A private company grants stock options to a handful of employees.
The grants are approved. The employees receive their agreements. The cap table is updated. Everyone moves on.
Then the auditors ask for the stock-based compensation expense.
Now finance needs to know when each award was granted, what it was worth on that date, how it vests, whether any terms changed, and what happened to employees who left during the year.
The option grants themselves weren't particularly complicated.
Accounting for them can be.
That's where ASC 718 comes in.
ASC 718 is the U.S. accounting guidance governing share-based payment arrangements, including employee stock options, restricted stock, restricted stock units (RSUs), and certain other equity-based awards. It generally requires companies to recognize compensation cost for awards received in exchange for employee services, with measurement and recognition depending on the award's terms and classification.
For private companies, the challenge isn't simply calculating an expense. It's maintaining the award information, valuations, vesting schedules, and transaction history needed to support that calculation.
And those records don't become easier to reconstruct just because the audit is approaching.
What is ASC 718?
ASC 718, Compensation—Stock Compensation, is part of the Financial Accounting Standards Board's Accounting Standards Codification (FASB ASC).
It establishes how companies account for share-based payment transactions, including awards granted to employees and certain nonemployees in exchange for goods or services.
Under ASC 718, a company generally recognizes compensation cost for equity awards as employees provide the services required to earn them.
That means a company can incur stock-based compensation expense without paying employees cash.
Consider an employee who receives stock options that vest over four years.
The employee may not exercise those options for several more years. They may never exercise them at all.
But the company may still need to recognize compensation expense during the period in which the employee earns the award.
That's an important distinction.
The accounting doesn't wait for the employee to sell shares or receive cash.
For private companies preparing financial statements under U.S. GAAP, ASC 718 is a significant part of managing an equity compensation program.
Does ASC 718 apply to private companies?
Yes. ASC 718 applies to private companies preparing financial statements under U.S. GAAP when they have share-based payment arrangements within its scope.
It isn't limited to public companies or businesses preparing for an IPO.
A family-owned company that grants options to executives may need to apply ASC 718. So might a private business offering restricted stock to key employees or an established company using equity awards to retain management.
Private companies do have certain accounting alternatives and practical expedients that aren't available to public companies.
But being privately held doesn't eliminate the underlying accounting requirements.
The question isn't whether the company's shares trade on an exchange.
It's whether the company has issued awards that fall within the guidance.
Which equity awards fall under ASC 718?
The guidance can apply to several forms of share-based compensation.
The form of the award matters because different terms can lead to different accounting outcomes.
An option with a four-year service vesting schedule isn't necessarily accounted for the same way as an award that vests only if the company reaches a revenue target.
A cash-settled stock appreciation right may require liability accounting rather than equity accounting.
And an award that looks straightforward in an agreement can become considerably less straightforward once someone starts examining the settlement provisions, repurchase rights, or performance conditions.
This is one reason the award agreement matters just as much as the number of shares appearing on the cap table.
How does ASC 718 stock-based compensation accounting work?
At a high level, ASC 718 involves determining what an award is worth for accounting purposes and recognizing the appropriate compensation cost as the related goods or services are received.
For a typical equity-classified employee option award, the process looks something like this:
First, establish the appropriate grant date and award terms.
Then determine the award's grant-date fair value using an appropriate valuation method.
Next, recognize compensation expense over the applicable requisite service period, accounting for the award's vesting conditions and other relevant requirements.
Finally, reconcile the expense and outstanding awards as employees vest, leave, exercise, forfeit, or have their awards modified.
The accounting rules are more detailed than those four steps suggest. But from an operational standpoint, they reveal the real challenge.
You need accurate information from the beginning of the award's life through its eventual settlement, expiration, or cancellation.
Why does grant-date fair value matter?
Under ASC 718, equity-classified awards are generally measured using their fair value at the grant date.
That amount becomes the basis for recognizing compensation cost, subject to the applicable accounting rules.
For publicly traded companies, determining the underlying share price is often relatively straightforward because there is an observable market price.
Private companies don't have that convenience.
There may be no active market for their shares. Transactions may happen infrequently, and different classes of equity may carry different rights.
That makes valuation more involved.
For stock options, companies commonly use an option-pricing model such as Black-Scholes-Merton. Inputs can include the underlying share value, exercise price, expected term, expected volatility, risk-free interest rate, and expected dividends.
Those assumptions can materially affect the calculated fair value.
A finance team shouldn't have to guess which assumptions were used for a grant from three years ago.
The valuation and its supporting information should be retained alongside the relevant award records.
ASC 718 vs. 409A valuation: What's the difference?
This is one of the more common points of confusion for private companies.
ASC 718 and Section 409A can both involve valuing private-company equity, but they serve different purposes.
ASC 718 is an accounting standard. It governs how share-based compensation is measured and recognized in financial statements prepared under U.S. GAAP.
Section 409A is part of the Internal Revenue Code. Among other things, its rules are relevant to the exercise price of certain nonqualified stock options and the tax treatment of deferred compensation.
A 409A valuation commonly helps establish the fair market value of private-company common stock for tax-related purposes.
