ASC 718 stock-based compensation

What does ASC 718 cover?

Share-based payment awards granted to employees and, since ASU 2018-07, to nonemployees for goods or services: stock options, restricted stock and restricted stock units, performance shares, stock appreciation rights and employee stock purchase plans. ASU 2024-01, effective for public business entities from 2025 and others from 2026, added examples to help companies decide whether profits interest awards fall under ASC 718 or are ordinary compensation under ASC 710. Shares or options received from a customer as payment are not in scope; they follow ASC 606.

Is an award equity or a liability?

Most awards settled in shares are equity. An award is a liability if it is settled in cash or other assets, such as a cash-settled stock appreciation right; if the employee can require the company to repurchase the shares soon after vesting; or if it is indexed to something other than a market, performance or service condition. Equity awards are measured once, at the grant date. Liability awards are remeasured at fair value at each reporting date until settlement, though nonpublic companies may elect intrinsic value instead.

How is grant-date fair value measured?

For shares and RSUs, usually the market price of the stock on the grant date. For options, with an option pricing model such as Black-Scholes-Merton, a lattice model or a Monte Carlo simulation, using the exercise price, expected term, expected volatility, expected dividends and the risk-free rate. Nonpublic companies have practical expedients: a simplified expected term, the volatility of an appropriate industry index when their own cannot be estimated, and, since ASU 2021-07, a current price input for their own shares determined by a reasonable valuation method. ASC 718 sets its own fair-value-based measure, so ASC 820 fair value measurement does not apply to these awards.

How is stock-based compensation cost recognized over time?

• Service conditions: cost is recognized over the requisite service period, usually the vesting period.
• Graded vesting: for awards vesting in tranches with only a service condition, a company chooses as a policy to recognize cost straight-line over the whole award or separately for each tranche, but cumulative cost must at least equal the portion vested.
• Performance conditions, such as a revenue target: cost is recognized only when achieving the condition is probable, and reversed if it stops being probable.
• Market conditions, such as a share price target: reflected in the grant-date fair value, with no reversal if the condition is not met, as long as the service is provided.
• Forfeitures: since ASU 2016-09, a company chooses as a policy either to estimate expected forfeitures or to account for them when they occur.

ASC 718 in practice: graded vesting under both methods

On January 1, 2026 a company grants 10,000 RSUs with a grant-date fair value of $40 each, a total of $400,000. A quarter vests on each of the next 4 anniversaries, subject only to continued service. No forfeitures are expected.

Both methods recognize $400,000 in total. The graded method treats each tranche as a separate award, so the first year carries the whole first tranche plus a share of the later ones, $208,333, front-loading the cost. The straight-line method charges $100,000 a year, which here never falls below the value already vested. Each year the entry is a debit to compensation cost and a credit to additional paid-in capital. When the first tranche vests at a share price of $50, the company's tax deduction is based on $50 rather than $40, and the excess tax benefit of $5,250 at a 21% rate reduces income tax expense in that period.

What happens when an award is modified?

A change to terms, such as repricing underwater options or extending the exercise period, is a modification. For an award expected to vest both before and after the change, the company recognizes the incremental fair value at the modification date on top of the original grant-date fair value. If an award that was not expected to vest becomes probable of vesting, the cost is based on fair value at the modification date instead. In September 2026 the FASB proposed a technical correction on how to account for changes to a nonvested award after the employee has left, with comments due by November 19, 2026.

How do income taxes work for stock-based compensation?

For awards that will produce a tax deduction, such as nonqualified options and RSUs in the US, the company records a deferred tax asset as it recognizes the cost. The actual deduction usually depends on the share price at vesting or exercise. Since ASU 2016-09, any excess tax benefit or deficiency goes to income tax expense in the period it arises, which can make the effective tax rate swing with the share price. Incentive stock options generally produce no deduction, so no deferred tax asset is recorded. See deferred taxes under ASC 740.

How do awards affect earnings per share?

Unvested RSUs and outstanding options are included in diluted EPS using the treasury stock method, where the assumed proceeds include the cost not yet recognized. Awards that would raise EPS, such as options with an exercise price above the average share price, are left out. See ASC 260 earnings per share.

How does ASC 718 compare with IFRS 2?

The two share the grant-date fair value model, but IFRS 2 requires graded attribution for each tranche, requires forfeitures to be estimated, records excess tax benefits in equity, and treats some awards differently, such as those where the employee or the company can choose cash or shares. US GAAP's nonpublic company practical expedients have no IFRS equivalent. See IFRS 2 share-based payment and stock compensation at technology companies.

This guide is general information. It is not tax or legal advice for your situation.