You have decided to reward your senior managers with EMI share options instead of a cash bonus, partly to save cash and partly because the tax treatment is generous. The scheme has been set up, the valuation has been done, and the options have been granted. Then your accountant mentions that this needs to go through your profit and loss account as an expense, even though no cash has changed hands. If that sounds confusing, you are not alone. Many SME owners assume that because options have not been exercised, there is nothing to account for yet. In reality, UK accounting standards require you to recognise a cost from the day you grant the options, and getting this wrong can distort your profit figures and confuse investors or lenders.
What Are Share-Based Payments and Why Do EMI Options Need Accounting For?
A share-based payment is any transaction where your business pays someone, usually an employee, with shares or share options instead of cash. Enterprise Management Incentive (EMI) schemes are the most common route for UK SMEs because they offer valuable tax reliefs to both the company and the employee. But from an accounting perspective, EMI options are treated no differently to any other equity-settled share-based payment. The key idea is simple: your senior team is providing a service to the business, usually time and effort over a vesting period, in exchange for the right to buy shares later at a fixed price. Because they are being paid in a form of value, accounting standards say that value must be recognised as an expense in your accounts, spread over the period the employee has to work to earn the right to those options.
The Accounting Rule: IFRS 2 and FRS 102 Section 26
If you report under IFRS, the relevant standard is IFRS 2 Share-based Payment. If you use UK GAAP, the equivalent rules sit in FRS 102 Section 26. Both say broadly the same thing for EMI schemes settled in shares: you calculate the fair value of the options at the date they are granted, and you spread that total cost as an expense over the vesting period, the time your senior team must stay and work before the options actually become theirs. This is not a cash cost. It does not reduce your bank balance. But it does reduce your reported profit, and the offsetting entry builds up a reserve within equity, because ultimately the value is being funded by existing shareholders through potential future dilution rather than by the company spending money.
Key point: the accounting expense for EMI options has nothing to do with the tax relief you receive. You can have a real corporation tax deduction on exercise while also recognising a non-cash charge to profit years earlier. These two things run on separate tracks.
Worked Example: A £40,000 EMI Grant to Three Senior Managers
Suppose your company grants EMI options with a total fair value of £40,000 to three senior managers, calculated at the grant date using an appropriate option pricing model. The options vest over three years, meaning each manager must remain employed for three years before they can exercise. There are no performance conditions attached, only the requirement to stay employed, known as a service condition. Under both IFRS 2 and FRS 102, you spread this £40,000 fair value evenly across the three-year vesting period, assuming no one is expected to leave before vesting. If you do expect leavers, you would adjust the charge, but for simplicity we will assume all three managers stay for the full term.
| Detail | Figure |
|---|---|
| Array | Array |
| Array | Array |
| Array | Array |
| Array | Array |
| Array | Array |
| Array | Array |
| Total fair value of EMI options at grant date | £40,000 |
| Vesting period | 3 years |
| Annual charge (Year 1) | £13,333 |
| Annual charge (Year 2) | £13,333 |
| Annual charge (Year 3, balancing figure) | £13,334 |
| Cumulative expense over vesting period | £40,000 |
| Account | Dr | Cr |
|---|---|---|
| Staff costs (Share-based payment expense) – P&L | £13,333 | |
| Share option reserve – Equity | £13,333 |
Year 1: recognise one third of the total EMI fair value as a non-cash staff cost, spreading the charge over the vesting period.
| Account | Dr | Cr |
|---|---|---|
| Staff costs (Share-based payment expense) – P&L | £13,333 | |
| Share option reserve – Equity | £13,333 |
Year 2: same treatment, continuing to build the share option reserve within equity.
| Account | Dr | Cr |
|---|---|---|
| Staff costs (Share-based payment expense) – P&L | £13,334 | |
| Share option reserve – Equity | £13,334 |
Year 3: final tranche, rounded to bring the cumulative charge to exactly £40,000 across the vesting period.
Common pitfall: many SME owners assume that if an employee leaves before their options vest, no adjustment is needed because nothing was ever paid out. In fact, if a leaver forfeits unvested options, you must reverse the cumulative expense already charged for that individual, which can create a credit (profit-boosting) entry in the year they leave. Also, if a disqualifying event occurs under HMRC rules—for example, if the company is acquired and loses its independence, or ceases to carry on a qualifying trade—tax advantages can be restricted even though the accounting charge continues unchanged. Note that merely exceeding the gross asset or employee limits after grant is not a disqualifying event for existing options, as those thresholds apply only at the time of grant.
Deferred Tax: The Often-Missed Piece
Here is where many finance teams stumble. The accounting expense of £40,000 does not reduce your corporation tax bill at the time it is charged. Corporation tax relief for EMI options generally only arises when the options are exercised, and the relief is based on the actual gain, the difference between the market value of the shares at exercise and the price the employee pays, not the £40,000 fair value you have been expensing in your accounts. If you expect the options to be exercised and the tax deduction to materialise in future, you may need to recognise a deferred tax asset in the meantime, reflecting the future tax saving. This is a technical area and the calculation changes as your share price moves, so it is worth discussing with your accountant each year rather than setting it up once and forgetting about it.
Takeaways You Can Apply Now
- Recognise that EMI option grants create a real, non-cash expense in your profit and loss account from the grant date, spread evenly over the vesting period, even though no cash leaves the business.
- Get a proper fair value calculation done at grant date, ideally from a specialist, since this figure drives your accounting charge for the entire vesting period and cannot be casually estimated.
- Build a simple schedule tracking each tranche of options, the vesting dates, and any leavers, so you can adjust the cumulative expense correctly if someone departs before their options vest.
- Talk to your accountant annually about the deferred tax position on your EMI scheme, since the tax relief timing and amount can diverge significantly from the accounting expense you have already recognised.
Need help accounting for your EMI or share option scheme?
Share-based payments are one of the easiest areas for growing SMEs to get wrong, with knock-on effects for profit, equity, and tax. Our team can help you set up the right valuation, journals, and ongoing tracking so your financial statements tell the right story.
