IFRS 2 Share-based Payment

IFRS 2 covers (IFRS 2.1-6) transactions in which a third party is entitled to receive equity instruments of the entity (or another group entity) or cash amounts based on the value of such equity instruments in exchange for goods or services. See definitions of share-based payment arrangement and share-based payment transaction in Appendix A to IFRS 2.

There are three main categories of share-based payment transactions within the scope of IFRS 2:

  • equity-settled share-based payment transactions
  • cash-settled share-based payment transactions
  • share-based payment transactions with cash alternatives

IFRS 2 applies also to group arrangements where different entities receive goods or services and settle share based payments.

IFRS 2 does not apply to assets acquired in a business combination (see IFRS 3), however share-based payment transactions with employees of the acquiree (target) that relate to future services (i.e. not part of a consideration for a transfer of control over a business) are within the scope of IFRS 2.

Entities should recognise goods or services acquired in a share-based payment transaction as they are obtained/received. Application of other IFRS will determine whether entities should recognise an expense or an asset as a result of goods or services received (IFRS 2.7-9).

Equity-settled share-based payment transactions are transactions in which the entity receives goods or services in exchange for its own equity instruments (e.g. shares, options). Transactions that are settled by other entity (e.g. by a parent) are also treated as equity-settled from a perspective of the entity receiving goods or services (IFRS 2.Appendix A).  Group schemes are covered in a separate section.

Goods or services received are measured at their fair value, unless it cannot be estimated reliably (e.g. for arrangements with charities). In such a case, fair value of goods or services is determined with reference to the fair value of equity instruments granted. In particular, IFRS 2 considers that employee services received in a share-based payment transaction should be recognised with reference to fair value of equity instruments granted, as it is not possible to reliably estimate and distinguish services received in exchange for equity instruments from services received for other forms of remuneration (IFRS 2.10-13A). IFRS 2 uses the term ’employees and others providing similar services’ to encompass also individuals who work for the entity in the same way as individuals regarded as employees for legal or tax purposes (IFRS 2.Appendix A).

From a P/L perspective, it does not make any difference whether an entity, in order to fulfil its obligations stemming from share-based payment arrangements, issues new equity instruments or repurchases them on the market. See also a discussion on credit entry below.

The measurement date is the date when entity obtains goods or services or, specifically for transaction with employees, the grant date. It is the date at which the fair value of equity instruments granted is measured (see definitions in Appendix A). The grant date has the following characteristics:

  • both parties have agreed to a share-based payment arrangement and its conditions (sometimes the agreement may be implicit, i.e. no documents need to be signed)
  • all necessary approvals have been obtained (e.g. approval by shareholders or the supervisory board).

Arrangements with employees often come with a obligatory service period lasting a few years, but the fair value of equity instruments is set at a grant date and remains unchanged.

It is important to note that the goods or services acquired in a share-based payment transaction should be recognised as they are obtained/received. It is possible that grant date might occur after the employees to whom the equity instruments were granted have begun rendering services (IFRS 2.IG4).

Example: Grant date

On 1 January 20X1 the management board of Entity A announced a share award plan to its employees, specifying all terms and conditions. The vesting period for this plan is 3 years. The announcement also made clear that this share award plan needs to be approved by the supervisory board. The supervisory board approved the plan on 20 February 20X1.

In this example, the grant date is 20 February, but the expense is recognised starting from 1 January 20X1. Fair value of equity instruments, used as a basis for recording relevant expense, is first estimated before it is known on 20 February.


If equity instruments vest immediately (‘to vest’, ‘vesting conditions’ and ‘vesting period’ are crucial terms in IFRS 2 – see Appendix A and familiarise yourself with these definitions), entities should assume (unless there is evidence to the contrary) that all services have been received. Therefore, on grant date (another term to familiarise yourself with – see Appendix A to IFRS 2) entities should recognise services received with a corresponding increase in equity (IFRS 2.14).

If there are vesting conditions attached, but they are service conditions only (e.g. employee must work for the entity for another 3 years – see definition of service conditions in Appendix A), share-based payment transaction is recognised over time during the vesting period. Service conditions are not taken into account in calculation of fair value of instruments granted. Instead, they are taken into account by adjusting the number of equity instruments included in the measurement of the transaction and this estimate is revised at each reporting date (an entity should make the best available estimate of the number of equity instruments expected to vest).  In effect, after the vesting period, cumulative expense relates only to those instruments that actually vested (IFRS 2.19-20).

