IFRS 2 – SHARE BASED PAYMENTS
Share-based payment occurs when any entity purchases goods or services from another party such as a supplier or employee and rather than paying directly in cash, settles the amount owing in shares, share options or future cash amounts linked to the value of shares.
Prior to the publication of IFRS 2 there appeared to be an anomaly to the extent that if a company paid its employees in cash, an expense was recognised in profit or loss, but if the payment was in share options, no expense was recognised.
IFRS 2 requirements
IFRS 2 requires an expense to be recoginsed in profit or loss in relation to share-based payments.
- The argument against expensing share-based payments was that there is no true expense although expense is being recognised.
- The main argument for was the share-based payments are simply another form of compensation that should go into the calculation of earnings for the sake of transparency for investors and the business community.
The objective of this IFRS is to specify the financial reporting by an entity when it undertakes a sharebased payment transaction.
A share-based payment transaction is one in which the entity transfers equity instruments, such as shares or share options, in exchange for goods and services supplied by employees or third parties.
IFRS 2 applies to all share-based payment transactions. The Standard recognises and addresses three types of transactions according to the method of settlement.
- Equity-settled share-based payment transactions
The entity receives goods or services in exchange for equity instruments of the entity (including shares or share options).
- Cash-settled share-based payment transactions
The entity receives goods or services in exchange for amounts of cash that are based on the price (or value) of the entity’s shares or other equity Instruments of the entity.
- Transactions with a choice of settlement
The entity receives goods or services and either the entity or the supplier has a choice as to whether the entity settles the transaction in cash (or other assets) or by issuing equity instruments.
Transactions outside the scope of IFRS 2
The following are outside the scope of IFRS 2:
- Transactions with employees and others in their capacity as a holder of equity instruments of the entity
- The issue of equity instruments in exchange for control of another entity In a business combination Contracts that may or will be settled, net in company shares (IFRS 9)
Before considering the accounting treatment of share-based payment transactions, it is important to understand the terminology used within the topic.
Share-based payment transaction A share-based payment transaction in which the entity
acquires goods or services by incurring a liability to transfer cash or other assets to the supplier of those goods or services for amounts that are based on the price (or value) of equity instruments (including shares or share options) of the entity or another group entity.
Share-based payment arrangement An agreement between the entity and another party (including an employee) to enter into a share-based payment transaction, which thereby entitles the other party to receive cash or other assets of the entity for amounts that are based on the price of the entity’s shares or other equity instruments of the entity, or to receive equity instruments of the entity, provided the specified vesting conditions, if any, are met.
Equity instrument A contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities.
Equity instrument granted The right (conditional or unconditional) to an equity instrument of the entity conferred by the entity on another party, under a share-based payment arrangement.
Share option A contract that gives the holder the right, but not the obligation, to subscribe to the entity’s shares at a fixed or determinable price for a specified period of time.
Grant date The date at which the entity and another party (including an employee) agree to a sharebased payment arrangement, being when the entity and the other party have a shared understanding of the terms and conditions of the arrangement. At grant date the entity confers on the other party (the counterparty) the right to cash, other assets, or equity instruments of the entity, provided the specified vesting conditions, if any, are met. If that agreement is subject to an approval process (for example, by shareholders), grant date is the date when that approval is obtained.
Intrinsic value The difference between the fair value of the shares to which the counterparty has the (conditional or unconditional) right to subscribe or which it has the right to receive, and the price (if any) the other party is (or will be) required to pay for those shares. For example, a share option with an exercise price of $15 on a share with a fair value of $20, has an intrinsic value of $5.
Measurement date The date at which the fair value of the equity instruments granted is measured. For transactions with employees and others providing similar services, the measurement date is grant date.
For transactions with parties other than employees (and those providing similar services), the measurement date is the date the entity obtains the goods or the counterparty renders service.
Vest To become an entitlement. Under a share-based payment arrangement, a counterparty‘s right to receive cash, other assets or equity instruments of the entity vests when the counterparty‘s entitlement is no longer conditional on the satisfaction of any vesting conditions.
