Nil cost share options

Nil cost share options

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Forgive the question from someone that doesn't do accounts. A lot of commentary talks about "nil cost" share options, ie where the individual is required to pay nothing (I assume that "nil" means "nil") to exercise the option. Since, as far as I am aware, a company cannot issue shares at a discount to their nominal value, how does this work? (And what are the accounting entries?)

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By thisistibi
20th Feb 2012 16:48

Well

My understanding is that the amount paid by the employer (whether nominal value or not) is effectively a salary cost for the company.  So the cost element goes into the P&L - it's no different to the company paying an employee £100 and the employee using it to buy £100 worth of shares, it simply skips those steps and the end result is the same - the employee gets £100 worth of shares and is taxed on it, as if it's salary.

The issuing of the shares is has a nil impact on cashflow for the company, so it's remunerating employees with no cash cost.  It does, of course, dilute the value of the shares belonging to other shareholders.

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By Milamb
26th Jun 2012 17:56

Nil cost share options

I agree with the comments above.  

UK law requires that a company can't issue shares below their nominal value - ie £1 shares cannot be issued for less than £1 each.  

So, regardless of the option price (in this case £nil) the shares must still be issued at par or higher (Cr share capital £100) and the cost is taken to the P&L as an employee cost (Dr P&L expense £100).

In practice, the accounting is to use the "fair value" of the shares at the time the option is granted (ie the date the employer commits to the employee) rather than the "nominal value" (in this case 100 shares of £1 each).  There are complex rules on how to calculate the fair value, but for this example let's assume there are 100 shares of nominal value £1 each but their fair value is £1.25 each.  The accounting is then:

Dr £125 Employment expense (P&L)

  Cr £100 Share capital (balance sheet)

  Cr £25   Share premium (balance sheet)

Also in practice, the employer might issue new shares this way or buy existing shares from other shareholders/market via a trust and give them to employees that way.  Either way, the accounting principle is broadly the same but in the first case the percentage of the company owned by existing shareholders is reduced ("diluted").

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