Fair value measurement can be challenging when accounting for share-based payments. FPM’s Senior Manager Ashok Thomas outlines three common approaches.
Share-based payments such as share options continue to be popular among businesses across UK and Ireland. They are particularly favoured by start-ups and early-stage high-growth companies as they provide a way to reward employees without having to part with cash. However, the complexity of share-based payment arrangements, and variations in investing and settlement, make accounting for these payments quite challenging.
FRS 102 requires that the expenses relating to certain share-based payments must be recognised based on ‘fair value measured at grant date’.
A three-tier measurement hierarchy can be used to determine the fair value:
- The observable market price for equity instruments;
- Observable market data such as recent transaction; or
- Alternative valuation methodology
For smaller companies that have no market data for the equity instruments, measuring the fair value at the grant date is often challenging.
IFRS 2 provides some guidance on valuation pricing models. The most commonly used of these is the Black Scholes model. This requires knowledge of observable parameters such as underlying share price, exercise price, time to maturity, and volatility. In our experience with this model, the most challenging input to calculate is the underlying share price. In the absence of market data on the current share price, it is difficult to calculate the share price at the grant date.
There are several methods that can be used to calculate the share price. The three most common approaches are the market approach, the income approach (using discounted cash flows), and the cost approach.
A considerable degree of professional judgement is required in selecting the most appropriate approach.