Vesting conditions The conditions that must be satisfied for the counterparty to become entitled to receive cash, other assets or equity instruments of the entity, under a share-based payment arrangement. Vesting conditions include service conditions, which require the other party to complete a specified period of service, and performance conditions, which require specified performance targets to be met (such as a specified increase in the entity’s profit over a specified period of time).
Vesting period The period during which all the specified vesting conditions of a share-based payment arrangement are to be satisfied.
General rules – A summary
- An entity shall recognize the goods or services received or acquired in a share-based payment transaction when it obtains the goods or as the services are received.
- When the goods or services received or acquired in a share-based payment transaction do not qualify for recognition as assets, they shall be recognized as expenses.
- Goods might be consumed over a period of time or, in the case of inventories, sold at a later date, in which case an expense is recognized when the goods are consumed or sold.
- The entity shall recognize a corresponding increase in equity if the goods or services were received in an equity-settled share-based payment transaction or a liability if the goods or services were acquired in a cash-settled share-based payment transaction.
- For equity-settled share-based payment transactions, the entity shall measure the goods or services received, and the corresponding increase in equity, directly, at the fair value of the goods or services received, unless that fair value cannot be estimated reliably.
- If the entity cannot estimate reliably the fair value of the goods or services received, the entity shall measure their value, and the corresponding increase in equity, indirectly, by reference to the fair value of the equity instruments
EQUITY-SETTLED SHARE-BASED PAYMENT TRANSACTIONS
Where payment for goods or services is in the form of shares or share options, the fair value of the transaction-is recognised in profit or loss, spread over the vesting period.
If goods or services are received in exchange for shares or share options the transaction is accounted for by:
Dr. Expense/Asset Cr. Equity
IFRS 2 does not stipulate which equity account the credit entry is made to. It is normal practice to credit a separate component of equity, mostly retained earnings are credited.
We must next consider:
- Measurement of the total expense taken to profit or loss
- When this expense should be recorded.
When considering the total expense to profit or loss, the basic principle is that equity-settled share-based transactions are measured at fair value.
Fair value will depend upon who the transaction is with:
- There is a rebuttable presumption that the fair value of goods / services received from a third party can be measured reliably.
- It is not normally possible to measure services received when the shares or share options form part of the remuneration package of employees.
Transactions in Which Services are Received
Allocation of expense to financial years
Where the instruments granted vest immediately, i.e. the recipient party becomes entitled to them immediately, and then the transaction is accounted for in full on the grant date.
Vesting period exists
Where entitlement to the instruments granted is conditional on vesting conditions, and these are to be met over a specified vesting period, the expense is spread over the vesting period.
Transactions with third parties (non-employees)
Applying the rules seen in the sections above, transactions with third parties are normally
- Measured at the fair value of goods / services received
- Recorded when the goods / services are received
Transactions with employees
Applying the rules seen in the sections above, transactions with employees are normally
- Measured at the fair value of equity instruments granted at grant date Spread over the vesting period (often a specified period of employment)
If the equity instruments granted vest immediately, the counterparty is not required to complete a specified period of service before becoming unconditionally entitled to those equity instruments. The entity shall presume that services rendered by the counterparty as consideration for the equity instruments have been received. In this case, on grant date the entity shall recognize the services received in full, with a corresponding increase in equity.
If the equity instruments granted do not vest until the counterparty completes a specified period of service, the entity should account for those services as they are rendered by the counterparty during the vesting period.
Transactions Measured by Reference to the Fair Value of the Equity Instruments Granted Determining the fair value of equity instruments granted
For transactions measured by reference to the fair value of the equity instruments granted, an entity shall measure the fair value of equity instruments granted at the measurement date, based on market prices if available.
If market prices are not available, the entity shall estimate the fair value of the equity instruments granted using a valuation technique to estimate what the price of those equity instruments would have been on the measurement date in an arm‘s length transaction between knowledgeable, willing parties.
Treatment of Vesting Conditions
The Impact of Different Types of Vesting Conditions
Vesting conditions may be:
- Non-market based i.e. not relating to the market value of the entity’s shares
- Market based i.e. linked to the market price of the entity’s shares in some way
Non-market based vesting conditions
- These conditions are taken into account when determining the expense which must be taken to profit or loss in each year of the vesting period.
- Only the number of shares or share options expected to vest will be account for.
