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CFA Level II Exam · Employee Compensation: Post-Employment and Share-Based

Share-Based Compensation and Stock Options Accounting

Updated 7 October 2026 · Fact-checked

Share-based compensation pays employees with equity or equity-linked awards. For equity-settled awards such as options and restricted stock, measure fair value at the grant date, then expense it straight-line over the vesting period. Cash-settled awards such as SARs are remeasured to fair value each period until settled.

Understand Share-Based Compensation and Stock Options

Companies pay employees in shares or share-linked awards to tie pay to firm value and to conserve cash. The main types are restricted stock (shares given with conditions, usually continued service), stock options (the right to buy shares at a fixed exercise price), and stock appreciation rights (SARs), which pay the rise in share price, usually in cash.

The accounting idea is simple. The award is pay for services, so it is an expense. The cost is the fair value of the award, and it is spread over the period in which the employee earns it, called the vesting period. The other side of the entry is a credit to an equity reserve (paid-in capital) for equity-settled awards, or a liability for cash-settled awards. For equity-settled awards, retained earnings fall through the expense while paid-in capital rises by the same amount, so total equity is unchanged.

For equity-settled awards, fair value is fixed at the grant date and is not changed later when the share price moves. For restricted stock, fair value is the market price of the share at the grant date. For options, it is estimated with an option pricing model such as Black-Scholes-Merton or a binomial model. Inputs include share price, exercise price, expected term, volatility, dividend yield and the risk-free rate.

Cash-settled awards such as SARs create a liability. You remeasure the liability at each reporting date, and the expense each period reflects the change in fair value. Expense is therefore volatile and follows the share price.

For analysis, expense reduces net income but is non-cash. Higher assumed volatility or a longer expected term raises option value and expense. Managers can choose assumptions to lower the expense, so analysts check them. Exercise also dilutes existing shareholders.

Key formulas to remember

Total expense (equity-settled)
Total expense = Grant-date fair value per award × Number of awards expected to vest
Fair value is fixed at grant. If forfeiture estimates change, revise the number expected to vest and apply the change as a cumulative catch-up.
Annual expense, straight-line
Annual expense = Total expense ÷ Vesting period (years)
Applies to cliff vesting. Expense is recognized over the service period. For graded vesting, IFRS treats each tranche as a separate award, each expensed over its own vesting period. Revised forfeiture estimates are applied as a cumulative catch-up in the period of change.
Restricted stock fair value
Fair value per share = Market price at grant date
Only for shares with service conditions. No option model needed.
Option intrinsic value
Intrinsic value = max(Share price − Exercise price, 0)
Fair value of an option is at least this, plus time value.
Cash-settled award liability
Liability at date t = Fair value at t × Awards expected to vest × (Service rendered ÷ Total vesting period)
This formula applies to cliff-vesting awards. Remeasured each period. Expense = change in liability plus any cash paid.
Effect of assumptions on option value
Higher volatility, longer term, lower dividend yield → higher option value
Higher value means higher expense.

How to solve Share-Based Compensation and Stock Options questions

Use this sequence for any share-based pay question in a vignette.

  1. 1Identify the award type: restricted stock, option, or SAR. Check whether it is equity-settled or cash-settled.
  2. 2Find the grant date and the vesting period and type (cliff or graded) in the vignette.
  3. 3Get the fair value. For restricted stock, use the grant-date share price. For options, use the grant-date option value given in the exhibit.
  4. 4For equity-settled awards, do not update fair value after grant. For cash-settled awards, use the fair value at the current reporting date.
  5. 5Multiply by the number of awards expected to vest, after forfeitures, to get total expense.
  6. 6Divide by the vesting period for the annual expense. For graded vesting, treat each tranche as a separate award under IFRS. If forfeiture estimates change, revise the expected number to vest and record a cumulative catch-up: cumulative expense to date under the new estimate less expense already recognized.
  7. 7State the effect: expense lowers net income and there is no cash outflow for equity-settled awards. The credit goes to an equity reserve (paid-in capital) for equity-settled awards, so total equity is unchanged, or to a liability for cash-settled awards.
  8. 8If asked about assumptions, link volatility, term and dividend yield to option value and expense.

Quickest way: Grant-date value × expected vesting ÷ years

When to use it: Use for straight-line expense questions on equity-settled awards with a single vesting period.

  1. Pick the grant-date fair value per award, ignoring later price moves.
  2. Multiply by awards granted × (1 − forfeiture rate).
  3. Divide by vesting years.
  4. If cash-settled with cliff vesting, multiply the current fair value by awards expected to vest and by the fraction of service completed, to get the liability. Expense = change in liability from last year plus any cash paid. After vesting, the fraction is 1, so the liability equals the full fair value, and further changes in fair value go to expense until settlement.