If the vesting conditions are performance targets, the approach to recognition depends on whether these are market or non-market targets (see definition of performance condition in Appendix A to IFRS 2). Non-market conditions (e.g. specified minimum revenue growth of the entity for next 3 years) are treated similarly to service conditions (see above). The vesting period is sometimes evident, but sometimes entities need to estimate it based on the performance target (i.e. how long will it take to achieve a target). Such an estimate is then revised based on subsequent actual data. The period of achieving the performance targets cannot end after the service period specified in the arrangement. If it does, such a performance target is treated as a non-vesting condition. Similarly to service conditions, cumulative expense relates only to those instruments that actually vested (IFRS 2.19-20).

For performance targets that are market conditions, see the section below.

If performance targets are market conditions (e.g. share price of the entity will exceed $100 by a given year), they should be taken into account when estimating fair value of the equity instruments granted, but not taken into account when estimating the number of equity instruments expected to vest. Fair value cannot be subsequently revised if the fulfilment of market conditions becomes more or less likely. Goods or services are recognised immediately or during vesting period (if there are other vesting conditions) irrespective of whether the market condition is met. So it may happen that an entity will recognise an expense relating to share-based payments even if there are no instruments that eventually vested because the market condition was not met (IFRS 2.21). This approach to market conditions can be counter-intuitive, but it stems from the ‘grant date approach’ adopted by IFRS 2 under which equity instruments cannot be remeasured after initial recognition.

The requirements above are summarised below:

Decision tree for recognition of equity-settled share-based payment transactions under IFRS 2
Decision tree for recognition of equity-settled share-based payment transactions under IFRS 2

Example: share-based payment with service vesting condition and market condition

On 1 January 20X1, Entity A grants 100 shares to each of its 200 employees, under the following 2 vesting conditions:

1/ a 3-year service condition and

2/ share price of the entity after these 3 years must be higher by at least 20% compared to grant date.

At the grant date, fair value of granted shares is estimated at $30 each. This fair value does not take into account 3-year service condition but takes into account the market vesting condition from point 2/ above.

At the grant date, it is estimated that 90% out of 200 employees will meet the service condition. In summary:

number of employees: 200
number of shares per employee: 100
fair value of shares at grant date (taking into account market vesting condition in point 2/): $30
service condition in years: 3
estimated % of employees that will meet the service condition: 90%

All calculations presented in this example can be downloaded in an excel file.

Year 20X1

During the first year, entity A recognises this share based-payment transaction as follows:

 DRCR
Employee benefits expense180,000
Equity180,000

Note that the market vesting condition (point 2/) is not taken into account when estimating number of share options that will eventually vest. Instead, it impacted the fair value of share options.

Year 20X2

At 31 Dec 20X1, the price of Entity A shares falls on the stock exchange and the fair value of share options is now $20. However, the decrease in fair value of share options does not impact recognition of share-based payment transaction as this is a market condition. It was taken into account when estimating the fair value of share options at grant date which is not remeasured subsequently after the grant date.

Additionally, only 2% of employees left during 20X1, therefore Entity A revised its original estimate and now 190 employees (i.e. 95% of the starting 200) are expected to meet the service condition.

Entries in year 20X2 are as follows:

 DRCR
Employee benefits expense200,000
Equity200,000

Year 20X3

This is the final year of service condition. 186 employees (93% of the original 200) remained in the company after these 3 years. It turned out that the share price at 31 December 20X3 was only 15% higher compared to grant date and employees did not receive any shares. But the expense recognised during years 20X1-20X2 is not reversed as the condition relating to 20% share price increase was taken into account when estimating fair value of shares at grant date (this is a market condition).  The fair value of instruments granted is not subsequently remeasured after grant date and the recognition of shares options is not reversed.

Entity A recognises expense for the third year updated with the actual number of employees that met the service condition:

 DRCR
Employee benefits expense178,000
Equity178,000

In summary, cumulative expense recognised during these three years amounts to $558,000:

186 employees that met the service condition x 100 instruments per employee x $30 of fair value of instruments at grant date = $558,000


Example: share-based payment with non-market performance vesting condition and flexible vesting period

On 1 January 20X1, Entity A promises to grant 100 shares to each of its 200 employees when the number of customers for their new product X reaches 1 million. If this target is not met by 31 December 20X4, no shares will be granted. In order to receive shares, employees must also be still employed in Entity A when this target is met.

