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 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
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). 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 & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd 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 or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at and we will use commercially reasonable efforts to determine and correct the problem promptly.