The short answer: ASC 718 is the US GAAP standard for stock-based compensation. It requires companies to measure each stock option, RSU or other equity award at its fair value on the grant date, usually with an option-pricing model such as Black-Scholes, and to record that amount as compensation expense over the vesting period. It applies to public and private companies that prepare GAAP financial statements, and to grants to employees and non-employees alike.
What US companies need to know about measuring, recognizing and disclosing share-based payments, with worked examples, comparison tables and the valuation models behind the numbers.
Key takeaways
- Measure once: equity awards are valued at grant-date fair value and not remeasured.
- Expense over vesting: cost is spread over the service period, straight-line or by tranche.
- Private companies too: anyone issuing GAAP financials must apply it.
- 409A feeds in: the 409A value is usually the share price input to the option model.
- ISO or NSO, same expense: the book cost is identical; only the tax side differs.
- Disclose the assumptions: volatility, expected term, risk-free rate and dividend yield go in the footnotes.
What Is ASC 718?
ASC 718 is the US GAAP standard that tells companies how to put a dollar value on the equity they grant to employees and non-employees, and how to spread that cost across the income statement over the period the recipient earns it.
The Financial Accounting Standards Board (FASB) publishes US accounting rules in the Accounting Standards Codification, a library where each standard sits under a numbered topic. Topic 718 covers compensation paid in stock rather than cash: stock options, restricted stock units (RSUs), restricted stock awards, employee stock purchase plans, performance shares and similar instruments.
In plain English: ASC 718 requires a company to record the grant-date fair value of every share-based award as compensation expense over the period the recipient must work or perform to earn it.
Before FAS 123R was issued in 2004, companies could account for options under the older intrinsic value rules (APB 25) and, for at-the-money grants, show the cost only in a footnote. The result was financial statements that looked healthier than reality, especially in tech, where equity is often the largest form of pay. FAS 123R required the cost to be expensed, and in 2009 it was codified as ASC 718.
Who Falls Under ASC 718?
- Public companies: required, and central to every SEC filing.
- Private companies with GAAP financial statements: required as soon as an audit, a lender covenant or an institutional investor calls for GAAP statements.
- Early-stage startups: required if they prepare GAAP financials; many first apply it properly when they raise a priced round, prepare for an audit or approach an IPO, which often means catching up on prior grants.
- Grants to non-employees: consultants, advisors and contractors; ASU 2018-07 brought these grants into the same model as employee awards.
Why ASC 718 Matters to Founders, CFOs and Investors
ASC 718 is not just an accounting hurdle. It shapes how investors read a company, how auditors sign off and how the tax side is recorded. Six reasons it sits high on the finance team’s list:
True Cost Visibility
Equity is real compensation. Without ASC 718, a company that pays its team partly in stock looks more profitable than it is. The standard puts the cost on the income statement.
Audit and IPO Readiness
Auditors will not give a clean opinion on GAAP financial statements that leave out stock compensation expense, and an S-1 registration statement needs several years of it.
Investor Due Diligence
Series A and later investors expect stock-based compensation as a line item and a clean cap table behind it. Missing or messy records slow down due diligence and can affect deal terms.
Tax Coordination
ASC 718 works with ASC 740 (income taxes) on deferred tax assets and on the excess tax benefits and shortfalls that now run through income tax expense.
Comparability
Common rules let analysts compare companies on equal terms, which matters because stock compensation can be a large share of operating expense at growth companies.
Fewer Restatements
Errors in stock compensation are a recurring cause of restatements. Getting ASC 718 right from the start avoids costly corrections later.
The Six Subtopics That Make Up ASC 718
| Subtopic | Title | What it covers |
|---|---|---|
| ASC 718-10 | Overall | Scope, the grant-date fair value measurement principle, service, performance and market conditions, forfeitures, modifications and disclosures |
| ASC 718-20 | Awards classified as equity | Most options, RSUs and restricted stock; measured once at grant date and not remeasured |
| ASC 718-30 | Awards classified as liabilities | Cash-settled awards and some puttable or variable awards; remeasured at fair value (or intrinsic value for some private companies) every reporting period until settled |
| ASC 718-40 | Employee stock ownership plans | Accounting by the sponsoring employer for ESOP shares, including leveraged ESOPs |
| ASC 718-50 | Employee share purchase plans | When an ESPP is compensatory (for example a discount above 5% or a look-back feature) and how to value it |
| ASC 718-740 | Income taxes | Deferred tax assets on awards, and the excess tax benefits and shortfalls that now run through income tax expense |
How ASC 718 Works: A Three-Stage Process
Whether you grant 100 options or 100,000 RSUs, the workflow is the same, in this order.
1. Establish Fair Value
2. Recognize the Expense
The total grant-date fair value is spread across the requisite service period, usually the vesting schedule, using straight-line or graded attribution.
3. Disclose and Reconcile
The expense runs through the income statement, and outstanding awards, weighted-average exercise prices and key assumptions appear in the financial statement footnotes each period.
Recognizing the Expense: Straight-Line vs. Graded Attribution
For awards with only service conditions, ASC 718 lets a company choose, as an accounting policy, between two attribution methods. The choice changes when expense hits the income statement; total expense over the life of the award is the same.
The setup (hypothetical): Nimbus Robotics, a private tech startup, grants 120,000 stock options to a new VP of Engineering on January 1. The award vests in four equal annual tranches. Using Black-Scholes (see the worksheet below), the grant-date fair value is $3.69 per option, so total compensation cost is $442,800.
Straight-Line: Even Recognition Across the Service Period
Under the straight-line method, the $442,800 is spread evenly over the four-year service period, $110,700 a year.
| Year 1 | Year 2 | Year 3 | Year 4 | Total | |
|---|---|---|---|---|---|
| Expense recognized | $110,700 | $110,700 | $110,700 | $110,700 | $442,800 |
| Share of total cost | 25% | 25% | 25% | 25% | 100% |
One rule applies: cumulative expense at any date must be at least the grant-date value of the portion already vested. Here, 25% vests each year and 25% is expensed each year, so the rule is met.
When to choose it: service-only awards, predictable results and a preference for smooth quarterly expense. Most private companies use straight-line for its simplicity.
Graded: Front-Loaded Recognition by Tranche
Under the graded method, each annual tranche is treated as a separate award with its own service period: the first tranche vests in one year, the second in two years, and so on. The result is heavier expense early and lighter expense later. For simplicity, this example gives every tranche the same fair value; in practice each tranche can be valued with its own expected term.
Step 1: identify each tranche
| Tranche | Options | Vesting period | Tranche fair value |
|---|---|---|---|
| Tranche 1 | 30,000 | 1 year | $110,700 |
| Tranche 2 | 30,000 | 2 years | $110,700 |
| Tranche 3 | 30,000 | 3 years | $110,700 |
| Tranche 4 | 30,000 | 4 years | $110,700 |
| Total | 120,000 | $442,800 |
Step 2: spread each tranche over its own vesting period
| Tranche | Year 1 | Year 2 | Year 3 | Year 4 | Total |
|---|---|---|---|---|---|
| Tranche 1 (1 year) | $110,700 | $110,700 | |||
| Tranche 2 (2 years) | $55,350 | $55,350 | $110,700 | ||
| Tranche 3 (3 years) | $36,900 | $36,900 | $36,900 | $110,700 | |
| Tranche 4 (4 years) | $27,675 | $27,675 | $27,675 | $27,675 | $110,700 |
| Annual expense | $230,625 | $119,925 | $64,575 | $27,675 | $442,800 |
The front-loading is clear: 52% of the total cost ($230,625 of $442,800) falls in year 1 under the graded method, compared with 25% ($110,700) under straight-line. Awards with performance conditions must be expensed this way, tranche by tranche.
Side-by-Side Comparison
| Year | Straight-line | Graded | Difference |
|---|---|---|---|
| Year 1 | $110,700 | $230,625 | +$119,925 |
| Year 2 | $110,700 | $119,925 | +$9,225 |
| Year 3 | $110,700 | $64,575 | ($46,125) |
| Year 4 | $110,700 | $27,675 | ($83,025) |
| Cumulative | $442,800 | $442,800 | $0 |
Need your stock compensation expense calculated and documented?
Countsure prepares ASC 718 expense schedules, option valuations and footnote disclosures that your auditors can follow.
How the Grant-Date Fair Value Is Calculated
ASC 718 does not prescribe one formula. It requires a valuation technique suited to the award, which for options in practice means Black-Scholes or a lattice (binomial) model. RSUs and restricted stock are simpler: their fair value is the share price at grant.