Fair value of one share is estimated at $30, without taking into account vesting conditions as they are non-market conditions.

On 1 January 20X1, Entity A estimates that the target of 1 million customers will be met on 31 December 20X3 and 170 employees (i.e. 85%) will still work for the company by then.

In summary:

number of employees: 200
number of shares per employee: 100
fair value of shares at grant date: $30
estimated vesting period: 3 years
estimated % of employees that will meet the service condition: 85%

All calculations presented in this example can be downloaded in an excel file.

Year 20X1

During the first year, entity A recognises this share based-payment transaction as follows:

 DRCR
Employee benefits expense170,000
Equity170,000

Year 20X2

The number of customers is growing slower than expected and now Entity A estimates than it will be met one year later, i.e. on 31 December 20X4. There are no changes in assumptions for employee turnover. The entry in year 20X2 is as follows:

 DRCR
Employee benefits expense85,000
Equity85,000

Year 20X3

There are no changes in assumptions in third year. Entity A recognises expense for this year as follows:

 DRCR
Employee benefits expense127,500
Equity127,500

Year 20X4

The vesting condition relating to number of customers is met on 31 December 20X4, therefore employees receive their shares. Employee turnover was very low in 20X4, so ultimately 180 employees (90%) that were at the company at grant date received the shares. Entries for the last year are as follows:

 DRCR
Employee benefits expense157,500
Equity157,500

Note that any changes in fair value of shares after the grant date do not have any impact on recognised expense as fair value of equity instruments is not subsequently remeasured.

In summary, cumulative expense recognised during these three years amounts to $540,000:

180 employees that met the service condition x 100 instruments per employee x $30 of fair value of instruments at grant date = $540,000.


Example: share-based payment with market performance vesting condition and flexible vesting period

On 1 January 20X1, Entity A promises to grant 100 shares to each of its 200 employees if and when the share price of Entity A reaches $50. If this target is not met by 31 December 20X4, no shares will be granted. In order to receive shares, employees must also still be employed in Entity A when this target is met.

According to the fair value valuation prepared by Entity A, the most likely date when the price target will be achieved is 31 December 20X3. Fair value of one share that was granted is estimated at $30 and this takes into account the market vesting condition, i.e. the vesting share price target. Entity A estimates that 180 employees (i.e. 90%) will still be employed at 31 December 20X3.

In summary:

number of employees: 200
number of shares per employee: 100
fair value of shares at grant date: $30
estimated vesting period: 3 years
estimated % of employees that will meet the service condition: 90%

All calculations presented in this example can be downloaded in an excel file.

During the first two years there are no changes in assumptions and entity A recognises this share based-payment transaction as follows:

 DRCR
Employee benefits expense180,000
Equity180,000

Note that the above entry is booked during each year (i.e. the amount relates to one year only).

Year 20X3

The share price target is not achieved during 20X3, but this fact does not impact the recognition, as the estimate of the length of the expected vesting period, which was based on market performance condition, cannot be subsequently revised (IFRS 2.15b). Additionally, the actual number of employees that fulfilled the service condition during estimated vesting period was 184 (92%).

Entity A recognises final year of expected vesting period (even though the share price target was not achieved), adjusting only for the number of employees that fulfilled the service condition during estimated vesting period. As a result, accounting entry for year 20X3 is as follows:

 DRCR
Employee benefits expense192,000
Equity192,000

Year 20X4

The share price target is not achieved during 20X4 as well, so there will be no shares delivered to employees. 176 employees (88%) still work for the company on 31 December 20X4. However, these facts do not impact the recognition, as the estimate of the length of the expected vesting period, which was based on market performance condition, cannot be subsequently revised (IFRS 2.15b). Therefore, whatever happens in 20X4, no entries will be booked by Entity A during this year.

Interestingly, it is not clear what should be done in opposite situation, i.e. when the $50 share price target would be met sooner than estimated, e.g. in year 20X2.