An ASC 718 valuation of an option award generally needs to determine the fair value of the option itself.
Those are not the same number.
A company may use a common-stock valuation developed for 409A purposes as an input to its ASC 718 analysis when appropriate. But that doesn't automatically satisfy every ASC 718 measurement requirement.
The distinction is especially important when the company has multiple share classes, complex rights, unusual award terms, or material changes in its circumstances.
How is stock-based compensation expense recognized?
Consider a simplified example.
A private company grants an employee 10,000 stock options.
An appropriate valuation determines that each option has a grant-date fair value of $4.
Total illustrative grant-date fair value = $40,000.
Assume the options vest over four years, the employee must provide service throughout that period, straight-line attribution is appropriate, and no forfeitures or modifications affect the calculation.
Under those assumptions, the company would recognize $10,000 in compensation expense annually over four years.
In practice, awards may vest in different tranches, carry performance conditions, or require a different expense attribution approach.
Employees may leave. Awards may be modified. Expectations about vesting may change.
The accounting needs to reflect those events.
The original grant-date calculation is only the beginning.
What happens when an employee leaves before their options vest?
This is where maintaining accurate equity records becomes particularly important.
Suppose an employee receives options that vest over four years but leaves after 18 months.
Some options may have vested.
Others may be forfeited.
The company needs to account for the award based on its terms and the applicable ASC 718 rules.
For awards with service conditions, ASC 718 permits an accounting policy election to recognize forfeitures as they occur or estimate them in advance. Awards that fail to vest because required service or performance conditions aren't satisfied generally don't result in retained compensation cost for those forfeited portions.
That means finance needs more than the employee's original grant information.
It needs the termination date, vesting schedule, award terms, forfeiture activity, and any relevant exceptions.
If HR knows the employee left, legal has the award agreement, and finance is working from a spreadsheet that hasn't been updated, reconciling the expense becomes unnecessarily difficult.
The accounting depends on events that happened elsewhere in the business.
Those events need to reach the equity records.
Performance-based awards add another layer
Not every equity award vests simply because an employee stays with the company.
Some awards depend on reaching revenue targets, profitability milestones, or other performance goals.
Under ASC 718, the accounting for performance conditions generally depends on whether achieving the relevant condition is probable. Companies may need to reassess that conclusion and adjust recognized compensation cost as circumstances change.
Market conditions are treated differently. Their effect is generally incorporated into grant-date fair value, and failing to meet a market condition does not necessarily reverse compensation cost when the required service has been provided.
The distinction can have a meaningful effect on reported expense.
It also creates an ongoing information requirement.
Finance needs to know what the award requires, whether the relevant conditions have been satisfied, and whether management's assessment has changed.
A cap table showing the number of outstanding awards won't answer those questions by itself.
Equity-classified vs. liability-classified awards
Another important ASC 718 distinction is how the award is classified.
Equity-classified awards are generally measured at grant-date fair value and are not subsequently remeasured merely because the company's share value changes.
Liability-classified awards are generally remeasured at each reporting date until settlement, with changes reflected in the accounting.
The classification depends on the specific terms and applicable guidance, not simply whether the company calls something an option, RSU, or stock appreciation right.
For a private company, this can affect both the amount of ongoing accounting work and the information required at each reporting period.
It's a good reason to involve accounting professionals when designing equity awards, not only after the awards have been granted.
Award modifications can change the accounting
An employee gets promoted, and the company accelerates their vesting.
An executive negotiates an extension to the exercise period.
The company reprices outstanding options.
A departing employee receives different treatment from what their original agreement contemplated.
These decisions may make sense from a compensation or business standpoint.
But they can also create ASC 718 consequences.
Changes to an award's terms may require modification accounting, including an assessment of incremental fair value and changes to the compensation cost that should be recognized. The treatment depends on the circumstances and the relevant accounting guidance.
And here's where private companies sometimes create problems for themselves.
The compensation decision gets made.
The agreement gets amended.
Everyone involved understands what was intended.
But the equity records still reflect the original award.
Six months later, finance is preparing its year-end expense calculation using terms that are no longer accurate.
An award modification isn't finished from an administrative standpoint until the records supporting that award reflect what actually changed.
That's not an ASC 718 calculation problem. It's an ownership workflow problem.
What records should private companies maintain for ASC 718?
A company doesn't necessarily need a complicated equity program to create complicated recordkeeping.
Even a relatively small number of awards can generate years of accounting activity.
At a minimum, the finance and equity administration teams should be able to locate the information relevant to each award, including:
- Grant information: recipient, award type, grant date, number of shares or units, exercise price where applicable, and approval records.
- Award agreements: the actual terms, including vesting requirements, settlement provisions, and relevant restrictions.
- Valuation records: grant-date fair value, supporting valuation assumptions, and the methodology used.
- Vesting history: what has vested, what remains unvested, and the conditions attached to each award.
- Award activity: exercises, settlements, forfeitures, expirations, cancellations, and repurchases.
- Modifications: amended terms, approval dates, supporting documentation, and the accounting analysis.