The Six Inputs Every Option Model Needs
| Input | Symbol | What it captures | Typical source |
|---|---|---|---|
| Share price | S | Fair value of the underlying common share at grant date | Most recent 409A valuation; private companies may use it as a practical expedient (ASU 2021-07) |
| Exercise (strike) price | K | The price the holder pays for each share | Set at or above fair market value on the grant date |
| Expected term | t | How long the option is likely to stay outstanding before exercise | Simplified method (midpoint of average vesting and contractual term) or company history |
| Volatility | σ | Expected variability of the share price over the term | Historical volatility of comparable public companies; some private companies use an industry index |
| Risk-free rate | r | Zero-coupon US Treasury yield for the expected term | US Treasury yield curve |
| Dividend yield | q | Expected dividends during the term | Usually 0% for early-stage companies |
Black-Scholes vs. Lattice: Which Model Fits?
Black-Scholes-Merton
- A single formula with a single output; fast and easy to audit.
- Assumes constant volatility and a single expected exercise date.
- Cannot model market conditions, such as a share price target, directly.
- Best suited to plain options with service-only vesting.
- The default for most private company option grants.
Lattice (binomial)
- Builds a tree of possible share prices over time.
- Lets volatility, dividends and interest rates vary by period.
- Models early exercise behavior and market conditions.
- Preferred for executive awards with complex terms; Monte Carlo simulation is often used for market-condition awards.
- More work to build and needs fuller documentation in the valuation memo.
What a Real Calculation Looks Like
Here is the Black-Scholes worksheet for the Nimbus Robotics grant above.
| Assumption | Value | Basis |
|---|---|---|
| Share price (S) | $8.00 | 409A fair market value of common stock |
| Strike price (K) | $8.00 | Granted at fair market value |
| Expected term (t) | 6.25 years | Simplified method: (2.5-year average vesting + 10-year contractual term) ÷ 2 |
| Volatility (σ) | 40% | Median of eight comparable public companies |
| Risk-free rate (r) | 4.05% | US Treasury yield for a term of about 6 years |
| Dividend yield (q) | 0% | No dividends expected |
| Fair value per option | $3.69 | Black-Scholes-Merton output |
| Total grant-date fair value | $442,800 | 120,000 options × $3.69. |
Tax Treatment: ISOs vs. NSOs at a Glance
ASC 718 governs the books, but the tax code governs the tax. The two run in parallel, and the type of option you grant changes both.
| Incentive stock options (ISOs) | Non-qualified stock options (NSOs) | |
|---|---|---|
| Who can receive them | Employees only | Employees, contractors, advisors and non-employee directors |
| Strike price rule | At least fair market value at grant (110% for owners of more than 10%) | Should be at least fair market value to avoid Section 409A penalties |
| Tax at exercise | No regular income tax; the spread is an AMT adjustment | Ordinary income on the spread (fair market value less strike), with payroll tax for employees |
| Tax at sale | Long-term capital gain if shares are held 2 years from grant and 1 year from exercise | Capital gain or loss on change in value after exercise |
| Employer tax deduction | None, unless there is a disqualifying disposition | Equal to the ordinary income the holder recognizes |
| $100,000 limit | Only the first $100,000 of stock (valued at grant) that first becomes exercisable in a year qualifies; the excess is treated as NSOs | No limit |
| Reporting | Form 3921 after exercise | Form W-2 (employees) or 1099-NEC (others) |
| ASC 718 book expense | Same as NSOs | Same as ISOs |
| Deferred tax under ASC 718-740 | No deferred tax asset recorded, since no deduction is expected | Deferred tax asset recorded as expense is recognized |
The ASC 718 Footnote Checklist
Expensing the award is only half the job. ASC 718 also requires detailed footnote disclosure so readers understand the assumptions behind the number.
| Disclosure | What to include | Frequency |
|---|---|---|
| Plan description | Types of awards, eligible recipients, shares authorized and available | Annual |
| Award activity rollforward | Outstanding, granted, exercised, forfeited and expired, with weighted-average exercise prices | Annual |
| Valuation assumptions | Volatility, expected term, risk-free rate and dividend yield for each year's grants | Annual |
| Compensation cost | Cost recognized in the period, and unrecognized cost with the period over which it will be recognized | Annual, plus interim for public companies |
| Tax effects | Tax benefits realized from exercises and vesting | Annual |
| Modifications | Awards whose terms changed during the period and the incremental cost | Annual |
| Liability awards | Fair value or intrinsic value at period end and the effect of remeasurement | Each reporting period |
| Policy elections | Forfeiture method, attribution method and any private company practical expedients | Annual |
Common ASC 718 Mistakes We See in Practice
Across audit support and ASC 718 cleanup work, the same issues come up again and again. If you spot any of these in your books, it is worth a closer look.
