Under FRS 20, accounting for share-based payments means recognizing the fair value of the arrangement as an expense over the period the counterparty earns the award, with the credit going either to equity or to a liability depending on how the award settles. The standard adopted IFRS 2 almost verbatim for UK and Irish GAAP, so its measurement and recognition rules match the IFRS treatment worldwide. FRS 20 was superseded when FRS 102 took effect for accounting periods beginning on or after 1 January 2015, and Section 26 of FRS 102 now covers the same ground with the same underlying logic. The mechanics below apply whether you are restating a comparative period under FRS 20 or applying current FRS 102 Section 26.
Equity-Settled Versus Cash-Settled: The Split That Drives Everything
FRS 20 covered three categories of share-based payment: equity-settled arrangements, cash-settled arrangements, and transactions where either party could choose the settlement method.1IFRS Foundation. IFRS 2 Share-based Payment The split matters because it dictates the measurement date, whether you remeasure later, and which side of the balance sheet the credit lands on.
An equity-settled award is one the entity discharges by issuing its own shares or share options. A standard employee stock option plan is the classic case. No cash liability arises, and the credit sits in equity.
A cash-settled award creates a liability. The entity owes cash (or other assets) to the counterparty, with the amount linked to its share price. Share Appreciation Rights are the standard example: the employee receives cash equal to the increase in share price over a defined period. Because the entity will ultimately pay out, the obligation is a liability until settlement.
There is also a measurement split based on who receives the award. For employees, the cost is measured by reference to the fair value of the equity instruments granted, because valuing employee services reliably is treated as impractical.1IFRS Foundation. IFRS 2 Share-based Payment For non-employees such as suppliers or consultants, the fair value of the goods or services received is presumed to be measurable and is used instead. Only in rare cases where that measurement is impossible does the entity fall back to valuing the equity instruments.
Measuring Equity-Settled Awards
Equity-settled awards are measured at the fair value of the equity instruments on the grant date, which is when the entity and counterparty agree the terms.1IFRS Foundation. IFRS 2 Share-based Payment That grant-date fair value is locked in. Share price movements after grant do not change the number in the accounts, and after vesting there are no further adjustments to equity even if options expire unexercised.
Share options rarely have a quoted market price, so the entity uses an option pricing model. Both closed-form models such as Black-Scholes-Merton and lattice models such as binomial trees are acceptable. The inputs feeding the model are:
- Current share price at the grant date.
- Exercise price the holder will pay to acquire shares.
- Expected volatility, being the annualised standard deviation of continuously compounded share price returns, usually estimated from historical data or implied volatility of traded options.
- Expected term over which the options are likely to remain outstanding, reflecting likely early exercise rather than the full contractual life.
- Expected dividends the option holder will not receive during the option’s life.
- Risk-free interest rate, taken from zero-coupon government bond yields with a maturity matching the expected term.
Higher volatility and longer expected term push the fair value up. That in turn increases the total expense the entity will recognize.
Measuring Cash-Settled Awards
Cash-settled awards work differently. The entity measures the liability at fair value at each reporting date and keeps remeasuring until settlement.1IFRS Foundation. IFRS 2 Share-based Payment Any change in fair value between reporting dates goes straight through profit or loss.
The reasoning is direct: the entity owes cash, and the amount owed moves with its share price. A liability frozen at grant would drift from the real obligation. Cumulative expense across all periods ends up equal to the final cash payout. This produces more profit-and-loss volatility than an equity-settled award, which is one reason entities sometimes prefer equity settlement.
Vesting Conditions: Market and Non-Market
Most awards only vest if conditions are met, and how those conditions affect the accounts depends on whether they are market conditions or non-market conditions. The two are treated in opposite ways, and confusing them is a common source of error.
Market Conditions
A market condition ties vesting to something observable in the market, such as the share price hitting a target or the entity outperforming an index. Market conditions go straight into the grant-date fair value through the pricing model. The consequence: even if the condition is never met and the awards never vest, the expense stays recognized as long as the employee provided the required service.1IFRS Foundation. IFRS 2 Share-based Payment The probability of failure is already priced into the fair value.
Non-Market Conditions
Non-market conditions cover service conditions (staying employed for a set period) and performance conditions tied to operational targets like revenue or profit. These are not included in the fair value calculation. Instead, the entity adjusts the number of instruments expected to vest.1IFRS Foundation. IFRS 2 Share-based Payment
At each reporting date, the entity estimates how many awards will ultimately vest based on current expectations about turnover and performance. Cumulative expense is trued up to reflect that estimate. On vesting date, it is trued up again to the actual number that vested. If a non-market condition is not satisfied and the awards lapse, all previously recognized expense is reversed. So a failed market condition produces no reversal; a failed non-market condition wipes the expense out.
Recognizing the Expense Over the Vesting Period
The expense is spread over the vesting period, which is the time the counterparty spends earning the right to the award. A three-year cliff-vesting option grant produces one-third of the total expense in each year.