- Expense history: amounts recognized in prior periods, current-period expense, and remaining unrecognized compensation cost.
Not every field will be relevant to every award. The required accounting support depends on the arrangement.
The larger point is that the company needs both the current award position and the history behind it.
This is the same distinction we make in our guide to shareholder recordkeeping.
The current balance tells you where things stand.
The history tells you why.
Why spreadsheets become difficult for ASC 718 administration
Spreadsheets can be perfectly reasonable for a company with a small, uncomplicated equity compensation program.
They aren't inherently inaccurate.
The trouble starts when the spreadsheet becomes responsible for remembering everything that happened to every award.
Imagine a private company with 200 employees and several years of option grants.
Some employees have multiple awards.
Some have left.
Some exercised options.
Others received modified grants.
Different awards have different vesting schedules.
The company has completed multiple valuations.
Finance needs to prepare the stock-based compensation expense for the current reporting period.
The calculation may still be manageable.
But the information feeding it is scattered.
HR has termination dates. Legal has award amendments. The equity administrator has grant and exercise records. Accounting has the expense schedules. The valuation firm has the supporting assumptions.
A spreadsheet can calculate the result.
It can't independently establish that all those inputs are complete, authorized, and consistent.
That's the real limitation.
The spreadsheet doesn't necessarily break. The process around it does.
And by the time someone notices, the company may have several reporting periods to reconcile.
ASC 718 and the cap table are connected, but they're not the same thing
A cap table helps a company understand its ownership structure, including outstanding shares and, depending on its scope, equity awards and potential dilution.
ASC 718 answers a different question.
How should the company measure and recognize the compensation cost associated with its share-based payment arrangements?
Those two responsibilities overlap, but one doesn't replace the other.
A company can have an accurate cap table and still have incomplete stock-based compensation accounting.
It can also have an expense calculation that appears correct while the underlying award records contain outdated information.
The better approach is to keep the ownership and award records aligned with the information used for accounting.
When someone exercises an option, the transaction should be reflected appropriately.
When an award is forfeited, its status should change.
When terms are amended, the original and revised records should be preserved.
When a new valuation is completed, the company should be able to identify which awards and measurements it supports.
That's part of the broader challenge we discuss in The Ultimate Guide to Cap Table Management.
The cap table is important.
But it isn't the entire equity administration process.
What do auditors typically review for ASC 718?
When auditors examine stock-based compensation, they may need to understand both the accounting conclusions and the underlying award activity.
Depending on the company and the awards involved, that can include reviewing grant approvals, agreements, valuation methods, vesting terms, forfeitures, modifications, expense calculations, and relevant financial statement disclosures.
The questions often sound straightforward.
When was this award granted?
Who approved it?
What was its fair value?
Why did the expense change?
What happened to these unvested options?
Can you support the assumptions used?
Those questions get much harder when the answer requires reconstructing an award from several versions of a spreadsheet.
An accurate ownership audit trail helps preserve the events behind the current record.
It doesn't replace the company's accounting judgments or valuation work.
It gives those judgments a more reliable factual foundation.
How should private companies prepare for ASC 718 reporting?
Start before the reporting deadline.
If the company issues equity compensation, finance should understand how grants are approved, how award terms are recorded, who maintains vesting information, and how changes reach the accounting team.
The company should also establish a consistent process for reconciling award activity to its accounting records.
That means identifying grants, exercises, forfeitures, expirations, and modifications during the period rather than discovering them during the audit.
Valuation work should be coordinated with qualified professionals. Accounting policies and conclusions should be documented. Relevant information should be preserved so the company can support calculations in later periods.
Most importantly, the process shouldn't depend on one person remembering what happened.
A finance team should be able to explain the expense without calling the employee who maintained the original option spreadsheet five years ago.
Where Nth Round fits into the process
Nth Round isn't an ASC 718 valuation firm or a substitute for the accountants responsible for stock-based compensation reporting.
Our focus is the ownership administration that surrounds those calculations.
Private companies need reliable equity records, transaction histories, supporting documents, and a way to manage ownership changes without losing track of what happened.
Nth Round's shareholder management platform helps companies manage ownership information and the workflows connected to it.
For companies administering employee equity alongside other shareholder activity, that matters.
The accounting professionals still determine how ASC 718 applies.
But the company should be able to provide accurate records rather than asking those professionals to reconstruct its equity history first.
Good ASC 718 accounting starts before the calculation
It's tempting to think of ASC 718 as something finance deals with at the end of the quarter or year.
In reality, the accounting is affected by decisions and events that happen throughout the life of an equity award.
A grant is approved.
An employee begins vesting.
A performance condition changes.
Someone leaves.
An option is exercised.
An agreement is modified.
The company completes another reporting period.
Each event can affect the information needed to account for the award.
And each is much easier to deal with when it's recorded at the time.
The calculation matters. So do the valuation assumptions and the accounting judgments.
But none of those things benefits from an incomplete history.
The best time to get an equity award's records right is when the award changes—not six months later when the auditors ask what happened.
