International Financial Reporting Standard (IFRS®) 2, Share-based Payment, applies when a company receives goods and services in exchange for its own equity instruments or a cash amount based on the price of its own equity instruments.
These goods can include inventories, property, plant and equipment, intangible assets, and other non-financial assets. There are two notable exceptions: shares issued in a business combination, which are dealt with under IFRS 3Business Combinations; and contracts for the purchase of goods that are within the scope of International Accounting Standard (IAS®) 32 Financial Instruments: Presentation or IFRS 9 Financial Instruments. In addition, a purchase of treasury shares would not fall within the scope of IFRS 2, nor would a rights issue where some of the employees are shareholders.
Examples of some of the arrangements that would be accounted for under IFRS 2 include call options, share appreciation rights, share ownership schemes, and payments for services made to external consultants based on the company’s equity capital.
Recognition of share-based payment
IFRS 2 requires an expense to be recognised for the goods or services received by a company. The corresponding entry in the accounting records will either be a liability or an increase in the equity of the company, depending on whether the transaction is to be settled in cash or in equity shares. Goods or services acquired in a share-based payment transaction should be recognised when they are received. In the case of goods, this is obviously the date when this occurs. However, it is often more difficult to determine when services are received. If shares are issued that vest immediately, then it can be assumed that these are in consideration of past services. As a result, the expense should be recognised immediately.
Alternatively, if the share options vest in the future, then it is assumed that the equity instruments relate to future services and recognition is therefore spread over that period.
Equity settled transactions
Equity-settled transactions with employees and directors would normally be expensed and would be based on their fair value at the grant date. Fair value should be based on market price wherever this is possible. Many shares and share options will not be traded on an active market. If this is the case then valuation techniques, such as an option pricing model, would be used. IFRS 2 does not set out which pricing model should be used, but describes the factors that should be taken into account. It says that ‘intrinsic value’ should only be used where the fair value cannot be reliably estimated. Intrinsic value is the difference between the fair value of the shares and the price that is to be paid for the shares by the counterparty.
The objective of IFRS 2 is to determine and recognise the compensation costs over the period in which the services are rendered. For example, if a company grants share options to employees that vest in the future only if they are still employed, then the accounting process is as follows:
- The fair value of the options will be calculated at the date the options are granted.
- This fair value will be charged to profit or loss equally over the vesting period, with adjustments made at each accounting date to reflect the best estimate of the number of options that will eventually vest.
- Shareholders’ equity will be increased by an amount equal to the charge in profit or loss. The charge in the profit or loss reflects the number of options vested. If employees decide not to exercise their options, because the share price is lower than the exercise price, then no adjustment is made to profit or loss. On early settlement of an award without replacement, a company should charge the balance that would have been charged over the remaining period.
EXAMPLE 1
On 1 June 20X6, a company purchased inventory and paid for it by issuing shares to the supplier with a fair value of $6.3 million. The fair value of the inventory on 1 June 20X6 was $6m.
How will this transaction be dealt with in the financial statements?
Answer
IFRS 2 states that the fair value of the goods and services received should be used to value the share options unless the fair value of the goods cannot be measured reliably. Thus, equity would be increased by $6m and inventory increased by $6m.
Performance conditions
Schemes often contain conditions which must be met before there is entitlement to the shares. These are called vesting conditions. Conditions specifically related to the market price of the company’s shares are called market conditions, and these are ignored for the purposes of estimating the number of equity shares that will vest. The thinking behind this is that these conditions have already been taken into account when measuring the fair value of the share options.
EXAMPLE 2
A company grants 2,000 share options to each of its three directors on 1 January 20X6. The options will vest on 31 December 20X8 if the directors are still employed and if the company’s share price reaches $14 per share. The fair value of each option on 1 January 20X6 is $10.
The share price at 31 December 20X6 is $8 and it is not anticipated that it will rise over the next two years. At 31 December 20X6, it is anticipated that only two directors will still be employed on 31 December 20X8.
How will the share options be treated in the financial statements for the year ended 31 December 20X6?
Answer
The market-based condition (i.e. the increase in the share price) can be ignored for the purpose of the calculation. However, the employment condition must be taken into account.
2,000 options x 2 directors x $10 x 1 year / 3 years = $13,333
Equity will be increased by $13,333 and an expense shown in profit or loss for the year ended 31 December 20X6.
Cash settled transactions
Cash settled share-based payment transactions occur where goods or services are paid for at amounts that are based on the price of the company’s equity instruments. The expense for cash settled transactions is the cash paid by the company.
As an example, share appreciation rights entitle employees to cash payments equal to the increase in the share price of a given number of the company’s shares over a given period. This creates a liability, and the recognised cost is based on the fair value of the instrument at the reporting date. The fair value of the liability is re-measured at each reporting date until settlement.
EXAMPLE 3
Jay is a public limited company with a year end of 31 July 20X6. on 1 July 20X5, it granted 300 share appreciation rights to each of its 500 employees. The vesting date is 31 July 20X7. The fair value of each share appreciation right on 31 July 20X6 is $15.
At 31 July 20X6, management believe that 80% of the employees will still be employed on 31 July 20X7.
How will the transaction be recorded in the year ended 31 July 20X6?
Answer
The liability is measured using the fair value of the rights at the reporting date. The expense is recognised over the vesting period of two years.
300 rights x 500 employees x 80% x $15 x 1 year / 2 years = $900,000
A liability of $900,000 should be recognised in the statement of financial position. A corresponding expense of $900,000 should be recognised in the statement of profit or loss.
Deferred tax implications
In some jurisdictions, a tax allowance is often available for share-based transactions. It is unlikely that the amount of tax allowance will equal the expense charged to profit or loss under IFRS 2.
Often, the tax deduction for equity-settled schemes is based on the option’s intrinsic value. This is the difference between the fair value of a share and exercise price of an option. A deductible temporary difference will arise between the tax base of the employee’s services received to date, and the carrying amount of the share-based payment (normally zero). A deferred tax asset will be recognised if the company has sufficient future taxable profits against which it can be offset.
For cash settled share-based payment transactions, the standard requires the estimated tax deduction to be based on the current share price. As a result, all tax benefits received (or expected to be received) are recognised in the profit or loss.
EXAMPLE 4
A company operates in a country where it receives a tax deduction equal to the intrinsic value of the share options at the exercise date. The company grants share options to its employees with a fair value of $4.8m at the grant date. The company receives a tax allowance based on the intrinsic value of the options which is $4.2m. The tax rate applicable to the company is 30% and the share options vest in three-years’ time.
Answer
A deferred tax asset would be recognised for:
$4.2m x 30% tax rate x 1 year / 3 years = $420,000
The deferred tax will only be recognised if there are sufficient future taxable profits available.
Disclosure
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.
SBR candidates need to be comfortable with the above accounting principles and be able to explain them in the context of some accounting numbers.
Written by a member of theStrategic Business Reporting examining team
