FRS 20 (IFRS 2) 'Share-based Payment' was issued in April. It reflects the proposal in FRED 31 that the final international standard should be issued as a UK standard.

The Board has long held the view that transactions where employees and others receive shares or share options give rise to an expense and that the expense should be measured at fair value and recognised in the profit and loss account (or included as part of the cost of an asset recognised on the balance sheet). However, although aspects of the arrangements were dealt with in various UITF Abstracts, there had been no standard in the UK or the Republic of Ireland dealing comprehensively with the subject. The introduction of FRS 20 therefore represents a major improvement in UK financial reporting.

The FRS will apply to listed entities from 2005 and unlisted entities from 2006

FRED 31 proposed that the UK standard would come into effect from the effective date of the IFRS - which will be accounting periods beginning on or after 1 January 2005. For listed entities, this proposal is reflected in FRS 20.

The Board concluded, however, that is was reasonable to allow a longer period for implementation by unlisted entities: they are therefore not required to apply the standard until 2006.

The FRS will apply to all share-based payments, including SAYE schemes

The IFRS contains no exemptions. In developing FRS 20, the Board considered whether there were any matters unique to the UK or the Republic of Ireland that justified some exemptions in the FRS, but concluded they were none. As a result, the FRS applies to all share-based payments including all Save-As-You-Earn (SAYE) schemes.

The principles underlying FRS 20

There are two main types of share-based payment: equity-settled share-based payments and cash-settled share-based payments. Equity-settled transactions are when the payment takes the form of equity instruments; cash-settled transactions involve payments in cash (or other assets), the amount of which is calculated by reference to the price of an equity instrument of the payee.

For equity-settled transactions, FRS 20 takes the view that, at the date the transaction was entered into (ie grant date), the entity must have thought the value of the promise it was making (to issue equity instruments if certain criteria are met) was equal to the value of the goods or services it expected, at grant date, to receive in return. The fair value of the goods or services received can therefore be determined either directly (by measuring the fair value of the goods and services received) or indirectly (by using, as a proxy for the fair value of the goods and services received, the grant date fair value of the equity instrument issued).

The FRS sets out the factors that determine whether the direct method or the indirect method is to be used. It also explains how to allocate the amounts calculated to the relevant accounting periods, and how to adjust those amounts in the light of subsequent events.

For cash-settled transactions, FRS 20 requires charges to be made to the profit and loss account to build up a provision equal to the amount that will eventually be paid over the period in which the goods or services are received.

The FRS provides guidance on how to estimate the fair values needed to apply the standard. It recognises that option-pricing models will often have to be used, although it does not require the use of any particular model. It also sets out how to account for reload features and for events such as the repricing, cancellation or replacement of a share option plan.