| Mistake | Why it is a problem | How to fix it |
|---|---|---|
| Stale 409A valuation | Options granted below fair market value can create Section 409A tax penalties for employees and a cheap-stock question from auditors | Refresh the 409A at least every 12 months and after any material event, such as a priced round |
| Missing modification accounting | Repricing, accelerating or extending an award without recording any incremental cost | Measure fair value just before and after the change and expense the increase; apply the Type I to IV framework for vesting changes |
| Wrong attribution for performance awards | Straight-lining a graded-vesting award with performance conditions understates early expense | Use graded (tranche-by-tranche) attribution for performance awards; document the policy for service-only awards |
| Forgetting non-employee grants | Consultant and advisor grants have been inside ASC 718 since ASU 2018-07 | Value and expense non-employee awards in the same framework as employee awards |
| Inconsistent forfeiture policy | Switching between estimating forfeitures and recording them as they occur, without disclosure | Pick one method, document it and apply it to all awards |
| Skipping ESPP valuation | ESPPs with a look-back or a discount above 5% are compensatory | Value each offering period (usually with Black-Scholes) and expense the cost |
Get ASC 718 Right Before Your Audit, Your Raise or Your IPO
Countsure’s valuation and accounting team prepares ASC 718 workpapers, Black-Scholes and lattice valuations, footnote disclosures and 409A valuations in one coordinated engagement. We work with founders, CFOs and audit firms across the US.
Frequently Asked Questions
1. What is ASC 718?
ASC 718 is the US GAAP standard for share-based payments. It requires a company to measure stock options, RSUs, restricted stock and similar awards at their grant-date fair value and recognize that amount as compensation expense over the period the recipient must work to earn them, with detailed footnote disclosure.
2. Does ASC 718 apply to private companies?
Yes. It applies to any company that prepares US GAAP financial statements and grants share-based payments, public or private. Private companies usually first apply it in earnest when they need audited financials or raise institutional capital, and they have some practical expedients, such as using a 409A valuation as the share price input.
3. Is ASC 718 the same as a 409A valuation?
No. A 409A valuation sets the fair market value of common stock for tax purposes and supports the option strike price. ASC 718 is the accounting standard that measures and records the resulting compensation expense. The 409A value is usually an input into the ASC 718 calculation, but they answer different questions.
4. What is the difference between straight-line and graded attribution?
Straight-line spreads the total grant-date fair value evenly over the service period. Graded attribution treats each vesting tranche as a separate award, which puts more expense in the early years. For awards with only service conditions, companies can choose either as a policy; awards with performance conditions are expensed tranche by tranche.
5. How are forfeitures handled under ASC 718?
Companies elect either to estimate forfeitures at grant and true up later, or to account for forfeitures as they occur. It is an accounting policy election that must be applied consistently. Most early-stage private companies record forfeitures as they occur because it is simpler.
6. Which valuation model should I use, Black-Scholes or lattice?
Black-Scholes suits plain options with service-only vesting. A lattice (binomial) model or a Monte Carlo simulation is preferred when the award has market conditions, such as a share price target, or when early exercise patterns matter. Document the choice and apply it consistently.
7. Do RSUs follow the same ASC 718 rules as stock options?
Yes. RSUs are measured at grant-date fair value and expensed over the service period. Their fair value is simply the share price at grant, less the present value of any dividends the holder will not receive, so no option-pricing model is needed.
8. Do ISOs and NSOs have different ASC 718 expense?
No. The book expense is the same for both. The difference is in tax: NSOs give the company a tax deduction when exercised, so a deferred tax asset is recorded as the expense is recognized; ISOs normally give no deduction, so no deferred tax asset is recorded.
Related Countsure Blogs
- ASC 718 Stock Compensation Guide: an overview of the standard.
- 409A Valuation Guide: how the common stock value is set.
- Sample 409A Valuation Report: what a valuation report contains.
- Form 3921 Filing Guide: reporting ISO exercises.
Parth Shah, Managing Director
(CPA-US, FCA, RV-S&FA, DISA)
Parth Shah who is head of Accounts and Book keeping has experience of more than 10 years. A Certified Public Accountant – US, fellow Chartered Accountant, Registered Valuer and Diploma in Information System Audit.