On one hand, IFRS 2 states that the estimate of the length of the expected vesting period which was based on market performance condition cannot be subsequently revised (IFRS 2.15b). On the other hand, expense relating to fully vested awards should be recognised immediately. In my opinion, the fulfilment of market vesting condition sooner than estimated should result in accelerated recognition of expense.


Example: share-based payment with variable awards based on market vesting conditions

On 1 January 20X1, Entity A promises to grant 100 shares to each of its 200 employees if the share price will exceed $10 at 31 December 20X2 or 150 shares if the share price will exceed $15 at that date. In order to receive shares, employees must also be still employed in Entity A at 31 December 20X2. Fair value of one share with a market vesting condition of a target price at $10 is $7 and it drops to $4 with a target price at $15.

In summary:

number of employees: 200
number of shares per employee if a target share price of $10+ is met: 100
number of shares per employee if a target share price of $15+ is met: 150
fair value of a share with a market vesting condition of a target share price at $10+: $7
fair value of a share with a market vesting condition of a target share price at $15+: $4
estimated % of employees that will meet the service condition: 90%

The recognition of such a share-based payment with variable awards is based on 150 shares per employee, but the first 100 shares have fair value of $7 and the following 50 shares have fair value of $4.

All calculations presented in this example can be downloaded in an excel file.

Year 20X1

During the first year, entity A recognises this share based-payment transaction as follows:

 DRCR
Employee benefits expense81,000
Equity81,000

Year 20X2

The share price at 31 December 20X2 is $9, therefore no shares are given to employees. 92% of employees still work at the company at 31 December 20X2. The fact that the market vesting condition (i.e. target share price) is not met does not impact the recognition of share based payment arrangement. It was taken into account when estimating the fair value of share options at grant date. Their fair value is not subsequently remeasured after grant date. The entity adjusts the recognition only for the % of employees that met the service condition.

Entries recognised during year 20X2 are as follows:

 DRCR
Employee benefits expense84,600
Equity84,600

Non-vesting conditions are treated similarly to market vesting conditions, i.e. they are included in fair value of equity instruments granted and goods or services are recognised immediately or during vesting period (if there are vesting conditions) irrespective of whether the non-vesting condition is eventually met (IFRS 2.21A). Interestingly, IFRS 2 does not give a definition of a non-vesting condition. It can be found in IFRS 2.BC364: non-vesting condition is any condition that does not determine whether the entity receives the services that entitle the counterparty to receive cash, other assets or equity instruments of the entity under a share-based payment arrangement. Examples of non-vesting conditions are: target based on a commodity index, specified payments towards a savings plan during vesting period, continuation of the plan by the entity, non-compete clause, transfer restrictions.

Credit entry and allocation within equity

The credit entry of equity-settled share-based payment transactions goes to equity. IFRS 2 does not specify which part of equity, but says in a few places that transfers within equity are allowed. The approach an entity follows usually results from national law which can set some rules regarding presentation of items within equity (e.g. separate presentation of share capital equalling face value of shares in issue).

Some entities set up a separate reserve within equity labelled ‘share based-payments’ where all the credit entries go, other entities recognise the credit entry directly in retained earnings. The latter seems more convenient in the long-run, as entities won’t get stuck with a separate item within equity that relates to arrangements that can be many years old.

If actual shares are issued, or previously acquired treasury shares are passed on to employees, reclassification within share capital, treasury shares and a separate share-based payment  reserve will be necessary.

In any case, total equity cannot change after the vesting date (IFRS 2.23). This approach may be counter-intuitive in some instances, e.g. share options that were granted to employees and vested, but were never exercised. But the lapse of a share options does not change the fact that they are financial instruments that were actually issued to employees in exchange for their services (work) and a related expense cannot be reversed at a later date (IFRS 2.BC218-219).

Reload features are not taken into account when estimating the fair value of options granted. Reload option, if granted, is treated as a new option grant (IFRS 2.22, see Appendix A for definitions).

Modifications, cancellations and settlements are dealt with in paragraphs IFRS 2.26-29,B42-B44. In general, the cumulative expenses recognised with respect to equity settled share-based payment transactions after modifications, cancellations or settlements cannot be lower than before those events. In other words, entities can only increase expenses and this will happen if modifications, cancellations and settlements are beneficial to employees (or other party).

