Step 2: Allocating the Expense Over the Option’s Useful Economic Life
Once fair value is calculated, the expense can be recorded. However, because the value of an option can change over time, the expense is not recorded all at once. Instead, it is recorded over the useful economic life of the grant, which is the period of time during which it continues to incentivize and compensate the option holder.
In most cases, options vest over time—so their useful economic life generally aligns with their vesting period. While there is more than one way to allocate options over their useful economic life, the easiest way is to allocate the expense over the vesting period in even increments. This is called the straight-line allocation method. That said, an accelerated method can be used. To determine which method is right for you, it makes sense to consult with a professional advisor.
More Complex Than It Seems
While this two-step process for expensing options under ASC 718 may seem straightforward, in practice it can get quite complex. If, for example, options are expensed when they are issued but an employee leaves the company before their options vest, the recorded expense may need to be reversed. A repricing event, where the strike prices for existing options are adjusted, can trigger exception accounting. Early exercise provisions, changes to existing option agreements and grants to non-employees may change how options are expensed. There are also numerous other edge cases where the option expense may need to be handled in a manner different from what is described above.
For these reasons and more, it may make sense to use an equity plan management platform to help calculate your stock option expenses under ASC 718.