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FRS 20 and its identical international equivalent IFRS 2 deals with situations where entities grant shares or share options to:
• Employees – as a feature of their remuneration package; and
• Suppliers – as consideration for the provision of consultancy services or for the receipt of goods.
FRS 20 is effective for accounting periods beginning on or after 1 January 2006 and is applicable for all UK companies, except those applying the Financial Reporting Standard for Smaller Entities (FRSSE). This represents a dramatic change in UK GAAP.
FRS 20 must be applied to grants of shares or share options that were granted after 7 November 2002 and had not yet vested at the relevant effective date of FRS 20 (1 January 2005 for unlisted companies with a 31 December year-end).
What to do!
The accounting and valuation of share options can be a complex area. If you need advice then please contact us and we will arrange a meeting to explain the implications and how we can assist you.
Measuring share options
FRS 20 requires companies that grant share options to their employees to estimate the fair value of those options and to recognise that value as a charge in the profit and loss account over the “vesting period.” The vesting period is the period during which all the specified vesting conditions of an option agreement are satisfied. Vesting conditions can include a specified period of service or performance targets.
The primary objective is to account for the employee services received as payment for the issue of shares or options.
FRS 20 does not stipulate how to value these options however it does state that companies should use an appropriate valuation technique such as option pricing models.
Option pricing models aim to measure the fair value by taking into account, as a minimum, the following factors:
• Exercise price
• Current price
• Life of the option
• Expected volatility
• Dividends expected
• Risk-free interest rate
The debit side of the entry is a charge to profit and loss account in determining operating profit. The credit side is an increase in equity (i.e. P&L reserve or Other reserve)
Cash-settled share based payment transactions
An example is where an employee is promised a cash reward based on the future movement of the entity’s share price. For such transactions, the employee’s services received by the entity and the corresponding liability incurred should be measured at the fair value of the liability. The entity should remeasure the liability annually and at the date the liability is settled.
The debit side of the entry is a charge to the profit and loss account in determining operating profit. The credit side is an increase in creditors.
Share-based payment transactions with cash alternatives
Where an entity has a choice of issuing shares or paying cash then the entity shall recognise a liability if it determines that it has an obligation to settle the liability in cash. If on settlement the entity issues shares rather than paying cash then the value of the liability should be transferred to equity.
Unlisted entities
Share-based payments in unlisted entities can be more difficult to value due to the lack of a readily available market price or historical information to consider when estimating expected volatility.
Management should consider the method used to calculate the exercise price for share options granted (this may be calculated based on the deemed current share price). Input variables such as historic volatility may be obtained from similar sized listed company within the same sector.
Disclosures
The disclosure requirements are split into three main areas:
• the nature and extent of share-based payment arrangements;
• how the fair value of the goods or services received, or the fair value of the equity instruments granted, during the period were determined; and
• the effect of share-based payment transactions on the entity’s profit or loss for the period and on its financial position.
Small companies
Certain small companies are able to adopt the FRSSE. The latest version of the FRSSE which is effective from January 2007 has an exemption from FRS 20 and requires a disclosure-only approach for share options.
For more information
Please contact Anna Garvey at haysmacintyre.
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