In the equity incentive practices of startups, granting common stock to employees and external advisors is a common practice. However, the accounting treatment for the two groups may follow different standards due to their different statuses. Based on a specific case, this article explores the accounting logic for stock grants to non-employees.

Case Background: Use of the Deferred Compensation Account

A startup issued common stock to both employees and several advisors. In the general ledger (GL), the company used a "deferred compensation" account to record the unvested portion of stock received by employees, and recognized expenses monthly after the start of each vesting period. The question now is: should the same deferral and amortization approach be applied to non-employee advisors?

This issue involves two key aspects: first, whether the stock grant constitutes compensation; second, whether there is a fundamental difference in accounting treatment between non-employees and employees.

Typical Treatment of Employee Equity Incentives

For employees, stock grants are typically share-based payments, subject to ASC 718 (or IFRS 2). At the grant date, the company must measure the award at fair value and recognize expense over the service period (i.e., the vesting period). In practice, many startups use a "deferred compensation" account as a transitional account, amortizing to expense over the vesting period, which is consistent with the accrual basis of accounting.

Accounting Framework for Non-Employee Advisors

Advisors are not employees of the company, and their stock grants are generally not considered "employee share-based payments," but rather transactions involving the purchase of services or goods from non-employees. Under US GAAP, such transactions should follow ASC 505-50 (Equity Issued to Non-Employees) or specific guidance in ASC 718 for non-employee awards (if applicable).

The key difference is that the measurement date for non-employee awards is not fixed at the grant date, but rather depends on when services are completed or performance obligations are satisfied. Specifically, if the advisor is required to provide ongoing services, expense should be recognized over the service period, and fair value must be remeasured at each reporting date until services are completed.

Should the Deferred Compensation Account Be Used?

Conceptually, the deferred compensation account is typically used for the deferred recognition of employee compensation. For non-employees, it is more appropriate to recognize expense directly with a corresponding increase in equity or liabilities, rather than through a deferred compensation account. However, if the advisor's service period aligns with the vesting period and the company chooses to amortize over the vesting period, using a deferred account may be operationally feasible, but the nature of the account must be consistent with the standards.

In practice, many startups simplify by applying the same amortization pattern to both employees and non-employees. However, strictly speaking, the measurement and remeasurement requirements for non-employee awards may introduce additional complexity. For example, if the advisor's stock grant is not fully vested before services are completed, the expense amount must be adjusted each reporting period, which may lead to profit volatility.

Recommended Accounting Treatment Path

  • Clarify the grant terms:Review the advisor agreement to determine whether it includes service conditions, vesting schedules, and termination clauses, to assess whether it constitutes a share-based payment with "service conditions."
  • Distinguish between employees and non-employees:If the advisor is not an employee, the employee deferred compensation account should not be automatically applied; instead, assess whether ASC 505-50 or the non-employee portion of ASC 718 applies.
  • Measurement and remeasurement:If the advisor's service period spans multiple reporting periods, remeasure the fair value of the stock at each reporting date and adjust recognized expense accordingly.
  • Consult professional advice:Given the complexity of the standards, it is recommended to consult a CPA or auditor with startup experience to ensure compliance with GAAP or IFRS requirements.

Conclusion

For stock grants to non-employee advisors, the company should not simply apply the employee deferred compensation treatment. Although there are similarities in amortization over the vesting period, the measurement and remeasurement rules for non-employee awards differ. It is recommended that the company select an appropriate accounting policy based on the nature of the advisor's services and ensure adequate disclosure. If the advisor's services have been fully completed, expense should be recognized in full at the grant date; if services are ongoing, expense should be amortized over the service period with periodic remeasurement.

Note: In this case, the company's use of the "deferred compensation" account may stem from internal management practices, but for external reporting, the account classification and expense recognition should comply with applicable standards. For non-employees, a more common approach is to debit expense directly and credit "common stock" or "additional paid-in capital."

Finally, it is recommended that the company review all advisor agreements to assess whether implicit service conditions exist, and communicate with the audit team to determine the most robust accounting treatment.