The ASC 718 disclosure requirements tell a company what it must say in its financial statements about the stock-based compensation it grants: a description of each plan, the assumptions behind the fair value of the awards, the compensation cost recognized and still to be recognized, the related tax effects, and reconciliation tables that track every award-level movement during the year. These disclosures live mainly in the notes to the annual financial statements, typically the 10-K, and they exist so investors can see the real cost of the equity awards and the dilution those awards could cause.
Plan Descriptions and Award Terms
Start with a plain-language description of each stock-based compensation arrangement. Identify the types of instruments granted: incentive stock options, nonqualified stock options, restricted stock units, stock appreciation rights, or compensatory employee stock purchase plans.
The description has to cover the conditions an employee must satisfy before an award vests. Three types appear most often:
- Service conditions, where the employee must remain employed for a set period, often with annual vesting over three or four years.
- Performance conditions, where the employee must meet operational targets like revenue or earnings thresholds. These are non-market goals tied to internal results.
- Market conditions, where the award depends on a stock-price target or total shareholder return hurdle. A market condition is built into the grant-date fair value, and the expense is recognized regardless of whether the target is hit, as long as the employee provides the required service.
State the maximum contractual term of each award type. Stock options commonly carry a ten-year contractual life, and that deadline is the final date an unexercised option expires. Report the number of shares authorized under each plan and any significant modifications during the reporting period. Modifications, such as repricing underwater options or extending a post-termination exercise window, trigger a new fair value measurement and may generate incremental compensation expense equal to the excess of the modified award’s fair value over the original award’s fair value at the modification date.
Fair Value Measurement Assumptions
Compensation cost is measured at the grant-date fair value of each award. Because that measurement rests on forward-looking estimates, the disclosures have to lay open the valuation model and every significant input.
Valuation Model
Identify the valuation technique for each class of award. Acceptable models include the Black-Scholes-Merton closed-form formula, lattice models such as the binomial model, and Monte Carlo simulation. Lattice models handle features like early-exercise behavior and changing volatility over time. Monte Carlo simulation is common for awards with market conditions. The choice of model and the reasoning behind it should be clear in the notes.
Key Inputs
For each year an income statement is presented, disclose the significant assumptions feeding the model:
- Expected volatility. This is the most sensitive input. Explain how it was estimated, whether from historical stock-price data over a period matching the expected term, implied volatility from traded options, or a blend. If different volatilities apply during different portions of the contractual term, disclose the range and the weighted average.
- Expected term. The period options are expected to remain outstanding before exercise or forfeiture, drawn from historical exercise patterns, vesting schedules, and post-vesting termination behavior. Companies with limited historical data can use the SEC’s simplified method, which sets the expected term as the midpoint between the vesting date and the contractual expiration date. It is available only for plain vanilla options: granted at the money, subject only to service-based vesting, forfeited if the employee leaves before vesting, and nontransferable.
- Risk-free interest rate. The implied yield on U.S. Treasury zero-coupon securities with a remaining term matching the expected term (for a closed-form model) or the contractual term (for a lattice model).
- Expected dividend yield. The anticipated annual dividend payout relative to the stock price. A higher yield lowers the option’s fair value because option holders don’t receive dividends. Companies that pay no dividends disclose a yield of zero.
Present these weighted-average assumptions for each class of award granted during the period, typically in tabular form so readers can trace how the reported expense was derived.
Forfeiture Policy
Disclose the accounting policy for forfeitures. Since ASU 2016-09, companies may either estimate forfeitures up front when the award is granted or recognize them as they occur. Either approach is acceptable, but the chosen policy must be stated and applied consistently.
Compensation Cost Recognized and Remaining
Report the total compensation cost recognized in each period presented, and show where it landed on the income statement by functional line, such as cost of revenue, research and development, or selling, general, and administrative expense. That breakdown lets analysts see which parts of the business are driving the equity compensation bill.
The remaining unrecognized cost at the balance sheet date matters just as much. This figure represents the portion of grant-date fair value not yet expensed because the awards are still vesting. Include the weighted-average period over which the remaining cost is expected to be recognized, so investors have a timeline for future charges.
Income Tax Effects
Stock compensation opens a gap between book expense and the tax deduction a company eventually receives. A deferred tax asset builds up as compensation cost is recognized on the income statement. When the award is exercised or vests, the actual tax deduction is based on intrinsic value at that date, not the original grant-date fair value. If the tax deduction exceeds cumulative book expense, the difference is a windfall; if it falls short, a shortfall.
Before ASU 2016-09, windfalls and shortfalls flowed through additional paid-in capital and were nearly invisible to income statement readers. That update moved all excess tax benefits and deficiencies into the income tax provision, where they now affect reported earnings directly. Disclose the actual income tax benefit realized from exercises and vestings during the period. If the deferred tax asset requires a valuation allowance because realization is not more likely than not, disclose that too.
