Under Section 26 of FRS 102, an equity settled award such as a share option is measured at the fair value of the equity instruments at grant date and charged over the vesting period, with only the number of awards expected to vest being updated. A cash settled award is a liability measured at fair value and remeasured at every reporting date until paid. Small companies follow the same recognition and measurement rules, with relief on valuation method and disclosures, while micro entities using FRS 105 do not account for equity settled awards until shares are issued.

What is a share based payment?

Section 26 applies when a business receives goods or services, usually employee services, in exchange for its own equity instruments or for cash amounts based on the value of its shares. Paragraph 26.1 covers three types: equity settled transactions, cash settled transactions, and arrangements where either party can choose between cash and shares. It also applies where another group company or a shareholder settles the award on the entity’s behalf (paragraph 26.1A).

Paragraph 26.2 gives share appreciation rights as the classic cash settled award, where an employee is paid cash based on growth in the share price. It also treats rights to shares that are redeemable, mandatorily or at the employee’s option, as cash settled. Approved schemes such as EMI options and CSOP options are equity settled share based payments for accounting purposes, whatever their tax treatment.

How are equity settled awards measured?

The services received are recognised with a matching increase in equity (paragraph 26.3). Because the value of an employee’s services cannot usually be measured reliably, paragraph 26.7 requires them to be measured by reference to the fair value of the equity instruments granted, and paragraph 26.8 fixes that fair value at grant date for employee awards. The glossary defines grant date as the date when the entity and the counterparty have a shared understanding of the terms and conditions.

If an award vests immediately, the whole charge is recognised on grant date (paragraph 26.5). If the employee must complete a period of service, the charge is spread over the vesting period as the services are received (paragraph 26.6).

Paragraph 26.9 treats conditions in two different ways:

  • Service conditions and non market performance conditions, such as staying employed for three years or hitting a profit target, are not built into the fair value. They affect the number of awards expected to vest, which is re estimated each year and trued up to the actual number on vesting.
  • Market conditions, such as a share price target, and conditions that are not vesting conditions, such as a requirement to keep saving, are built into the grant date fair value, with no later adjustment if the target is missed, provided all other vesting conditions are met.

How is fair value found for an unlisted company?

Paragraph 26.10 sets a three tier hierarchy for shares: an observable market price if there is one; otherwise entity specific market data such as a recent transaction in the shares or a recent independent valuation of the company or its main assets; and only if that is impracticable, a valuation method using market data as far as practicable. At the third tier the directors must use their judgement to apply a generally accepted valuation methodology suited to the company’s circumstances. Paragraph 26.11 applies a similar hierarchy to options, with an option pricing model as the fallback, using inputs such as share price, exercise price, expected volatility, option life, expected dividends and the risk free rate.

The FRC explains in paragraph B26.1 of the Basis for Conclusions that option pricing models can be difficult for unlisted entities, which is why paragraph 26.10(c) leaves the choice of model to the directors’ judgement.

What does a worked example look like?

Illustration only. A company grants 1,000 options each to 10 employees, vesting if they stay for three years. The grant date fair value is £3 per option. The company expects 8 employees to remain at the end of year 1, revises that to 9 at the end of year 2, and 7 actually remain at vesting.

Year Cumulative charge Charge for year
1 8 × 1,000 × £3 × 1/3 = £8,000 £8,000
2 9 × 1,000 × £3 × 2/3 = £18,000 £10,000
3 7 × 1,000 × £3 = £21,000 £3,000

Each year the charge is debited to profit and loss and credited to equity, usually a separate reserve shown in the statement of changes in equity. The £3 is never revised, even if the share value later rises or falls.

How are cash settled awards measured?

For a cash settled award, paragraph 26.14 requires the services and the liability to be measured at the fair value of the liability, remeasured at each reporting date and at settlement, with changes taken to profit or loss. Non market vesting conditions again affect the number of awards expected to vest, while market conditions are built into the fair value at every remeasurement (paragraph 26.14B). The result, as paragraph 26.14C states, is that the cumulative expense equals the cash actually paid.

Where the company can choose how to settle, the award is treated as equity settled unless the share alternative has no commercial substance or the company has a past practice or stated policy of paying cash (paragraph 26.15A). Where the employee can choose, it is treated as cash settled unless the cash alternative has no commercial substance or relates only to net settlement to meet a tax withholding obligation (paragraph 26.15B).

What happens if an award is modified or cancelled?

A modification that increases fair value adds the incremental fair value, measured at the modification date, over the remaining vesting period, on top of the original grant date charge. A modification that is not beneficial to the employee, such as a longer vesting period, is ignored and the original charge continues (paragraph 26.12). A cancellation or settlement of an equity settled award is treated as an acceleration of vesting, so the remaining charge is recognised immediately (paragraph 26.13). A cash payment on settlement is deducted from equity, with any excess over the fair value of the instruments expensed (paragraph 26.13A).

What simplifications are there for small companies?

The FRC considered a lighter regime during the Periodic Review 2024 but decided that small entities should apply the same recognition and measurement rules as larger ones (paragraph B26.12). The practical simplifications are:

  • Valuation method. Directors choose an appropriate generally accepted method under paragraph 26.10(c), rather than being tied to a particular model.
  • Group allocation. Where a parent grants awards to employees across a group, group entities may measure their charge as a reasonable allocation of the group expense (paragraph 26.16).
  • Disclosures. A small entity using Section 1A must give only the disclosures listed in paragraph 1AC.31D: a description of each type of arrangement, the number and weighted average exercise price of options outstanding at the start and end of the period and exercisable at the end, the total expense for the period and the carrying amount of related liabilities. See Section 1A for small entities.

Micro entities applying FRS 105 have a much simpler rule. Paragraph 21.2 of FRS 105 says a micro entity does not account for equity settled share based payments until shares are issued, at which point the share issue is recorded under its Section 17. Cash settled awards are still recognised, measured as a provision under Section 16 of FRS 105 (paragraph 21.7). See FRS 105 micro entity accounts.

How does the accounting charge interact with tax?

For corporation tax, section 1038 of the Corporation Tax Act 2009 generally disallows deductions relating to the provision of shares to employees, including the accounting charge for options, where relief is available under Part 12 of that Act. Part 12 gives its own deduction instead: for an option over shares that are neither restricted nor convertible, section 1018 sets the relief as the market value of the shares when acquired less any consideration given. The tax deduction therefore usually comes in the year the option is exercised and bears no relation to the grant date charge.

Common mistakes include remeasuring an equity settled award each year as if it were cash settled, ignoring awards granted by a parent company, treating EMI options as outside the standard because they are tax advantaged, and forgetting that leaver provisions requiring redemption of shares can turn an award into a cash settled one.

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Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 8 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.