If a modification increases the fair value of equity instruments granted measured immediately before and after the modification, number of these instruments, or both (including replacement of old instruments with new ones), increased expense is recognised during the remaining vesting period in addition to the original expense. If the modification occurs after the vesting date, additional expense is recognised immediately.

A change in vesting conditions favourable to employees (or other party) should be accounted for as a revision to number of instruments that will vest. If the change relates to market conditions, it should be accounted as a change in fair value of instruments granted described above.

A decrease in fair value of instruments granted (including replacement of old instruments with new ones) or unfavourable change in vesting conditions should be ignored and entity should recognise expenses based on conditions before the modification.

If a grant of equity instruments is cancelled (including decrease in their number) or settled during the vesting period, it should be accounted as an acceleration of vesting and immediate recognition of expenses. Any payment made by the entity on the cancellation or settlement is treated as a deduction from equity, except to the extent that the payment exceeds the fair value of the equity instruments granted, measured at the repurchase date – such an excess is recognised as an expense. Similar approach should be followed for repurchases of vested instruments.

If an entity or counterparty can choose whether to meet a non-vesting condition, failure to meet that non-vesting condition during the vesting period is treated as a cancellation (IFRS 2.28A). Examples of such non-vesting conditions are payment of contributions towards the exercise price by the counterparty of continuation of the plan by the entity.

The approach of IFRS 2 to modifications, cancellations and settlements that decrease the benefits may be counterintuitive at first, but it results from the ‘grant date’ approach – once the equity instruments were granted, their fair value must be recognised over the vesting period (subject to fulfilment of non-market vesting conditions). See also the example and rationale in paragraphs IFRS 2.BC230-BC235 that the Board considered when reaching its conclusions on modifications, cancellations and settlements. Hopefully, after reading these paragraphs, you will see at least some logic behind such requirements 😉

Example: modification of a share-based payment through repricing of options

On 1 January 20X1, Entity A grants 100 share options to each of its 200 employees provided they will still work for Entity A on 31 December 20X3. Fair value of share options is estimated at $30 (without taking into account the service condition as it is a non-market condition).

In summary:

number of employees: 200
number of share options per employee: 100
fair value of share options at grant date: $30
vesting period in years: 3
estimated % of employees that will meet the service condition: 90%

All calculations presented in this example can be downloaded in an excel file.

Year 20X1

During the first year, Entity A recognises this share based-payment transaction as follows:

 DRCR
Employee benefits expense180,000
Equity180,000

Year 20X2

Entity A sees that its share price has fallen significantly on the stock market, the fair value of share options is now $15. To keep employees motivated, Entity A decides to reprice share options granted. The fair value of repriced options is $20. Estimated % of employees that will meet the service condition remains unchanged.

Entity A continues to recognise the original fair value of share options granted ($30 per option) as the decrease in fair value of these options cannot be reflected in accounts (equity instruments issued are not remeasured subsequently). Additionally, Entity A recognises the additional fair value of $5 ($20 – $15) per option granted in 20X2 over the remaining vesting period.

Entries during year 20X2 are as follows:

 DRCR
Employee benefits expense225,000
Equity225,000

Note that if Entity A decided to reprice the options down, there would be no impact on recognition, i.e. Entity A would continue to recognise expenses based on the original fair value of $30 per option.

Year 20X3

There was no further repricing. 88% of employees remained in employment.

Entries during year 20X3 are as follows:

 DRCR
Employee benefits expense211,000
Equity211,000

Modifications of share-based payment arrangements rarely work in one direction only. Instead, they often are a change in number of equity instruments combined with offsetting effect of changes in their fair value. Consider the next example:

Example: modification of a share-based payment through repricing of options and changes in their number

On 1 January 20X1, Entity A grants 100 share options to each of its 200 employees provided they will still work for Entity A on 31 December 20X3. Fair value of share options is estimated at $30 (without taking into account the service condition as it is a non-market condition).

In summary:

number of employees: 200
number of share options per employee: 100
fair value of share options at grant date: $30
vesting period in years: 3
estimated % of employees that will meet the service condition: 90%

All calculations presented in this example can be downloaded in an excel file.

