ASC 740 governs how companies recognize the effects of income taxes on their financial statements under U.S. GAAP. ASC 718 provides specific accounting guidance for the various types of stock options that companies use to compensate their employees. It also clarifies how the ASC 740 income tax provision should be applied to stock-based compensation.
What is the accounting treatment for ASC 718 stock-based compensation?
ASC 718 governs GAAP accounting for stock options. The standard requires companies to recognize compensation expense related to their equity awards on an award-by-award basis. The ASC 718 stock-based compensation expense is recorded on financial statements over a vesting period in which the award is earned and offset by a credit to additional paid-in capital (APIC). Depending on the type of equity awarded, the following variables are applied slightly differently to the accounting treatment for stock-based compensation:
- Grant date – The date on which the company grants the award to the employee and typically the day the vesting period begins
- Vest date – The date the award is available for exercise (in the case of options) or the restrictions lapse (in the case of restricted stock units). Options typically vest in tranches over three or four years with a multiple-year exercise period. Restricted stock units typically all vest on the same date after a three or four-year period. This is often referred to as a “cliff vest.”
- Exercise price or strike price – The price, established at the grant date, at which the option is exercisable
- Exercise date – The date an option is exercised
- Vesting period or service period – The period over which the award is earned and becomes available for exercise by the employee
Regardless of subsequent fluctuations in the value of the underlying stock, no subsequent adjustments are made to the total compensation expense associated with a particular award. Furthermore, the existence of underwater options (i.e., options where the exercise price exceeds the fair value) is not negative evidence in considering the need for an ASC 740 valuation allowance for deferred tax assets. However, if the deferred tax asset is material to the financial statements, it should be disclosed.
GAAP accounting for restricted stock units (RSUs)
Restricted stock units (RSUs) are shares of stock awarded to an employee at a future date if the employee satisfies specific vesting requirements, such as continued employment or achievement of performance goals.
For GAAP, the company records the value of the award as of the grant date as compensation expense over the vesting period with an offsetting credit to APIC. The company also recognizes a deferred tax asset related to the compensation expense in anticipation of the future deduction.
Upon vest, the company receives a tax deduction equal to the fair value of the awards.
The company reverses the deferred tax asset associated with the restricted shares upon vest. It records any excess benefit or shortfall as a discrete benefit or cost in the period in which the RSU is exercised.