ASC 718 stock compensation accounting requires companies to measure share-based awards at their grant-date fair value and recognize that amount as compensation expense over the period the recipient earns the award. The US GAAP standard covers stock options, restricted stock, restricted stock units, stock appreciation rights, and similar instruments issued to employees and non-employees in exchange for goods or services. The mechanics turn on five judgment areas: whether the award is classified as equity or a liability, how fair value is measured, how expense is attributed over vesting, how modifications and forfeitures are handled, and how the tax effects run through the financial statements.
Two kinds of share-based payments sit outside the standard. Shares issued as sales incentives to customers fall under ASC 606 revenue guidance. Awards structured to finance the issuer rather than pay for goods or services are also excluded. Everything else in the share-based payment universe, including non-employee awards after ASU 2018-07 folded them into the same framework, runs through ASC 718.
Equity or Liability: The Classification That Drives Everything
Classification decides whether the fair value you measure at grant date is the number you live with, or the starting point for quarterly remeasurement. Equity-classified awards are measured once at the grant date, and that fair value is never revisited. Liability-classified awards are remeasured to fair value every reporting period until they settle, so compensation expense moves with the instrument’s value.
An award is a liability when any of the following are true:
- The company is obligated, or could be required, to settle in cash — unless the cash contingency is both improbable and outside the employee’s control.
- A share award carries a put right that lets the employee sell the shares back to the company within six months of vesting, so the employee doesn’t actually bear ownership risk.
- Payout is indexed to something other than the company’s own stock price, and that variable isn’t a standard market, performance, or service condition.
- The company must settle a fixed-dollar obligation by issuing a variable number of shares, or the value of the obligation tracks something other than the company’s share price.
Settlement choice matters. If the employee picks between cash and stock, the award is a liability because the company can’t rule out a cash outflow. If the company holds that choice and has enough authorized shares to deliver, equity classification works.
One narrow practical rule protects the classification most companies rely on: shares withheld to cover tax withholding stay equity-classified as long as the amount withheld doesn’t exceed the maximum statutory tax rate in the employee’s jurisdiction and the employer has a statutory duty to withhold.
Setting the Grant Date and Measuring Fair Value
The grant date is established when four things line up at once: the employer and recipient have a mutual understanding of the award’s key terms, the company becomes contingently obligated to issue shares upon vesting, board approval has occurred if required and isn’t merely a formality, and the recipient begins to benefit from or be adversely affected by subsequent stock price changes. For employee awards, the grant date can’t precede the first day of employment.
Restricted stock units are the easier valuation. Fair value is the market price of the underlying stock on the grant date, adjusted for any dividends the holder won’t receive during vesting.
Stock options require an option-pricing model. Black-Scholes-Merton and lattice models such as binomial trees are both acceptable. ASC 718 doesn’t specify a model, but whichever you pick must incorporate six inputs:
- Current stock price on the grant date.
- Exercise price the holder must pay to exercise.
- Expected volatility over the option’s expected term. Established public companies typically use historical trading data; newer companies may blend historical and implied volatility or borrow from a peer group.
- Expected term, estimated from historical employee exercise behavior.
- Risk-free interest rate, taken from the yield on a zero-coupon US Treasury instrument with a maturity matching the expected term.
- Expected dividend yield over the expected term. A dividend-paying company projects an annualized rate, which reduces the calculated option value; a non-payer uses zero.
The first two are observable. The other four call for judgment, and those assumptions attract auditor and investor scrutiny. Multiplying per-unit fair value by the number of options granted gives you the total compensation cost that will hit the income statement over the service period.
The Simplified Method for Expected Term
Companies without enough exercise history to estimate expected term, such as recent IPOs or companies that have significantly changed their grant structure, can use the SEC’s simplified method under Staff Accounting Bulletin Topic 14. For “plain vanilla” options, expected term equals the midpoint of the vesting period and the contractual term. A four-year cliff with a ten-year contractual life gives a seven-year expected term.1U.S. Securities and Exchange Commission. Staff Accounting Bulletin No. 110 The SEC staff has said companies with sufficient historical exercise data shouldn’t use this shortcut, and companies that do use it must disclose which grants it was applied to and why more refined estimates weren’t available.2U.S. Securities and Exchange Commission. Codification of Staff Accounting Bulletins – Topic 14
Recognizing Expense Over the Vesting Period
Total grant-date fair value is recognized as compensation expense over the requisite service period, with a matching credit to additional paid-in capital for equity-classified awards. The vesting schedule defines the service period, and the type of vesting condition drives the pattern.
