# Stock Expensing: Calculating Term

This article is part of a series meant to help users and auditors better understand the calculations that are being made inside Shareworks Startup when calculating a company’s stock expense, either for ASC 718 or ASC 505-50 (previously known as FAS 123R).

The term calculation is an important input into the Black-Scholes equation used when generating a company’s option expense for financial reporting purposes.  In order to calculate the term, the first step is to determine whether we need to use the grant’s expected term, or remaining contractual term in the calculation.

• Expected Term:  Expected term is used for employee grants that only have time-based vesting associated with the grant (no milestone based vesting).  These grants fall within the definition of ASC 718 and we’ll be using SAB 107 to calculate the expected term for these grants.  It’s important to not confuse employee, with ISO.  While all ISO’s are employee grants and would fall within this category, employees can be granted NSO’s as well which would still fall within this first category.  So it’s very possible to see both ISO’s and NSO’s where the term is calculated using the expected term.
• Remaining Contractual Term:  The remaining contractual term (RCT) is used for grants to non-employees, as well as for grants where milestone based vesting is used.

# Calculating Expected Term:

To calculate the expected term, Shareworks Startup uses the SAB simplified formula which is: expected term = (vesting term + contractual term)/2.  This equation is applied to each vesting tranche that would occur, and then the weighted average is taken to determine an overall term for the grant.

Example:

Let’s look at a grant of 100,000 options that vests 25% annually for four years (25,000 options per year).  In the first step, I determine the expected term for each individual vesting tranche, as shown in the table below:

 Vesting Tranche Vesting Date Vesting Shares Contractual Life Tranche Vesting Term Tranche Expected Term 1 1/1/Y1 25,000 10 1 5.5 2 1/1/Y2 25,000 10 2 6.0 3 1/1/Y3 25,000 10 3 6.5 4 1/1/Y4 25,000 10 4 7.0

After these are calculated we take a weighted average based on the number of options vesting in each tranche (in this case it’s the same as the simple mean of the terms) to arrive at an overall expected term of 6.25.  This would be the expected term for the grant and would be the value used in the Black-Scholes calculation.

# Calculating Remaining Contractual Term:

To calculate the RCT, we simply take the total contractual term minus the time that’s passed to date.  For a grant that has a 10 year contractual term and is 1.5 years into its vesting, this is calculated as: 10 – 1.5 = 8.5 year remaining contractual term.  It’s important to note that this term can never be less then the remaining vesting life of the grant.

Once the appropriate term has been calculated for each grant, it’s saved and used in Black-Scholes computation to calculate the expense for each grant.  These term values can be viewed on the ‘Share-Level Detail’ tab of the generated option expense report.