- At each period end (including interim periods), the number expected to vest should be revised as necessary
- On the vesting date, the entity should revise the estimate to equal the number of shares or share options that do actually vest.
Market Based Vesting Conditions
- These conditions are taken into account when calculating the fair value of the equity instruments at the grant date.
- They are not taken into account when estimating the number of shares or share options likely to vest at each period end.
- If the shares or share options do not vest, any amount recognised in the financial statements will remain.
Market and non-market based vesting conditions
Where equity instruments are granted with both, market and non-market vesting conditions, an entity should recognise an expense irrespective of whether market conditions are satisfied provided all other vesting conditions are satisfied.
In summary, where market and non-market conditions co-exist, it makes no difference whether the market conditions are achieved. The possibility that the target share price may not be achieved has already been taken into account when estimating the fair value of the options at grant date. Therefore, the amounts recognised as an expense in each year will be the same regardless of what share price has been achieved.
Transactions during the year
Where the grant date arises mid-year, the calculation of the amount charged to profit or loss must be prorated to reflect that feet
Vested options not exercised
If, after the vesting date, options are not exercised or the equity instrument is forfeited, there will be no impact on the financial statements. This is because the holder of the equity instrument has effectively made that decision as an investor.
The services for which the equity instrument remunerated were received by the entity and the financial statements reflect the substance of this transaction. IFRS 2 does, however, permit a transfer to be made between reserves in such circumstances to avoid an amount remaining in a separate equity reserve where no equity instrument will be issued.
Variable vesting date
Where the vesting date is variable depending upon non-market based vesting conditions, the calculation of the amount expensed in profit or loss must be based upon the best estimate of when vesting will occur.
MODIFICATIONS AND RE-PRICING
Equity instruments may be modified before they vest.
E.g. A downturn in the equity market may mean that the original option exercise price set is no longer attractive. Therefore the exercise price is reduced (the option is ‘re-priced’) to make it valuable again.
Such modifications will often affect the fair value of the instrument and therefore the amount recognised in profit or loss.
The accounting treatment of modifications and re-pricing is:
- Continue to recognise the original fair value of the instrument in the normal way (even where the modification has reduced the fair value).
- Recognise any increase in fair value at the modification date (or any increase in the number of instruments granted as a result of modification) spread over the period between the modification date and vesting date.
- If modification occurs after the vesting date, then the additional fair value must be recognised immediately unless there is, for example, an additional service period, in which case the difference is spread over this period.
CANCELLATIONS AND SETTLEMENTS
An entity may settle or cancel an equity instrument during the vesting period. Where this is the case, the correct accounting treatment is:
- To immediately charge any remaining fair value of the instrument that has not been recognised in profit or loss (the cancellation or settlement accelerates the charge and does not avoid it).
- Any amount paid to the employees by the entity on settlement should be treated as a buyback of shares and should be recognised as a deduction from equity. If the amount of any such payment is in excess of the fair value of the equity instrument granted, the excess should be recognised immediately in profit or loss.
Cancellation and reissuance
Where an entity has been through a capital restructuring or there has been a significant downturn in the equity market through external factors, an alternative to repricing the share options is to cancel them and issue new options based on revised terms. The end result is essentially the same as an entity modifying the original options and therefore should be recognised in the same way.
Repurchase after vesting
Where equity instruments are repurchased by an employing entity following vesting, this is similar to the entity providing the employee with cash remuneration in the first instance. The reporting therefore reflects this with the payment being recognised as a deduction from equity. The charge recognised in profit or loss will remain, as this reflects the services for which the employee has been remunerated. If the payment made is in excess of the fair value of the instruments granted, then this is recognised immediately in profit or loss reflecting that this is payment for additional services beyond what was originally agreed.
Determining the fair value of equity instruments granted
Where a transaction is measured by reference to the fair value of the equity instruments granted, fair value is based on market prices where available.
If marker price are not available the entity should estimate the fair value of the equity instruments granted
CASH SETTLED BASED TRANSACTIONS
- For cash-settled share-based payment transactions, the entity shall measure the goods or services acquired and the liability incurred at the fair value of the liability.
- Until the liability is settled, the entity shall remeasure the fair value of the liability at the end of each reporting period and at the date of settlement, with any changes in fair value recognised in profit or loss for the period.
