To Expense or Not to Expense: An On-going Question Regarding Share Options

Posted by admin at 15:51 on 13 Feb 2017

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If a Company operates a share option scheme, or any other share-based awards, and is too ‘large’ to report under FRSSE and implement an option scheme then, as a result, these options will need to be expensed for in the Company’s annual accounts in accordance with FRS20.

To qualify as “small” for adopting FRSSE, the company must not exceed two of the criteria shown below in the current and preceding year, except that the exemption may be retained in the first year which criteria are exceeded.

  • Aggregate turnover £6.5m
  • Aggregate balance sheet total £3.26m
  • Aggregate number of employees 50

A parent company only qualifies as small if the group it heads is a small group.

Where the period is not a year the figures are to be adjusted proportionately.

The Accounting Standards Board (ASB), under FRS20, together with their international counterparts, under IFRS2, requires that the economic costs of equity based incentives are shown as a cost to profit and loss account. The cost is calculated using an option pricing or simulation model which takes account of the probability of a rise or fall in the price of the underlying share. This is (arguably) a controversial procedure as Share options do not bring about a cost to the company so why should Companies have to show fictitious costs to their profits? The rationale behind this is that when an employee receives a share option (or other share award), their services are an asset which is partly purchased by the shares. Therefore, the asset has to be expensed.

We have previously set out the current rules for accounting disclosure of share awards here, and explained why such disclosure is financially absurd here.

Finally, the Financial Reporting Council has listened to the professionals lobbying for a review of this matter and is now undertaking a consultation.

Some suggested changes include disclosure of the principle terms and conditions (e.g. number of shares and employee involved, grant date, performance conditions, option exercise prices) of employee share options, not their recognition. It thereby seeks to impose a lower financial reporting burden on smaller companies which is positive news and would help to eliminate a large problem for small companies associated with options expensing. It is widely known that it is very difficult to reliably expense the fair value of employee share options in a private company. Identifying appropriate peer comparator data is often just one of the challenges faced when considering the required inputs for an option pricing model. There is also the need for a well versed understanding of the intricacies of Black-Scholes or other appropriate mathematical simulations.

It may be that in the future, options expensing will only be required at the time of option exercise rather than at grant which would remove the problem of the ‘fictitious’ cost that has to be accounted for when options are expensed for even when the employee might leave without the options being realised. There will be calls from many respondents to abolish the principle entirely.

The consultation closes at the end of this month (July 2013) and it is therefore likely that there may be changes proposed in regards to future Option Expensing. We will know more following the consultation process and would be happy to advise regarding this change.

If you would like to discuss the implications of this accounting standard for your own company, and how the impact might be reduced, please call us on 020 8949 5522. Our current options expensing fact sheet is available for download here.