What Is ASC 718?
ASC 718 (formerly SFAS 123R) is the US GAAP standard that governs how companies account for share-based compensation — stock options, restricted stock units (RSUs), and other equity awards granted to employees and directors.
The core principle is straightforward: measure the fair value of equity awards on the grant date and recognize that amount as compensation expense over the vesting period. In practice, this involves option-pricing models, volatility estimation, and a fair amount of judgment.
Who Needs to Comply?
Every entity that issues share-based compensation — from Series A startups to public companies. If you grant stock options or RSUs, you need an ASC 718 valuation to record the expense in your financial statements.
- Pre-IPO startups — Required for audited financial statements, often starting at Series A when auditors first engage.
- Private companies — Needed for any GAAP-compliant financials, M&A due diligence, or SOX readiness.
- Public companies — Mandatory for SEC filings; compensation expense directly impacts EPS.
The Fair Value Framework
ASC 718 requires fair value to be measured at the grant date using an accepted option-pricing model. The two most common are:
Black-Scholes-Merton
Closed-form model. Preferred for "plain vanilla" options with standard vesting and a single expected term. Most startups use this.
Lattice (Binomial)
More flexible — can model early exercise behavior and changing volatility over time. Used by larger companies with complex award structures.
Key Inputs
Regardless of the model, you need these inputs:
| Input | Source |
|---|---|
| Stock price (S) | 409A valuation for private cos; market price for public |
| Strike price (K) | Set in the option agreement (often = common FMV at grant) |
| Expected term (T) | Simplified method or historical exercise data |
| Volatility (σ) | Comparable public companies (for private cos) |
| Risk-free rate (r) | US Treasury yield matching the expected term |
| Dividend yield (q) | Usually 0 for startups |
Expected Term — The Simplified Method
Private companies without sufficient historical exercise data can use the SAB 107/110 simplified method:
Expected Term = (Vesting Period + Contractual Term) / 2
For a typical 4-year vest with a 10-year contractual term, this gives 7 years. This is the most common approach for startups and is explicitly accepted by auditors.
Expense Recognition
Once you have the per-share fair value, multiply by the number of options granted to get the total compensation cost. This is recognized ratably over the requisite service period (usually the vesting period):
- Straight-line — Equal expense each period (most common for single awards).
- Graded vesting — Each vesting tranche is treated as a separate award; front-loads expense.
Forfeitures can be estimated upfront or recognized as they occur (ASU 2016-09 election). Most private companies now elect to recognize forfeitures when they happen, as it's simpler.
What Auditors Look For
- Documented rationale for comparable company selection
- Consistency in lookback period and frequency across grants
- Sensitivity analysis showing fair value across a range of volatilities and rates
- Board-approved grant dates matching the valuation date
- Reconciliation of total stock-based compensation expense to the financial statements
Common Mistakes
Run an ASC 718 valuation in minutes
ValPack calculates fair value, sensitivity tables, and generates an audit-ready pack.
Open calculator