Year 20X1

During the first year, entity A recognises this share based-payment transaction as follows:

 DRCR
Employee benefits expense180,000
Equity180,000

Year 20X2

Entity A sees that its share price has fallen significantly on the stock market, the fair value of share options is now $15. To keep employees motivated, Entity A decides to reprice share options granted. The fair value of repriced options is $25. At the same time, Entity A reduces the number of share options to 60 per employee, so that the total fair value per employee remains unchanged ($15 * 100 at the date of modification = $25 * 60 after modification). Estimated % of employees that will meet the service condition remains unchanged.

There are two possible approaches to such a modification as shown below. Approach #1 takes a single share option as a unit of account and focuses more on wording in paragraphs IFRS 2.B43a and B44b which refers to single equity instrument. On the other hand, Approach #2 considers the share-based payment arrangement as a unit of account and focuses more on wording in paragraph IFRS 2.27 which refers to the total fair value of the share-based payment arrangement.

Approach #1

Entity A recognises:

1/ The decrease in number of share options by 40 (i.e. from 100 to 60) as a cancellation and accelerates the recognition of the related expense.

2/ Continues to recognise the original fair value of $30 per share option for the remaining 60 options over the vesting period.

3/ Recognises additional expense for the 60 options that were repriced and their fair value at the modification date increased by $10 (from $15 at the modification date to $25). This expense is recognised over the remaining vesting period.

The following entries are made under Approach #1 during year 20X2:

 DRCR
Employee benefits expense144,000 1
Employee benefits expense108,0002
Employee benefits expense54,0003
Equity306,000

Footnotes:
1/ Acceleration relating to 40 share options
2/ Recognition of the original fair value of $30 per share option for the remaining 60 options over the vesting period.
3/ Recognition over the remaining vesting period (2 years) of additional expense for the 60 options that were repriced and their fair value at the modification date increased by $10 (from $15 at the modification date to $25).

Approach #2

Entity A keeps recognising the share-based arrangement as if nothing happened, as the total fair value per employee was not changed at the modification date.

Year 20X3

There were no further modifications. 88% of employees remained within company and met the service condition. Entries for year 20X3 under Approach #1 are as follows:

 DRCR
Employee benefits expense100,8001
Employee benefits expense51,6002
Equity152,400

Footnotes:
1/ Recognition of the original fair value of $30 per share option for the remaining 60 options over the vesting period.
2/ Recognition over the remaining vesting period (2 years) of additional expense for the 60 options that were repriced and their fair value at the modification date increased by $10 (from $15 at the modification date to $25).

As a result, total expense under Approach #1 amounts to $ 638,400 and can be broken down as follows:

$216,000: Expense relating to 40 share options per employee that were cancelled during year 2 (this amount is based on estimate % of employees that would fulfil the service condition made at the cancellation/modification date).

$316,800: Recognition of the original fair value of $30 per share option for the remaining 60 options over the vesting period.

$105,600: Recognition of additional expense for the 60 options that were repriced and their fair value at the modification date increased by $10 (from $15 at the modification date to $25).

As a reminder, all calculations presented in this example can be downloaded in an excel file.


Paragraphs IFRS 2.44A-C give also specific guidance on a modification of a share-based payment transaction that changes its classification from cash-settled to equity-settled.

Cash-settled share-based payment transactions are transactions in which the entity receives goods or services by incurring a liability to transfer cash or other assets in amounts that are based on the price (or value) of equity instruments of the entity or another group entity (IFRS 2.Appendix A). The most common examples of cash-settled share-based payment transactions are: SARs (share appreciation rights) and phantom stocks/options.

Cash-settled share-based payment transactions are covered in paragraphs IFRS 2.30-33D. The general criteria for recognition are very similar to equity-settled share-based payment transactions, but the credit entry goes to liability instead of equity. This liability is measured at fair value of instruments granted and remeasured at each reporting date. The expense and corresponding liability is recognised over time during vesting period. Treatment of vesting conditions is similar to equity-settled share-based payment transactions described above, with a notable exception of market vesting conditions, which should be taken into account when remeasuring the fair value of liability. As a result, the cumulative amount ultimately recognised for goods or services received for the cash-settled share-based payment is equal to the cash that is eventually paid to employee (or other party providing goods or services). This is not always the case in equity-settled share-based payment transactions, e.g. in the case of failure of fulfilment of market vesting conditions or cancellations.

