headaches later. Performance-based bonus accruals in particular sit in the crosshairs of PCAOB Auditing Standard 2110, which identifies compensation arrangements with senior management as a specific area auditors must understand when assessing risks of material misstatement, so the assumptions, supporting data, and rationale for mid-period adjustments should all be memorialized.5PCAOB Public Company Accounting Oversight Board. AS 2110: Identifying and Assessing Risks of Material Misstatement