Analysis of equity settled share based payments accounting regime (advanced)
Produced in partnership with William Franklin
Analysis of equity settled share based payments accounting regime (advanced)

The following Share Incentives guidance note Produced in partnership with William Franklin provides comprehensive and up to date legal information covering:

  • Analysis of equity settled share based payments accounting regime (advanced)
  • Option pricing theory—Black Scholes and Monte Carlo models
  • Black Scholes and disclosure rules
  • Accounting within groups
  • Exclusions from SBP
  • Cash cancelations, growth shares, JSOPs and acquisitions of companies
  • Fair market values and valuation for tax purposes

This Practice Note looks at some of the more complex issues associated with the equity settled accounting regime. For a more basic overview of the equity settled accounting regime, see Practice Note: Overview of the equity settled share based payments accounting regime. For an introduction into the cash settled share-based payment regime, see Practice Note: Analysis of cash settled share based payments accounting regime.

Option pricing theory—Black Scholes and Monte Carlo models

Where the equity award is an option or some other equity instrument which is not an ordinary share, a theoretical value of the instrument will need to be calculated. Although Black Scholes option pricing theory mathematics is not prescribed by the share based payments (SBP) standards, it has become the defacto-accepted basis for valuing options for SBP accounting purposes.

Basic Black Scholes is a complex formula, but it can be solved algebraically to calculate a theoretical value of an option based on the six Black Scholes assumptions. The theory is introduced in the Practice Note: Overview of the equity settled share based payments accounting regime, however, as a re-cap, the six Black Scholes assumptions are:

  1. market value of the ordinary shares

  2. exercise price of the option over ordinary shares

  3. expected life of the option

  4. expected dividend yield of the ordinary shares

  5. expected volatility of the ordinary shares, and

  6. expected