IFRS 2 has quite detailed discussion on measurement of the fair value of shares and share options granted in a share-based payment arrangement. It is contained in paragraphs IFRS 2.B2–B41. Basis for Conclusions paragraphs relevant to this topic are BC129-BC199 and BC306-BC310.

Additionally, paragraphs IFRS 2.24-25 cover instances where fair value of the equity instruments cannot be estimated reliably. Such cases are rare as even unquoted equities can be fair valued.

This section of the Knowledge Base of IFRScommunity will be expanded in the future.

Paragraphs IFRS 2.33E-H give specific guidance on share-based payment transactions with a net settlement feature for withholding tax obligations.

Paragraphs IFRS 2.35-40 cover share-based payment transactions with cash alternatives in which the terms of the arrangement provide the counterparty with a choice of settlement. Such transactions are quite common in share-based payment arrangements with employees.

In transactions with parties other than employees, where fair value of goods or services is measured directly, the entity measures the equity component as the difference between the fair value of the goods or services received and the fair value of the debt component (i.e. cash alternative), at the date when the goods or services are received.

For transactions where fair value of goods or services is measured with reference to instruments issued (most often to employees) entities need to measure fair value of two components. Such measurement starts with debt component (i.e. cash alternative), then the fair value of the equity component is measured taking into account that the counterparty will not receive cash in order to receive the equity instrument.

Debt and equity components are recognised in accordance with requirements for cash-settled and equity-settled share-based payment transactions, respectively.

On settlement, the liability needs to be remeasured so that it equals the payment amount. If the entity issues equity instruments on settlement rather than paying cash, the remeasured liability is transferred directly to equity. All previously recognised equity components remain within equity (transfers within equity are allowed).

Example: Share-based payment transaction with cash alternative

On 1 January 20X1, Entity A grants 100 shares to each of its 200 employees provided they will remain employed until 31 December 20X3. These shares will then be locked-in for another two years (i.e. employees would not be able to sell them until 31 December 20X5). Employees have also a right to receive cash instead of shares (so called ‘phantom shares’), the payment will be based on the market price of these shares as at 31 December 20X3 and payment will be made immediately.

However, the cash alternative will be based on 80 shares only.

Moreover, at the grant date:
– it is estimated that 90% out of 200 employees will meet the service condition
– fair value of phantom shares granted is $30 (cash alternative)
– fair value of shares granted is $28 (share alternative)

The measurement of such a share-based payment arrangement starts with debt component (i.e. cash alternative), then the fair value of the equity component is measured taking into account that the counterparty will not receive cash in order to receive the equity instrument. Liability component as at the grant date amounts to $432,000, whereas equity component amounts to $72,000.

All calculations presented in this example can be downloaded in an excel file.

Year 20X1

Entity A starts recognising the expense relating to both components over the vesting period. Entries for year 20X1 are as follows:

 DRCR
Employee benefits expense168,000
Equity24,000
Liability144,000

Year 20X2

Market price of Entity A shares increases. This is reflected only in liability component which increases to $32. Fair value of equity instruments is not subsequently remeasured.

Entries recognised for year 20X2 are as follows:

 DRCR
Employee benefits expense187,200
Equity24,000
Liability163,200

Year 20X3

85% of employees (170) remained in the workforce as at 31 December 20X3. 120 employees chose share alternative and 50 employees chose cash alternative. Market price of shares increased further so that the fair value of cash alternative is now $35.

First, Entity A recognises expense for year 3 taking into account actual number of employees that fulfilled service condition and final market price of shares (the latter for liability component only). This is recognised as follows for year 20X3:

 DRCR
Employee benefits expense188,800
Equity20,000
Liability168,800

Payment to 50 employees who chose cash alternative is booked as follows:

 DRCR
Cash175,000
Liability175,000

Issuance of shares to 120 employees who chose share alternative transfers the remaining liability balance to equity:

 DRCR
Equity301,000
Liability301,000

As a reminder, all calculations presented in this example can be downloaded in an excel file.


Paragraphs IFRS 2.41-43 cover share-based payment transactions with cash alternatives in which the terms of the arrangement provide the counterparty with a choice of settlement. For this type of transactions, the entity needs to determine whether to use general equity-settled or cash-settled basis of IFRS 2. Such a transaction is accounted for as cash-settled if, for example:

  • settlement in equity instruments has no commercial or economic substance
  • settlement in equity instruments is impracticable due to legal or other constraints
  • entity has a past practice or a stated policy of settling in cash whenever it can
  • entity has created a constructive obligation to settle in cash

In other cases, a transaction is accounted for as equity-settled.