Service Conditions
The employee simply has to stay employed for a set period. For cliff vesting on a single date, straight-line recognition applies. For graded vesting, where portions vest on different dates, the company elects a policy: treat the award as one unit and recognize expense straight-line over the longest tranche, or treat each tranche as a separate award and recognize expense on an accelerated basis. Apply the policy consistently to similar awards.
Performance Conditions
Performance conditions tie vesting to an operational target unrelated to stock price, such as hitting a revenue milestone or launching a product. Compensation cost is recognized only when achievement is probable, using the same threshold ASC 450 applies to contingencies. If the assessment moves from improbable to probable partway through the service period, the company records a cumulative catch-up so total recognized expense reflects the revised expectation. The probability call is revisited every reporting period.3Deloitte Accounting Research Tool. ASC 718 – Share-Based Payment Awards: Vesting Conditions
Market Conditions
Market conditions link vesting or exercisability to the company’s stock price or to total shareholder return against a peer group. A market condition isn’t treated as a vesting condition under ASC 718. Instead, the probability of hitting the market target is built into the grant-date fair value itself, typically through a Monte Carlo simulation. Because the probability of failure is already priced into the measured fair value, compensation cost is recognized regardless of whether the market target is ever reached, as long as the employee completes the requisite service.4Deloitte Accounting Research Tool. Share-Based Payment Awards – Multiple Conditions for Employee Awards
The consequence is asymmetric. A revenue target that isn’t met can zero out the expense. A stock price target that isn’t met cannot, because the option-pricing model already discounted for that outcome upfront.
Awards with graded vesting that include a market or performance condition must use the accelerated attribution method, with each tranche treated separately. The straight-line election is available only for service-condition-only awards.
Forfeitures: Estimate or Recognize as They Occur
When employees leave before vesting, the company has recognized expense on shares that will never be issued. ASU 2016-09 introduced a policy election. The company can estimate forfeitures based on historical turnover and recognize expense only on awards expected to vest, updating the estimate each period with true-ups. Or it can recognize the full expense as if every award will vest and reverse it as forfeitures actually occur.
Either method reaches the same cumulative result once all awards have vested or been forfeited. The difference is when the expense lands. The chosen policy has to be applied consistently and disclosed in the footnotes.
One point that catches people: previously recognized expense is never reversed when a vested option expires unexercised. Once the service period is complete, the compensation cost stands whether or not the employee ever exercises.
Modifications, Cancellations, and Acceleration
Any post-grant change to an award’s terms — repricing, extending the contractual life, adding or accelerating vesting — is a modification. The accounting compares two fair values, both computed with inputs as of the modification date: the modified award and the original award immediately before the change. Any excess of modified value over original value is incremental compensation cost, recognized over the remaining service period.5Deloitte Accounting Research Tool. Share-Based Payment Awards – Accounting for the Effects of Modifications
The original grant-date fair value acts as a floor. Total compensation cost can’t drop below what the original terms would have produced. A company that reprices underwater options to a lower strike will typically pick up incremental expense. A company that shortens an option’s life or adds a performance hurdle can’t push previously measured compensation below the original amount.
Cancellations
Cancelling an unvested award without a replacement triggers immediate recognition of all remaining unrecognized compensation cost on the cancellation date. Releasing the employee from the service obligation is treated as accelerating the benefit, so the remaining cost is booked at once.6Deloitte Accounting Research Tool. Share-Based Payment Awards – Cancellations
A cancellation paired with a replacement grant is treated as a single modification rather than two separate events. Incremental cost is the excess of the replacement award’s fair value over the cancelled award’s fair value at the cancellation date, and the unrecognized cost of the original carries forward into the new recognition schedule. That mechanic blocks companies from erasing expense by cancelling underwater options and reissuing at a lower strike.
Vesting Acceleration
Accelerating vesting removes the remaining service requirement. It shows up most often in change-in-control transactions, layoffs, and executive separations. When the company voluntarily accelerates vesting for an employee who otherwise would have forfeited the award on departure, that is a modification from improbable to probable. The incremental cost equals the full fair value of the modified award on the modification date, and if no further service is required, recognition can be immediate.
Income Tax Effects
Share-based compensation opens a gap between book expense and the tax deduction, and the ASC 718 and ASC 740 interaction moves the company’s effective tax rate.
As compensation expense is recognized each period, the company builds a deferred tax asset equal to cumulative book expense times the applicable tax rate. That deferred tax asset represents the future deduction the company expects when the award settles, and the deferred tax benefit runs through the income statement alongside the compensation expense.
