Recently our internal training program focused on a topic that has been around for quite a while – Stock Compensation. This topic is of particular importance to entrepreneurs and their start-up companies because the use of stock options and other equity-based awards is critical to recruiting and retaining key contributors to a start-up’s success.
Accounting for Stock Compensation has evolved over the years starting with Accounting Principles Board Opinion #25 up to today’s ASC 718 “Compensation – Stock Compensation”. In our training, we identified three steps necessary to understand and properly account for the equity awards:
- We identified the types of awards that are subject to the guidance of ASC 718 and the types of awards that are subject to other GAAP pronouncements.
- We discussed the various valuation methods and data inputs that are used to determine the fair value of the awards.
- We discussed the considerations and methods used to allocate that fair value to the P&L as an expense.
Stock options are probably the most familiar and widely used of the equity awards, but restricted stock, restricted stock units, and stock appreciation rights can also play important roles in recruiting and retaining key contributors.
The equity awards subject to ASC 718 are compensatory in nature; that is these awards are designed to be an important element of the compensation for the award recipients, primarily employees but also certain other service providers, for the work they do on behalf of the company. The award recipients earn the awards and the rights contained in them through “vesting”. The vesting schedule is the basis for allocating the fair value of the awards as expense in the P&L.
The most common method of vesting is for the vesting to occur ratably over a specified period during which the recipient renders services to the company. But often, when it comes to achieving technical, marketing, or sales milestones essential to the company’s growth and success, vesting can be performance-based and defined as occurring upon the achievement of strategic milestones, which will drive the company’s valuation to higher levels.
The structuring of stock compensation awards can be critical to developing the company’s business model and achieving the milestones essential to the company’s success.