ASC 718 Stock Compensation: Stock Option Grant Transaction Explained with Journal Entries
Posted In | ASC Education | Gridlex AcademyThe ASC 718 accounting standard, established by the Financial Accounting Standards Board (FASB), governs the accounting for stock-based compensation, including stock options. Stock options are a popular form of equity compensation that grants employees the right to purchase company shares at a predetermined price, known as the exercise price. In this article, we will provide an overview of stock option grant transactions under ASC 718 and illustrate how journal entries can be used to account for them.
Stock Option Grants under ASC 718
Under ASC 718, companies must recognize stock option compensation expense over the vesting period, which is the period during which employees become fully entitled to exercise the options. The compensation expense is typically determined using an option-pricing model, such as the Black-Scholes model, which estimates the fair value of the stock options at the grant date.
Journal Entries for Stock Option Grant Transactions
To illustrate the concept of stock option grants and the accounting treatment under ASC 718, let's consider a simplified example involving a company that grants 1,000 stock options to an employee. The options have an exercise price of $10, a fair value of $5 per option, and vest over a four-year period.
1. Calculate the total stock option compensation expense
The total stock option compensation expense is determined by multiplying the number of options granted by the fair value of each option:
Total Compensation Expense: 1,000 options x $5 = $5,000
2. Allocate the stock option compensation expense over the vesting period
The compensation expense is recognized over the four-year vesting period in equal annual installments:
Annual Compensation Expense: $5,000 / 4 years = $1,250 per year
3. Journal entries for stock option grant
Now, let's create journal entries to account for the stock option grant and the corresponding compensation expense:
a) Record the stock option grant:
No journal entry is required at the grant date.
b) Record the stock option compensation expense over the vesting period:
Debit: ompensation Expense - $1,250C
Credit: Additional Paid-in Capital (APIC) - Stock Options - $1,250
This journal entry is made annually over the four-year vesting period.
4. Journal entries for stock option exercise
When the employee exercises the stock options, the company must record the following journal entry:
Debit: Cash - $(1,000 options x $10 exercise price)
Debit: APIC - Stock Options - $5,000 (total compensation expense)
Credit: Common Stock - $(1,000 options x par value)
Credit: APIC - Common Stock - $(total cash received + total compensation expense - total par value)
The ASC 718 standard requires businesses to recognize stock option compensation expense over the vesting period, ensuring that the financial statements reflect the cost of equity-based compensation. By understanding the concept of stock option grants and properly accounting for them through journal entries, organizations can maintain accurate financial reporting and compliance with ASC 718. As businesses continue to navigate the complexities of stock-based compensation accounting, it is essential to invest in the right tools and resources, such as advanced accounting software, to streamline the process and ensure ongoing compliance.