The actual tax deduction at exercise or vesting is based on intrinsic value at that date, which almost never equals cumulative book expense. If the stock has risen, the tax deduction exceeds book expense, producing an excess tax benefit. If it has fallen, the deduction falls short, producing a tax deficiency.
Under ASU 2016-09, both excess tax benefits and tax deficiencies are recognized in income tax expense in the period the deduction is determined. That creates a permanent difference that flows into the effective tax rate. Before the update, excess tax benefits went through additional paid-in capital and never touched the income statement, which hid the volatility. The current treatment is more transparent but adds quarter-to-quarter noise to the tax line for companies with large option programs and volatile stock prices. For cash flow reporting, the tax effects are classified as operating activities, consistent with other income tax cash flows.
Diluted Earnings Per Share
Outstanding share-based awards are potential common shares that have to be considered in diluted EPS under ASC 260. The method depends on the award type.
Treasury Stock Method for Options
Stock options run through the treasury stock method. Assume the options are exercised at the beginning of the period and the company uses the proceeds to repurchase shares at the average market price. Assumed proceeds include the exercise price plus the average unrecognized compensation cost attributable to future service. Incremental dilutive shares equal the shares issuable on exercise minus the shares assumed to be repurchased with those total proceeds.
When the combined assumed proceeds exceed the average stock price, the options are anti-dilutive and are excluded from the calculation. This happens with deeply out-of-the-money options and awards carrying large remaining unrecognized compensation cost. The calculation uses the actual number of options outstanding and not yet forfeited, regardless of the forfeiture policy used for expense recognition.
Restricted Stock and RSUs
Unvested restricted stock and RSUs that vest solely on continued service are generally treated as contingently issuable shares. They are included in diluted EPS when dilutive, using a similar treasury stock approach where assumed proceeds consist of the unrecognized compensation cost.
Private Company Simplifications
Nonpublic entities face harder measurement problems because there is no active market price for their shares. ASC 718 and later updates provide two significant accommodations.
Nonpublic entities can make an entity-wide policy election to measure all liability-classified awards at intrinsic value rather than fair value. Intrinsic value is the difference between the current stock price and the exercise price, so no option-pricing model is needed. Awards still have to be remeasured at each reporting date until settlement. The election applies to all liability awards, not selectively. A company that starts with fair value can’t switch to intrinsic value later, because the standard treats fair value as the preferable method for accounting change purposes under ASC 250.7Deloitte Accounting Research Tool. Intrinsic-Value Practical Expedient for Nonpublic Entities
ASU 2021-07 tackled the current stock price input problem. The practical expedient lets nonpublic entities determine the current price using a “reasonable application of a reasonable valuation method” instead of a full independent appraisal. Relevant factors include tangible and intangible asset values, the present value of anticipated future cash flows, market values of comparable companies, and recent arm’s-length transactions in the company’s stock.8Financial Accounting Standards Board. FASB Accounting Standards Update 2021-07 – Compensation Stock Compensation Topic 718 A valuation performed under Treasury Regulation Section 1.409A-1(b)(5)(iv)(B), which many private companies already obtain for 409A purposes, qualifies. The valuation can’t be more than twelve months old as of the measurement date and must be updated for material subsequent information. The expedient is elected measurement-date-by-measurement-date but must be applied consistently to all awards with the same underlying shares and measurement date. Use of the expedient requires disclosure.
Required Disclosures
ASC 718 mandates footnote disclosures detailed enough that investors can evaluate the assumptions behind reported expense and the dilutive impact of outstanding awards.
Start with a description of the share-based compensation plans: vesting conditions, maximum contractual terms, shares authorized, and the valuation method. The forfeiture accounting policy election must be disclosed as well.
For stock options and similar awards, provide a rollforward of activity for the most recent income statement period, showing beginning and ending balances along with grants, exercises, forfeitures, and expirations, each with weighted-average exercise prices. For fully vested awards and those expected to vest, disclose aggregate intrinsic value and weighted-average remaining contractual term as of the balance sheet date. For restricted stock and other non-option awards, provide a parallel rollforward of nonvested shares showing grants, vestings, and forfeitures with weighted-average grant-date fair values.
The valuation assumptions disclosure covers the model inputs: expected volatility, expected term, risk-free interest rate, and expected dividend yield. Also disclose the weighted-average grant-date fair value of awards granted during the period, the total intrinsic value of options exercised and shares vested, total compensation cost recognized in income, the related tax benefit, unrecognized compensation cost for unvested awards, and the weighted-average period over which that remaining cost is expected to be recognized. Cash flow disclosures include cash received from option exercises and the tax benefit realized.