When actual equity instruments are issued, no changes in equity is recognised other than a transfer within equity if needed. If entity, despite the original choice of approach, settles in cash, the payment is treated as a deduction of equity. But if the entity, on settlement, chooses the alternative that has a higher fair value at settlement date, the difference between settlement date fair values is recognised as additional expense.

Share-based payment transactions among group entities are covered in paragraphs IFRS 2.43A-D and B45-B61. Such arrangements most often concern an (ultimate) parent and a subsidiary. The entity that receives goods or services should recognise expenses relating to them even if the payment or transfer of equity instruments is made by another group entity. The receiving entity should account for such an arrangement as cash-settled or equity-settled based on economic substance. In particular, when the receiving entity has no obligation to settle the share-based payment transaction, such a transaction is accounted for as equity-settled.

The table below provides a summary of classification of group employee shared-based payment transactions where a subsidiary is the entity receiving services from employees:

Classification of share-based payment transactions among group entities under IFRS 2
Classification of share-based payment transactions among group entities under IFRS 2

When the parent settles the share-based payment transaction, the debit entry in its separate financial statements normally increases the cost of investment in a given subsidiary.

IFRS 2 specifically states (B45-B46) that it does not cover the treatment of intragroup repayment arrangements. If the repayment is directly linked to the share-based payment arrangement, it is common practice to offset the original entries, i.e. to debit the equity by the subsidiary and to credit the investment in subsidiary by the parent.

It is often the case that the acquiring company (AC) replaces awards in place at the target company (TC). IFRS 3 has specific requirements on accounting for such replacements (IFRS 3.B56-B62). The fair value of the original awards is split between consideration transferred and post-acquisition P/L based on percentage of vesting period completed, whereas this percentage is calculated based on both original and modified terms (if applicable) and the lower percentage is attributed to consideration transferred. The difference between the fair value of replacement awards and the amount attributed to consideration transferred is treated as a post-combination service expense and accounted for using general IFRS 2 requirements.

IFRS 2 is silent on what to do with the part of share-based payment allocated to consideration transferred if the assessment about the number of equity instruments that eventually vest changes as a result of events occurring after the acquisition date. As a result, all approaches seem acceptable (i.e. do nothing, full recognition in post-acquisition P/L or adjustment to goodwill during provisional measurement period).

Example: replacement awards in the context of business combinations

Below are illustrative examples summarising the approach to replacement awards in the context of business combinations. Base scenario is as follows:

Acquiring company (AC) acquires target company (TC) on 1.01.20X1. At the date of acquisition, TC operated an equity-settled share based payment award with a total fair value determined (at 1.01.20X1) under IFRS 2 requirements amounting to $100 million.

AC replaces this award with a new one with a fair value of $150 million. These amounts are determined after taking account the estimated number of instruments expected to vest.

Further details are split into variants as shown below (vesting period is given in years). All calculations presented in the table below can be downloaded in an excel file.

Replacement awards in the context of business combinations under IFRS 2
Replacement awards in the context of business combinations under IFRS 2

However, if the original awards of TC would expire as a consequence of a business combination and if AC replaces those awards when it is not obliged to do so, the fair value of replacement awards should be recognised as a post-combination service expense in full and accounted for using general IFRS 2 requirements. IFRS 3.B56 considers that AC is obliged to replace awards if such a replacement is required by the acquisition agreement, terms of TC’s awards, or simply required by the law.

If the original awards at TC are not replaced by AC, the requirements set out in IFRS 3.B62A-B apply.

It’s worth noting that the TC should account for any modifications/replacements in its separate financial statements using general IFRS requirements for modifications and cancellations.

Disclosure requirements are set out in paragraphs IFRS 2.44-52. These include information on the nature and extent of share-based payment transactions, their effect on financial statements, as well as fair value disclosures.

 


© 2018-2019 Marek Muc

Excerpts from IFRS Standards come from the Official Journal of the European Union (© European Union, https://eur-lex.europa.eu). The information provided on this website does not constitute professional advice and should not be used as a substitute for consultation with a certified accountant.