Journal Entries for Equity-Settled Awards
The entry debits an expense in profit or loss (usually staff costs) and credits equity.2IFRS Foundation. Module 26 Share-based Payment Most entities credit a separate share-based payment reserve rather than share capital directly. That reserve stays in equity until exercise, when the entity transfers the balance to share capital and share premium and takes in the exercise price as cash. If options expire unexercised, the reserve can be transferred to retained earnings, but no reversal runs through profit or loss after vesting.
Journal Entries for Cash-Settled Awards
For cash-settled awards, the debit is the same expense, but the credit goes to a liability. At each reporting date the liability is remeasured to current fair value, and the movement flows through profit or loss. On payout, the entity debits the liability and credits cash. Total expense across all periods equals the cash actually paid.
Adjusting for Forfeitures
At each reporting date, the entity reassesses how many awards it expects to vest under the non-market conditions. If more employees have left than expected, cumulative expense is reduced. If fewer have left, it goes up. The adjustment in any period is the difference between the revised cumulative charge and what was recognized before. Expect movement year to year, especially early in the vesting period when turnover forecasts are least reliable.
Modifications, Cancellations, and Settlements
Awards change after grant. Options get repriced, vesting periods get extended, awards get cancelled and replaced. The governing principle is that the total expense cannot drop below the original grant-date measurement.
When a modification benefits the holder, the entity measures incremental fair value as the difference between the modified award’s fair value and the original award’s fair value, both at the modification date. The original grant-date fair value keeps running off over the remaining vesting period, with the incremental value added on top. A modification that shortens the vesting period accelerates recognition of the remaining unrecognized expense.
If the entity cancels or settles an equity-settled award during the vesting period, other than through failure of a vesting condition, remaining unrecognized expense is accelerated and recognized immediately.1IFRS Foundation. IFRS 2 Share-based Payment Any cash paid to the employee on cancellation is treated as a repurchase of equity and deducted from equity, unless it exceeds the fair value of the cancelled instruments at the repurchase date, in which case the excess is an expense.
Replacement awards issued in connection with a cancellation are accounted for as a modification. Incremental fair value is the difference between the replacement award’s fair value and the net fair value of the cancelled award, after any payment to the employee. If the entity does not designate the new awards as replacements, they are just a fresh grant.
Group Arrangements
Group share-based payment arrangements need a per-entity view. A parent often grants awards over its own shares to employees of a subsidiary, and each entity accounts for the arrangement in its own financial statements.
The subsidiary that receives the employee services recognizes the expense, because it gets the benefit of those services. If the parent’s equity instruments are granted and the subsidiary has no obligation to settle, the subsidiary treats the arrangement as equity-settled and credits equity as a capital contribution from the parent.1IFRS Foundation. IFRS 2 Share-based Payment The parent also treats it as equity-settled in its own separate accounts, because it settles by issuing its own shares.
The classification flips when a subsidiary grants rights to the parent’s equity instruments but is itself obliged to obtain and deliver those instruments. The subsidiary then treats the arrangement as cash-settled regardless of how it ends up acquiring the parent’s shares, because from its perspective settlement will consume assets.1IFRS Foundation. IFRS 2 Share-based Payment Entity-level classification can differ from the consolidated view, and misreading it puts the credit on the wrong side of the balance sheet.
Disclosures
Disclosure splits into qualitative and quantitative. Qualitatively, the entity describes each type of arrangement in force during the period, including general terms and conditions such as vesting requirements, maximum contractual life, and settlement method. Where there is more than one plan type, each is described separately. The entity also explains how it determined fair value.
Quantitatively, the entity reports the number and weighted average exercise price of options outstanding at the start and end of the period, along with options granted, exercised, forfeited, and expired during the period. For options exercised during the period, the weighted average share price at exercise date is disclosed. For options outstanding at period-end, the range of exercise prices and weighted average remaining contractual life are given.
The weighted average fair value of options granted during the period is disclosed, together with the pricing model used and its key inputs: share price, exercise price, expected volatility, expected term, expected dividends, and risk-free rate. Where historical volatility was used, the period measured should be stated. Finally, the total share-based payment expense recognized in profit or loss for the period must be disclosed, split between equity-settled and cash-settled.
Unlisted Entities
Unlisted entities have no quoted share price, which complicates both the current price input and the volatility estimate. Volatility is typically estimated from comparable listed companies in the same sector and of similar size. A newly listed entity with limited trading history should use the longest data period available and fill the remainder with comparable company data.
The absence of a market price also means an independent valuation of the shares is needed. That valuation should reflect present value of anticipated future cash flows, recent arm’s-length transactions in the entity’s shares, and any control premiums or marketability discounts. The share-based payment expense depends on this figure, so a valuation more than twelve months old is unlikely to reflect current circumstances and may not withstand audit scrutiny.