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Ext. PublicationAccounting for Stock Options, RSUs and Deferred Compensation in the Tech Industry
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For tech companies, attracting and retaining top talent often means offering complex compensation packages that may include stock options and restricted stock units (RSUs), performance bonuses and deferred compensation. These packages may help drive employee motivation, but they also pose significant accounting challenges.
The Financial Accounting Standards Board (FASB) provides guidance through ASC 710, Compensation — General and ASC 718, Compensation — Stock Compensation, to address various forms of employee rewards. ASC 710 covers nonequity compensation like bonuses and deferred payment arrangements, while ASC 718 focuses on share-based awards which are common in tech firms. It should be highlighted that 718 uses the term “shares” which “includes various forms of ownership interest that may not take the legal forms of securities.” These standards require careful measurement, recognition and disclosure, with ongoing valuation needs adding to the maintenance costs.
Compensation Decisions in the Tech Sector
Technology companies often use a mix of cash and equity compensation to align an employee’s personal interests with performance of the company. This might include stock options tied to milestones, RSUs or performance shares linked to growth metrics. These awards must be accounted for based on their nature, with share-based instruments falling under ASC 718 and cash-settled or deferred items under ASC 710. The challenge lies in valuing these packages amid volatility in tech valuations, impacting expense recognition and financial statements.
ASC 710: Accounting for General Compensation
ASC 710 addresses nonstock compensation, such as salaries, bonuses and deferred compensation plans. Entities must accrue liabilities for promised future payments if they are probable and estimable, recognizing expenses as services are rendered. For example, in technology firms, deferred bonuses tied to long-term projects are accrued over the service period.
A key implication is the timing of recognition: compensation costs are expensed when earned, but deferred arrangements require discounting if payments are delayed. In venture capital (VC)-backed tech startups, this can affect cash flow projections, as liabilities build on the balance sheet. Ongoing maintenance involves periodic reassessments for changes in estimates, potentially leading to adjustments in earnings.
ASC 718: Accounting for Share-Based Compensation
Share-based compensation, like stock options and RSUs, falls under ASC 718. Companies typically must recognize the fair value of awards as compensation expense over the vesting period, or in certain situations, a calculated or intrinsic value.
Defining the grant date
The grant date is critical and is defined as the date:
- The employer and employee reach a mutual understanding of the key terms and conditions of the award.
- The employer becomes contingently obligated to issue shares or transfer assets upon vesting.
- All necessary approvals (e.g., board or shareholder) are obtained.
- The employee begins to benefit from or be adversely affected by changes in the stock price.
If performance targets are not yet defined or approved, or if approvals are not perfunctory, the grant date is delayed until these are resolved.
On the grant date, companies must determine how much the award is worth and use that value to record the related compensation cost over the time the employee is expected to work. For equity awards, this means recording an expense and increasing paid-in capital, and for liability awards, the credit goes to a liability account. If the award is fully vested on the grant date, the full cost should be recorded right away.
Fair value and vesting impacts on recognition
Fair value at the grant date is determined using appropriate valuation techniques, such as the Black-Scholes-Merton formula or lattice (binomial) models for options, incorporating inputs like the current stock price, exercise price, expected term, expected volatility, expected dividends and risk-free interest rate. Market conditions (e.g., stock price targets) are factored into the fair value. Service or performance vesting conditions affect recognition but are not factored into the fair value. For nonpublic entities, if estimating expected volatility is impracticable, a calculated value using an industry sector index may be used as a practical expedient.
Equity vs. liability classification and reassessment
For equity-classified awards, measurement occurs at the grant date. Fair value is determined using models like Black-Scholes for options, with expense amortized straight-line or graded over requisite service periods. Implications include dilution of earnings per share in growing tech companies and potential volatility from modifications, such as repricing options in down markets.
For liability-classified awards (e.g., cash-settled stock appreciation rights), remeasurement at each reporting date is required. This can introduce earnings volatility, especially in technology firms with variable performance metrics. Private equity (PE)-backed entities must monitor for classification changes impacting balance sheets and tax deductions under Internal Revenue Code (IRC) Section 162(m).
For equity-classified awards, fair value is generally not reassessed after the grant date unless the award is modified (e.g., changes in terms, repricing). In these cases, the incremental fair value is calculated and recognized prospectively. If the service inception date precedes the grant date (e.g., awards contingent on future approval), fair value is estimated each reporting period until the grant date, with final adjustment to the grant-date fair value. For liability-classified awards, fair value is reassessed each reporting period until settlement, incorporating updated inputs like current stock price.
Valuation requirements and ongoing maintenance costs
Valuations are critical under ASC 718, particularly for private tech companies. Fair value for options requires models incorporating volatility, expected term and risk-free rates, often aligned with IRC Section 409A valuations to determine strike prices. For unlisted technology firms, independent 409A appraisals (under IRC Section 409A) are needed at least annually or after material events like funding rounds.
One of the most significant ongoing costs is hiring valuation experts. Failure to update valuations risks restatements or IRS penalties. Private companies may use practical expedients for expected term or volatility, but they must disclose assumptions. In technology, where awards tie to metrics, Monte Carlo simulations add complexity and expense.
Tax considerations and required filings
Beyond accounting, technology companies must address tax implications of compensation under ASC 710 and ASC 718 to avoid penalties and ensure compliance. For general compensation under ASC 710, such as deferred bonuses, taxation occurs when amounts are paid or no longer subject to substantial risk of forfeiture, per IRC Section 83. Deferred arrangements may fall under IRC Section 409A, requiring strict compliance with timing rules to defer taxation. Noncompliance can lead to immediate inclusion in income plus a 20% penalty tax. Employers must withhold income and employment taxes at payment, reporting on Form W-2 for employees.
Under ASC 718, employees typically owe regular income tax when their equity awards vest (for RSUs) or when they exercise their options for nonqualified stock options. The taxable amount is the market value at that time minus anything the employee paid for the shares.
Incentive stock options (ISOs) follow different rules. If they qualify under Section 422, no income tax payment is due at exercise, but the stock options might trigger the alternative minimum tax (AMT). If the employee holds the stock long enough after exercising, any gain may be taxed at lower capital gains rates.
Companies can usually deduct these expenses when employees report them as income, but there are limits for certain top executives under Section 162(m). Private companies tend to have more flexibility in this area.
Finally, for equity plans that include deferred compensation, companies must follow Section 409A rules to properly value stock and set exercise prices. If they don’t, both the company and the employee could face tax penalties. Required filings include:
- Form W-2 to report taxable compensation to employees and the IRS
- Form 3921 for ISO exercises, due by January 31 to employees and February 28 (paper) or March 31 (electronic) to the IRS
- Form 3922 for employee stock purchase plan (ESPP) share transfers
- Form 1099-NEC for nonemployee awards (IRC Section 6041)
Federal withholding is a mandatory 22% of supplemental wages up to $1 million and 37% above that. State taxes may apply with quarterly Form 941 filings for employment taxes.
Weaver Can Help
Is your tech business ready to attract and retain talent with compensation packages that meet your goals? Our accounting and tax teams help you develop optimized compensation structures while maintaining compliance with ASC 710, ASC 718 and relevant tax laws. We work with tech clients with equity plan design, valuation support and U.S. GAAP implementation to turn compensation into a strategic advantage. Contact us.
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