Award Activity Tables
The quantitative core of the disclosure is a set of reconciliation tables tracking every share-level movement during the period, presented for each major award type.
Stock Options
For stock options, show the number of shares and the weighted-average exercise price for each of these categories:
- Beginning balance of options outstanding at the start of the year.
- Activity during the year: options granted, exercised, forfeited, and expired.
- Ending balance of options outstanding at year-end.
- Options exercisable, meaning those that have vested and can be exercised at year-end.
Also disclose the weighted-average grant-date fair value of options granted during the year and the total intrinsic value of options exercised. Intrinsic value here is the spread between the market price and the exercise price at the date of exercise, which drives the company’s tax deduction.
For options that are fully vested or expected to vest at the balance sheet date, disclose the aggregate intrinsic value and the weighted-average remaining contractual term. This shows investors how much value employees could realize by exercising today and how long the dilutive overhang will last.
Restricted Stock Units and Similar Awards
For instruments without an exercise price, such as restricted stock units, track the number of non-vested awards and their weighted-average grant-date fair value. The table shows the beginning non-vested balance, awards granted, awards vested, and awards forfeited during the year. Also disclose the total fair value of shares that vested during the period.
Cash Flow and Liability-Classified Awards
Disclosure obligations extend past the income statement. Quantify the cash received from employees exercising stock options during the period; that figure represents the aggregate exercise price paid to acquire shares and is typically reported within financing activities.
Since ASU 2016-09, all excess tax benefits and deficiencies from stock compensation are classified as operating activities on the cash flow statement, grouped with other income tax cash flows.
Not every award qualifies for equity classification. Awards that will be settled in cash, or that contain certain features requiring liability treatment, must be carried on the balance sheet at fair value and remeasured every reporting period until settlement. Disclose the total liability at the balance sheet date and the effect of fair value changes on the income statement during the period. An increase in the liability adds compensation expense; a decrease reduces it. Cash paid to settle these awards is reported as a financing or operating outflow depending on the nature of the payment.
Private Company Practical Expedient
Private companies have a harder time measuring fair value because their shares don’t trade publicly. ASU 2021-07 introduced a practical expedient that lets nonpublic entities use “the reasonable application of a reasonable valuation method” to determine the current price input for equity-classified awards, rather than requiring a full fair-value measurement.
To qualify, the valuation must consider factors such as the value of the company’s tangible and intangible assets, the present value of future cash flows, the market value of similar companies, and recent arm’s-length transactions involving the company’s stock. A Section 409A valuation commonly satisfies these requirements if it was performed within the preceding twelve months and no material events have occurred since the valuation date that would affect the company’s value.
A company electing the expedient must apply it consistently to all equity-classified awards sharing the same underlying share class and measurement date, and must disclose the election in the notes. The expedient applies on a measurement-date-by-measurement-date basis, so it can be used for one set of grants and not another if circumstances change.
Interim Filings
The full suite of ASC 718 disclosures is required only in annual financial statements. Quarterly filings on Form 10-Q do not require the complete set of tables, assumption disclosures, and activity reconciliations. The interim reporting guidance in ASC 270 does require disclosure of any significant changes from the most recent annual report. A large new tranche of grants, a modification to existing awards, or an unusual volume of exercises during the quarter should be disclosed even in an interim filing. Many public companies voluntarily provide condensed stock compensation disclosures in their 10-Qs to keep transparency between annual reports.
What’s Changing Under ASU 2024-03
ASU 2024-03 takes effect for public companies for fiscal years beginning after December 15, 2026. It will add a new footnote disclosure that disaggregates major income statement expense captions into their natural components. Employee compensation, which explicitly includes stock-based compensation, is one of the required categories. Within each relevant expense line on the income statement, such as cost of sales, research and development, or selling and administrative expenses, you will separately quantify the stock-based compensation component in a tabular footnote. The change gives investors a clearer view of how much of each functional expense category consists of non-cash equity awards rather than cash costs.
Consequences of Inadequate Disclosure
Falling short on ASC 718 disclosures is more than an audit problem. The SEC can pursue civil enforcement against companies and their officers for materially deficient or misleading financial statement disclosures, including those tied to stock compensation. Potential consequences include financial penalties, officer and director bars, and “bad actor” disqualifications that block the company from raising capital under popular registration exemptions like Rule 506(b) and Rule 506(c). Investors may also have rescission rights, forcing the company to return invested capital plus interest. Beyond formal enforcement, weak disclosures can chill future fundraising, because sophisticated investors routinely demand representations about past securities-law compliance before committing capital.