UK: Tax, Employment and Pensions

Accounting for Employee Options and Share Awards
Last Updated: 7 January 2003

On 7 November 2002 the International Accounting Standards Board ("IASB") published "ED 2 Share Based Payments", an exposure draft setting out the recommended IASB accounting treatment of options, grants and share awards to employees. Comments are invited on various aspects of the exposure draft by 7 March 2003.


Under current accounting standards, a company in the UK only incurs a charge to profits for its share or option awards if employees receive shares or are awarded options for less than market value at the time of the award. In many cases, therefore, no expense is recognised in the company's profit and loss account for the "cost" of share awards. In July 2000, the UK Accounting Standards Board ("UKASB") published a discussion paper on the accounting treatment of share based payments. At the time, it proposed that companies should recognise the cost of employee options and awards by reference to the value of the underlying shares at the vesting date. This proposal caused much debate, and the IASB subsequently took over the project. The IASB has retreated somewhat in its proposals from the UKASB's discussion paper. Its recommendations that a charge should be calculated at grant (rather than vesting) are detailed below.

Share based payments with no cash alternative

Where an employee is awarded shares or options and no provision is made for the options to be cashed out, the IASB proposes that the awarding company should recognise an expense in its profit and loss account by reference to the value of the share or option grant at the time it is made, rather than at the time it vests. In the case of options, this would involve the awarding company using an option valuation model (in the UK and Continental Europe, usually a Black-Scholes model; in the United States, a binomial model). In both cases, the company will have to make a judgement as to the number of options/shares which it expects will vest in the future. Having ascertained the cost of the option/share award, the awarding company should calculate the number of units of service it expects to receive from employees during the vesting period. By way of example, where an option vests three years after the date of grant, the company would (if it expected the employee to remain in employment throughout the vesting period) expect to receive three units of service. Having made this calculation, which must include a discount for the likelihood of employees leaving and an assessment of when, within the period, they are likely to leave, the awarding company will be in a position to calculate a cost per unit of service it expects to receive over the life of the option. In each accounting period between the grant date and the vesting date, the awarding company will then record an expense equal to the actual number of units of service it has received from employees, multiplied by the cost of the unit of service initially calculated. It follows from the above that the company may in fact record a greater or lesser expense than it initially calculated in order to calculate a cost per unit of service at the grant of the option. An illustrative example of the calculation is set out below.


Company A grants options over 100 shares each to 50 of its employees. The options vest on the third anniversary of their date of grant, but there is no performance condition. Using a Black-Scholes model, the company calculates that the value of the option is £10 per option share at the date of grant. The total cost to the company is therefore £50,000. The company estimates that 10% of the employees will leave before the options vest, spread evenly over the vesting period. It therefore expects to receive three years' service from 45 employees and 1.5 years' service from the remaining five employees, a total of 142.5 units of service, making the cost per unit of service £350 approximately. In the first year, contrary to expectations, no employees leave. The company records an expense of £17,500. In the second year, 10% of employees leave, on the last day of the year. Again, the company records an expense of £17,500. In the final year, all employees then remaining complete the period of service. The company records an expense of £15,750. The total expense recorded (£50,750) is greater than the initial total, because the employees completed a greater period of service than anticipated.

Share options and awards with a cash settlement alternative

The accounting treatment differs depending on whether the cash settlement alternative is at the option of the awarding company or the employee. Where the employee has the choice of settlement, the company must determine the fair value of the cash and equity components of the option. Where the fair value of the two settlement alternatives are equal (i.e. there is no discount for cash), the equity component is deemed to have no value. The company will account for the cash component using normal accounting practice and in the case of equity component, if it has a value, the same rules as described above for options apply. Where the awarding company has the choice of settlement, it must first determine whether it has a present obligation to settle in cash. If it does, it will use those normal accounting methods; if it does not, it will account as described above for share based payments with no cash alternative.


The IASB proposals are not likely to take effect before 2004/2005 at the earliest. However, if introduced, the proposals would apply to options granted after 7 November 2002 which had not vested when the rules become effective. As a result, companies must consider as soon as possible the likely impact of the new requirements on their share incentive arrangements.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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