If goods or services are received in exchange for cash amounts linked to the value of shares, the transactions is accounted for by:
TRANSACTION WITH A CHOICE OF SETTLEMENT
Counter party has the choice
For transactions with parties other than employees, the entity shall measure the equity component of the compound financial instrument as the difference between the fair value of the goods or services received and the fair value of the debt component, at the date when the goods or services are received.
Fair value of goods/services $x
Less Liability (PV) ($x)
(R.V) Equity Option $x
Dr. Asset/ Expense $xxx
Cr. Liability $xxx Cr. Equity Option $xxx
Liability will be remeasured
For transactions with employees, the entity shall measure the fair value of the compound financial instrument at the measurement date, taking into account the terms and conditions on which the rights to cash or equity instruments were granted.
Fair value of equity route/ alternative $xxx
Less liability (PV) ($xxx)
(R.V) Equity Option $xxx
IFRS 2 requires that the value of the debt component is established first. The equity component is then measured as the residual between that amount and the value of the instrument as a whole. In this respect IFRS 2 applies similar principles to IFRS 9 Financial Instruments, where the value of the debt components is established first. However, the method used to value the constituent parts of the compound instrument in IFRS 2 differs from that of IFRS 9.
For transactions in which the fair value of goods or services is measured directly (that is normally where the recipient is not an employee of the company), the fair value of the equity component is measured as the difference between the fair value of the goods or services required and the fair value of the debt component.
For other transactions including those with employees where the fair value of the goods or services is measured indirectly by reference to the fair value of the equity instruments granted, the fair value of the compound instrument is estimated as a whole.
The debt and equity components must then be valued separately. Normally transactions are structured in such a way that the fair value of each alternative settlement is the same.
Entity has the choice
When entity has the choice of settlement, the entity shall determine whether it has present obligation to deliver cash or not. Such circumstances arise where, for example, the entity is prohibited from issuing shares or where it has a stated policy, or past practice, of issuing cash rather than shares.
If the entity has a present obligation to settle in cash, the entity should record the transaction as if it is cash settled share based payment transaction.
If no present obligation exists, the entity should treat the transaction as if it was equity settled transaction.
On settlement, if the transaction was treated as an equity-settled transaction and cash was paid, the cash should be treated as if it was a repurchase of the equity instrument by a deduction against equity.
DEFERRED TAX IMPLICATIONS
Share based payments
Share-based transactions may be tax deductible in some jurisdictions. However, the amount deductible for tax purpose does not always correspond to the amount that is charged to profit or loss under IFRS 2.
In most cases it is not just the amount but also the timing of the expense allowable for tax purposes that will differ from that required by IFRS 2.
For example an entity recognises an expense for share options granted under IFRS 2, but does not receive a tax deduction until die options are exercised. The tax deduction will be based on the share price on the exercise date and will be measured on the basis of the options’ intrinsic value i.e. the difference between market price and exercise price at the exercise date.
In the case of share-based employee benefits under IFRS 2 the cost of the services as reflected in the financial statements is expensed and therefore the carrying amount is nil.
The difference between the carrying amount of nil and the tax base of share-based payment expense received to date is a deferred tax asset, provided the entity has sufficient future taxable profits to utilise this deferred tax asset.
The deferred tax asset temporary difference is measured as:
Carrying amount of share-based payment expense 0
Less: tax base of share-based payment expense (X)
(estimated amount tax authorities will permit as a deduction In future periods, based on year end information)
Temporary difference (X)
Deferred tax asset at X% X
If the amount of the tax deduction (or estimated future tax deduction) exceeds the amount of the related cumulative remuneration expense, this indicates that the tax deduction relates also to an equity item.
The excess is therefore recognised directly in equity. The examples below show the accounting for equitysettled and cash-settled transactions.
IFRS 2 requires extensive disclosures under three main headings:
- Information that enables users of financial statements to understand the nature and extent of the share-based payment transactions that existed during the period.
- Information that allows users of financial statements to understand how the fair value of the goods or services received, or the fair value of the equity instruments which have been granted during the period, was determined.
- Information that allows users of financial statements to understand the effect of expenses, which have arisen from share-based payment transactions, on the entity‘s profit or loss in the period.