FINANCIAL PARTICIPATION
Businesses must react quickly to new share option accounting rules
UK companies need to get to work quickly on methodologies for valuing employee share-based payments following the recent publication of the International Accounting Standards Board's proposed new rules, warns consultants Watson Wyatt.
Background
Under the new accounting rules, the grant of share options will lead to an expense in a company's profit and loss account, even if there is no discount to the current market value of shares.
The UK's Accounting Standards Board intends to apply the new standard to UK companies for accounting periods starting on or after 1 January 2004. But the impact will be immediate: the new valuation rules will apply to options granted and share awards made since the draft was published on 7 November 2002. Earlier awards can continue to be treated under the old accounting rules.
Robust methodologies required
"The value to be charged will need to be based on a option-pricing model, such as the Black-Scholes formula, but with further adjustments for factors relevant to employee options such as non-transferability and performance conditions," said Andrew Wise, a partner at Watson Wyatt.
"Methodologies will need to be comprehensive and robust enough to deal with changing assumptions. For example, the 'expected life' of an option is dependent on the share price from one year to the next - in other words, how much are they in the money or underwater. Companies will need a methodology to justify any changes in assumptions - for each share plan in issue - from one year to the next."
Implications for LTIPs and SIPs
The change in accounting rules will also remove the current bias in favour of share options (including all-employee SAYE share option plans) in comparison with performance share plans (often known as LTIPs) and share incentive plans. Companies may therefore find these other types of plan more attractive in future, says Watson Wyatt.
The same valuation techniques that will be used for valuing options can be used for comparing awards under different types of share plan and also for comparing share awards with performance conditions that vary in difficulty.
Want to know more?
For more details on the proposed changes to the way employee share schemes are treated in profit and loss accounts visit the Accounting Standards Board's web site at www.asb.org.uk
Watson Wyatt Worldwide is a global consulting firm focusing on human capital and financial management. It specialises in four areas: employee benefits, human capital strategies, eHR, and insurance and financial services. Watson Wyatt has more than 6,300 associates in 87 offices around the world. www.watsonwyatt.com