Common mistakes in Share-Based Compensation and Stock Options

  • Using the current share price to update option expense each year for equity-settled options.

    Students confuse equity-settled awards with cash-settled SARs.

    Fix: Equity-settled fair value is fixed at grant. Only cash-settled awards are remeasured.

  • Expensing the full value in the grant year.

    The grant feels like the event that creates cost.

    Fix: Spread the cost over the vesting period, since it pays for service during that period.

  • Using the exercise price or intrinsic value as the option's fair value.

    Intrinsic value is easy to compute.

    Fix: Use the model value given at grant, which includes time value.

  • Ignoring expected forfeitures.

    Students multiply by all awards granted.

    Fix: Multiply by awards expected to vest and revise if estimates change.

  • Getting the direction of assumption effects wrong, such as thinking higher dividend yield raises option value.

    Dividends sound positive.

    Fix: Dividends lower the share price growth, so higher dividend yield lowers call option value. Higher volatility and longer term raise it.

  • Saying equity-settled expense reduces cash.

    Expense is mistaken for cash outflow.

    Fix: It is non-cash. The credit goes to paid-in capital (equity) while retained earnings fall through the expense, so total equity is unchanged by the entry.

Worked examples

Example 1

On 1 January, Norden Marine grants 100,000 options to employees. Grant-date fair value is €6.00 per option, the exercise price is €40, and the share price is €38. The options cliff-vest after 4 years of service. Management expects 10% of options to be forfeited. (1) What is total expense? (2) What is annual expense? (3) If the share price rises to €50 in year 2, does annual expense change?

Show the solution
  1. Options expected to vest = 100,000 × (1 − 0.10) = 90,000.
  2. Total expense = 90,000 × €6.00 = €540,000.
  3. Annual expense = €540,000 ÷ 4 = €135,000.
  4. Equity-settled options are fixed at grant-date fair value, so the share price rise to €50 does not change the expense.

Answer: (1) €540,000; (2) €135,000 per year; (3) No, it stays €135,000 unless the forfeiture estimate changes.

Example 2

Alpine Tech grants 20,000 SARs settled in cash, vesting after 2 years. Fair value per SAR is ₹150 at the end of year 1 and ₹210 at the end of year 2. All are expected to vest, and none are settled before year 2 ends. (1) What expense is recognized in year 1? (2) In year 2? (3) How does this differ from options?

Show the solution
  1. Year 1 liability = ₹150 × 20,000 × (1 ÷ 2) = ₹15,00,000.
  2. Year 1 expense = ₹15,00,000, since the opening liability was zero.
  3. Year 2 liability = ₹210 × 20,000 × (2 ÷ 2) = ₹42,00,000.
  4. Year 2 expense = ₹42,00,000 − ₹15,00,000 = ₹27,00,000.
  5. Unlike equity-settled options, SARs are remeasured each period, so expense follows the share price.

Answer: (1) ₹15,00,000; (2) ₹27,00,000; (3) SARs are a liability remeasured each period, whereas equity-settled options are fixed at grant-date fair value.

Exam tips

  • First decide equity-settled or cash-settled. This single choice decides whether fair value is fixed or remeasured.
  • Read the vignette for the vesting period and forfeiture rate, as they are the easy data to miss.
  • For assumption questions, rank effects: volatility up, term up, risk-free rate up raise call value; dividend yield up lowers it.
  • Remember that expense is non-cash, and dilution is a separate analytical concern from expense.
  • Check whether the question asks for expense in a single year or cumulative expense to date.

Share-Based Compensation and Stock Options in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Share-Based Compensation and Stock Options: frequently asked questions

What is the difference between restricted stock and stock options in accounting?

Restricted stock is valued at the market price of the share at grant date, since the employee receives the share itself. Options are valued with an option pricing model because the employee only gets the right to buy at a fixed price. Both are expensed over the vesting period.

Is the stock option expense based on grant date or exercise date?

For equity-settled options, it is based on the grant-date fair value. Later share price changes and the exercise itself do not change the expense. The expense is recognized over the vesting period.

How are stock appreciation rights accounted for?

SARs are usually cash-settled, so they create a liability. The liability is remeasured to fair value at each reporting date. Expense each period is the change in the liability, plus any cash paid.

Which assumptions increase option expense?

Higher expected volatility and a longer expected term raise option value, and so the expense. A higher dividend yield lowers call option value. Analysts watch these inputs because managers can use them to reduce reported expense.