UK: Accounting for Share Based Payments - the Effect on Employee Share Schemes

Last Updated: 31 December 2002

At present employee share options and other employee awards are accounted for only on the basis of any "intrinsic value" i.e. the difference between the market value of shares awarded to employees and the price they will eventually pay for them. If options are granted at market value there is no discount and no charge to the P&L account. Under important new proposals1 supported by international accounting standard setters, it is expected that in future options and awards will be accounted for on their "fair value" at the date of grant. This will mean valuing the option, usually by reference to an option pricing model, and charging the fair value to the P&L account over the award period. For companies which presently grant options at the current market value of their shares, this will mean a new P&L charge. This charge to P&L will also apply to SAYE schemes for which at present there is an exemption. This briefing considers the scope of the proposals and some possible effects on employee share schemes.

Proposals for share-based payments

The proposals set out in FRED 31 introduce a very significant change to the accounting treatment of employee share schemes because the basic principle of the FRED is that all share-based payment transactions should be recognised in a company’s financial statements using a fair value measurement basis estimated at the grant date.

To estimate the fair value of a share option, where a tradeable market price for such options does not exist, an option pricing model, such as Black-Scholes or the binomial model, will need to be used. FRED 31 does not specify which particular model should be used, but the company must disclose the model used, the inputs to that model as well as various other inputs into the fair value calculation. FRED 31 contains various proposals on estimating the fair value of employee share options, to allow for the differences between employee share options and traded options. For example, the valuation should take into account all types of vesting conditions, including service conditions and performance conditions.

One consequence of grant-day estimations is there is no reversal of the accounts charge if the option lapses. However, the grant date valuation will be reduced to allow for the possibility of forfeiture because of failure to satisfy vesting conditions. Under the methodology in the FRED, this fair value is divided by the expected units of service to be received from employees under the option grant. The resulting "fair value per unit of employee service" is then applied to the actual service received over the vesting period. This means that the charge will vary depending on how the number of actual leavers varies from the expected number of leavers.

Practical impact for UK companies

The new standard will create a P&L charge for grants of share options to employees where currently there is no charge at all (e.g. on grants of "market value" options or options under a SAYE scheme). This is because the fair value of a share option is always worth more than just its intrinsic value (i.e. the difference between the strike price and the share price at the date of grant), due to the time value of the option and expected share price volatility. So, remuneration charges will rise and consequently corporate earnings will fall, but by how much?

There have been figures quoted in the press suggesting that, on average, UK corporate earnings will fall by 5%. However, this is an average, and it was quoted before the detailed methodology was laid out as in FRED 31. Some aspects of the calculations are easy and companies can supply the inputs to the traded options models, such as Black-Scholes, and do their own calculations. However, some of the adjustments to the value of traded options to reflect restrictions on employee share options are subjective and quite hard to work out and companies may need some help. But be reassured: although the 5% is an average, many analysts believe that this is dragged up by some companies that are heavily reliant on share options as remuneration – for the bulk of UK companies the impact should be rather less than a 5% hit on earnings.

Analysis of the impact on earnings versus benefits

Many companies are likely to take the view that it is still better to accept the accounting charge of granting options rather than replacing them with cash schemes as cash schemes are likely to require an increase in pay in excess of the equity charge that gives equivalent benefit. The accounting charge is only on the value of the option when granted and, if one assumes a share price increase, the potential gain that an employee can realise should be considerably in excess of the charge to the P&L account.

Cash-based schemes do not provide the hedging of liability which share-based schemes involve where there is no cash outlay for the group (by contrast, cash-based schemes are limited by the cash reserves that a company actually has). Cash schemes would also be fully liable to national insurance, whereas the national insurance cost of options can be passed on to employees. Share options are likely, therefore, to remain an important part of a company’s remuneration policy.

Further, the accounting change must be seen in the context of the changes to the tax treatment of options announced in the Pre-Budget Report on 26 November (which provides for companies to receive a statutory corporation tax deduction for option gains, regardless of whether the options are approved or unapproved). The new corporation tax relief should go a long way towards compensating for the accounting charge.


The ASB would like to see the standard adopted in the UK as soon as possible, which means that, under the current IASB timetable, it would take effect for accounting periods beginning after

1 January 2004 (the date on which the international standard comes into effect). The ASB will withdraw most of the existing accounting guidance, much of which is in the form of Urgent Issues Task Force Abstracts, rather than a full accounting standard.

One particular concern is that, were the UK to introduce the new accounting charge before other countries, particularly the US, this may harm the competitive position of companies conforming to UK standards.

A legal problem?

The Law Society has written to the ASB outlining an opinion that the new standard will require a change in the law before it can be implemented. The letter has been copied to a number of other regulatory bodies including the European Commission and the Financial Reporting Review Panel. The ASB has stated that it does not believe a legal impediment exists and presumably this matter will have to be dealt with during the consultations on the proposals. If there is an impediment, the impact of the standard would nevertheless be delayed only for a year in the UK, at least for listed companies, which will in any case have to follow the international standard that is drawn up under ED 2 from 2005 under the EU Regulation on international accounting standards. Further implementation in the UK of this standard may depend on changes to the EU Directive.

Transitional arrangements

The transitional arrangements when the standard comes into force are worth noting. The normal approach for a new standard is that it should be applied retrospectively, i.e. it would be necessary to go back and restate all past transactions. In this case, the draft standard allows limited exemptions from retrospection, so that the requirements of the standard would not apply:

  • to any share-based payments that vested prior to 1 January 2004, or
  • retrospectively to grants of share awards that were made prior to the publication of FRED 31.

1 The International Accounting Standards Board ("IASB") has published an Exposure Draft, "ED 2 Share-based Payment" ("ED 2"), containing proposals on how companies should account for the cost of their employee share schemes. See

On the same day, the UK Accounting Standards Board ("ASB") published Financial Reporting Exposure Draft (FRED) 31 Share-based Payment ("FRED 31"). FRED 31 presents proposals for a UK accounting standard based on the IASB exposure draft. See

Comments are invited on both ED 2 and FRED 31 by 7 March 2003.

© Herbert Smith 2002

The content of this article does not constitute legal advice and should not be relied on as such. Specific advice should be sought about your specific circumstances.

For more information on this or other Herbert Smith publications, please email us.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

In association with
Related Topics
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of

To Use you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions