Share options – a brief accounting guide

14 June 2022 / Insight posted in Technical guidance

Issuing share options, whether to employees, directors or suppliers, has increased in popularity. Accounting for share options, referred to as share-based payments in accounting standards, can be complex. If you are considering issuing share options, you should obtain specialist accounting advice prior to issuing the options. This article does not include the taxation, or deferred taxation implications of share options.

Accounting for share options is dependent upon the type of share options. There are two main types of plans:

1. Where the plan is settled when the employee or supplier receives shares or options in shares. These are referred to as equity-settled share options.

2. When the employee or supplier has an option to or will receive cash in the future. These are called cash-settled share options.

 

Accounting for equity-settled share option

The double entry for equity-settled share options is simple. The challenge is calculating the numbers for the journal. The business recognises the charge as an expense (or rarely, as an asset, if the goods or services received qualify for recognition as an asset), with a corresponding increase in equity. The double entry is the same for both UK GAAP and UK-adopted International Accounting Standards preparers. The basic premise for the numbers included within the journal are that the fair value of the options is measured at the date the options are granted, for employee options, or the date services/goods are provided for supplier options. The expense/increase in asset is recognised over the vesting period, which is the period for which the supplier or employee must wait before having an unconditional right to the options. Supplier awards generally vest immediately and therefore no spreading of the expense or asset is needed.

The debit side of the journal should be posted to the same nominal ledger code as a cash expense would have been posted to. For staff, this is often a wages and salaries nominal code. For suppliers, the debit is often posted to consulting or cost of sales.

Neither FRS 102 or IFRS 2 include any guidance where the corresponding increase in equity should be recognised. Businesses with multiple share-option arrangements or those considering obtaining significant amounts of finance in the future commonly use a share option/share-based payment reserve. Smaller, family run businesses often post the credit side of the journal to retained earnings. The credit should be recognised in the same equity reserve in future periods.

 

Accounting for cash-settled share options

For cash-settled awards, the fair value of the award is calculated when the option is granted and is remeasured at each reporting date. The expense or increase in asset is recognised from the date of grant until the options become unconditional. The double entry under FRS 102 is to recognise an expense/increase in asset and to recognise a liability. For users of UK-adopted International Accounting Standards, when the employee or supplier has the option to receive either cash or shares, there will be both a liability and equity component to the credit side of the journal.

 

The fair value of the option used to pay a supplier

The fair value of the option used to pay a supplier will be the value of the services or goods that they have provided to the company. The expense is recognised by the company over the period it obtains the services. For example, if a consultant is being paid for their £40,000 of services over a four-month period in equity settled share options, a monthly charge of £10,000 is recognised.

 

The fair value of employee options

Obtaining the fair value of the employee options is more complex. The business is required to estimate the fair value of the share options. For privately owned businesses, this will involve a valuation model and a number of differing inputs. Your auditor is unlikely to be able to assist you with the inputs into your chosen valuation model, as they won’t be in a position to independently challenge these when undertaking the audit.

 

Calculating the debit side of the journal

The debit is calculated as the fair value of the options, multiplied by the number of options which are expected to vest.

Share option expense = Fair value of options X number of options expected to vest

 

Performance conditions

Share options often include performance conditions, such as a specified increase in turnover, remaining in employment for a set period or achieving a certain share price. Market conditions are linked to the market price of shares. The probability of achieving the market condition is factored into the fair value of the option at grant and not remeasured.

Non-market conditions, such as staying in employment, adjust the number of share options which are expected to vest. The expectation is updated at each reporting date.

 

A simple example

A company issues 50 share options at the start of the reporting period to each of its 10 founding employees with the performance condition that they remain in employment for three years. The business has calculated the fair value of the option at £1. At the grant date, the business does not expect any founding employees to leave and this expectation does not change, until the third year when two employees leave.

 

Share options

 

The debit for the first accounting period to 31 December X0 is calculated as:

£167 = (50 options*10 employees*£1 fair value*10/10 (all employees))*1/3 (as first year of 3)

The double entry will be:

DR staff costs
CR equity (profit and loss reserve, other reserve, share option reserve)
167
167

 

For the second accounting period to 31 December X1, the debit is calculated as:

£167 = (((50 share options*10 employees*£1 fair value*10/10))*2/3)-£167 charge recognised)

The double entry will be:

DR staff costs
CR equity (profit and loss reserve, other reserve, share option reserve)
167
167

 

For the third accounting period to 31 December X2, the debit is calculated as:

£66 = (((50 share options*8 employees*£1 fair value))*3/3)-£234 charge recognised)

The double entry will be:

DR staff costs
CR equity (profit and loss reserve, other reserve, share option reserve)
66
66

 

Exemptions

All companies will have to consider the materiality of any share options which have been granted as, unlike old UK GAAP, there are no exemptions for small companies. The only exception to this is companies which qualify as micro-entities, which do not have to account for share options. Except for micro-entities, the adjustments not being material is the only justification for excluding the journal for share options. When the expense is not material, we recommend that the existence of share options, as a potential dilution to ownership, is disclosed.

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