Our ‘Insights into IFRS 2’ series is aimed at demystifying IFRS 2. This article explains how to determine the classification of share-based payment transactions and vesting conditions, both of which significantly impact the accounting requirements to be applied under IFRS 2.
As explained in our article ‘Insights into IFRS 2 – Objective andscope of IFRS 2’, IFRS 2 also applies to arrangements involvingother group entities or shareholders. While the concepts inthis article also apply to group share-based payments, sucharrangements are covered in ‘Insights into IFRS 2 – Groupshare-based payments’. This article focuses on share-based payments directly between the reporting entity and a counterparty.
Classification of share-based payment transactions and vesting conditions
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Classification of share-basedpayment transactions
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Share-based payment transaction
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A transaction in which the reporting entity receives goods or services from an employee or supplier in exchange for its own equity instruments (including shares or share options) or for cash or other assets based on the price of those equity instruments.
Under IFRS 2, a share-based payment transaction must beclassified as either an equity-settled transaction or a cashsettledtransaction. As the accounting requirements forthese two classifications differ significantly, it is important tounderstand the differences between these two transactiontypes.
Equity-settled vs Cash-settled:
| Classification | Equity-settled share-based payment transaction | Cash-settled share-based paymenttransaction |
| Definition | A share-based payment transaction inwhich the entity:
| A share-based payment transactionin which the entity acquires goods orservices by incurring a liability to transfercash or other assets to the supplier ofthose goods or services, the amounts ofwhich are based on the price (or value)of equity instruments of the entity (oranother group entity). |
| Examples | Shares or options granted to employees inexchange for services rendered. | Share appreciation rights that entitleemployees to cash payments based onthe increase in the entity’s share price. |
The classification of share-based payment transactions as either equity-settled or cash-settled is based on the nature of theentity’s obligation to the employee or supplier. If the entity has an obligation to deliver only its own equity instruments, then thetransaction is equity-settled.
If the entity has an obligation to deliver cash or other assets, then the transaction is cash-settled. Particular care needs to be takenwhen transferring cash or other assets, for instance, because of the existence of a written put option granted to the employee thatupon exercise (at the discretion of the beneficiary) would require the entity to transfer cash in exchange for the shares held by theemployee. This type of arrangement often exists when the shares or options are issued by a non-listed parent or by a non-listedsubsidiary to its own employee. When the grant of the equity instrument (shares or options) and the put option form part of thesame global arrangement they should be dealt with altogether as a single cash-settled transaction as from the date the put isissued.
What complexities can affect the classification of share-basedpayment transactions?
If the entity has an obligation to settle the transaction with its own equity instruments, then classification of the transaction isunaffected by how it obtains the equity instruments that will be used to settle the obligation, (ie the arrangement will be treatedas an equity-settled transaction). In other words, whether the entity chooses, or is required, to buy its own equity instruments fromanother party in order to settle its obligation to deliver an instrument to the beneficiary of the share-based payment transactiondoes not impact the classification of the transaction.
Certain share-based payment arrangements require additional consideration to determine their classification as equity-settled or cash-settled. Download 'Classification of share-based payment transactions and vesting conditions', for more details on each of the following:
- Share-based payment transactions with cash alternatives
- Share-based payment transactions with contingent cash settlement features
- Grants of a variable number of equity instruments
- Grants of equity instruments that include redemption features
- Group share-based payments
Classification of vesting and non-vesting conditions
In many cases, share-based payments are conditional upon satisfying specific conditions. These conditions are typicallydesigned to motivate employees and suppliers to act towards certain outcomes or to align their interests with those of the entity’sshareholders. For example, grants of shares or share options to an employee are often conditional on the employee remaining inthe entity’s employment for a specified period of time or achieving a specified level of growth in the entity’s profit or share price.Different types of conditions can affect the accounting for share-based payments in different ways, and therefore it is importantto appropriately determine the classification of any conditions.
Vesting conditions
As we note in ‘Insights into IFRS 2 – What is IFRS 2?’, the general recognition principle is that an entity recognises the cost of ashare-based payment at the time when the goods are acquired or as the services are received (often referred to as the ‘service-date model’). Under IFRS 2, the period over which the cost is allocated depends on the concept of ‘vesting’. A share-basedpayment is said to ‘vest’ when the counterparty’s right to receive cash, other assets or equity instruments of the entity no longerdepends on satisfying any ‘vesting conditions’.
While every condition attached to a share-based payment factors into whether and when a counterparty (such as an employee)receives a share-based payment, vesting conditions focus on whether the entity has received the services required from thecounterparty to pay the share-based consideration the entity is issuing. Therefore, all vesting conditions must include a servicerequirement.
Non-vesting conditions
A non-vesting condition refers to any condition that does not meet the definition of a vesting condition. While non-vestingconditions factor into whether the counterparty will receive a share-based payment, unlike vesting conditions, non-vestingconditions do not determine whether the entity receives the services that will entitle the counterparty to the share-based payment.Even when all vesting conditions have been satisfied and the share-based payment has vested, the counterparty would notreceive the share-based payment if any non-vesting conditions have not been met. Recognition of these awards with non-vestingconditions are discussed inInsights into IFRS 2 – Basic principles of share-based payment arrangements with employees.
For example, an entity may issue to an employee a right to 50 shares in two years’ time, so long as the employee does not workwith a competing entity during that time. Such a non-compete restriction does not determine whether the entity will receiveservices, because the employee could provide no further service to the entity for the next two years and still be entitled to theaward.
Vesting conditions and non-vesting conditions affect when a counterparty is entitled to a share-based payment as well as theamount and timing of recognition in the entity’s financial statements. While we have provided guidance on the classification ofshare-based payments as equity-settled or cash-settled as well as the classification of conditions as vesting or non-vesting, howthese classifications impact the accounting under IFRS 2 is outside the scope of this article and is therefore discussed in additional Insights into IFRS 2.
How we can help
We hope you find the information in this article helpful in giving you some detail into aspects of IFRS 2. If you would like todiscuss any of the points raised, please speak to your usual Grant Thornton contact oryour local member firm.
