When it comes to accounting for equity settled share based payments, there are a number of confusing issues. One is how the numbers are calculated when staff leave. A second confusion can arise when the issue relates to a business combination. This latter point will be addressed in a subsequent article.
Equity settled share-based payments issued to staff
Equity settled share-based payments that are granted to staff are designed to act as an incentive. As such these options to subscribe to the company’s shares at a fixed price in the future are part of their remuneration. This is why they are written off against profit – even though there is no cash outflow for the company. The expense is based on the value of the options at the grant date. As with all equity instrument issued, no subsequent changes in this value are captured or recorded. This value is then charged to profit and loss over the qualifying period, based on the current number of employees expected to qualify at the vesting date.
The problem of the current number of employees expected to qualify at the vesting date
At each reporting date it may be necessary to revise the current number of employees expected to qualify at the vesting date. The number of employees expected to qualify at any time is the actual number at the reporting date less expected departures going forward (not the starting number less original estimate).
This estimate of the number of employees expected to qualify is not a problem if none are expected to leave and indeed none actually leave. 100% of the value of the options will be charged over the qualifying period. Let’s consider a four-year scheme with value of options at the grant date of $400,000. In this case the annual charge would be $100,000 and after two years the accumulated equity would be $200,000. Simple.
The challenge arises if – for example – in a similar four-year scheme the total value of options at the grant date were $400,000 and there were 100 employees of which 10 were expected leave annually.
However IF after one year, five employees have actually left then at year 1 the estimate of the numbers expected to qualify at the vesting date will be
Year 1 (100 – 5 – (3 x10)) = 65/100 (65%)
Meaning equity required and the expense of the first year would both be
$400,000 x 65\100 x 1/4 = $65,000
If then during year 2, twelve leave (not the expected 10) then the revised number of employees expected at the vesting date now becomes
Year 2 (100 -5 – 12 – (2×10)) = 63/100
Meaning that the equity required at Year 2 would be $400,000 x 63/100 x 2/4 = $126,000
And with a bought forward of $65,000 from equity in year 1, this means that the PL charge for Year 2 would be the difference, the increase in the equity of $61,000
Tom Clendon – whats app 07725 350793