Understanding IFRS 2 – Share-based Payments (2024)

Introduction

IFRS 2, also known as the International Financial Reporting Standard 2, is a set of accounting standards that governs the accounting treatment of share-based payment transactions. IFRS 2 is the accounting standard that outlines the requirements for companies to account for share-based payments. Share-based payments are a common way for companies to compensate their employees or suppliers by issuing equity instruments, such as stock options, restricted stock units, or shares, in exchange for services or goods.

Share-based payment transactions are those transactions in which an entity receives goods or services from employees or other parties in exchange for equity instruments (such as shares or share options) or other forms of equity-based compensation.

IFRS 2 requires entities to recognize the fair value of the goods or services received, as well as the fair value of the equity instruments granted, as an expense in their financial statements. The standard also requires entities to measure the fair value of the equity instruments granted using an appropriate valuation model. The fair value is determined at the grant date of the instruments and is generally based on a market-based approach, such as using the Black-Scholes model.

The expense is recognized over the vesting period of the equity instruments, which is the period during which the employee or supplier is required to fulfill the conditions for receiving the instruments. The expense is recognized in profit or loss, unless the equity instruments are granted as part of a business combination, in which case they are recognized as part of the cost of the combination.

The standard also requires entities to provide certain disclosures in their financial statements, including information about the fair value of the equity instruments granted, the assumptions used in determining the fair value, and the amount of the expense recognized for share-based payment transactions.

Overall, IFRS 2 applies to all entities that have share-based payment arrangements, including public and private companies, as well as not-for-profit organizations. The standard is designed to improve the transparency and comparability of financial statements and to provide investors and other stakeholders with more relevant information about the costs of share-based payment transactions.

The Black-Scholes model

The Black-Scholes model is a mathematical formula used to calculate the theoretical value of a stock option. It was developed by Fischer Black and Myron Scholes in 1973 and has become a widely used tool in finance and accounting.

The Black-Scholes model takes into account several variables, including the current stock price, the option's strike price, the time to expiration, the risk-free interest rate, and the volatility of the stock price. By inputting these variables into the formula, the model calculates the fair value of the option.

The model assumes that the stock price follows a lognormal distribution, which means that the probability of the stock price moving up or down is not equal. It also assumes that there are no transaction costs or taxes, and that the option can be exercised at any time up to its expiration date.

While the Black-Scholes model is widely used, it does have some limitations. For example, it assumes that the stock price follows a lognormal distribution, which may not always be the case. It also assumes that the volatility of the stock price is constant, which may not hold true in practice. As a result, the model may not always provide an accurate estimate of the fair value of an option.

Examples of Share-based payments

1. Stock options: A company may grant its employees the right to purchase a certain number of shares at a specified price, known as the exercise price or strike price. The employee can exercise the option by paying the exercise price and receiving the shares.
2. Restricted stock units (RSUs): A company may grant its employees RSUs, which represent a right to receive shares of the company's stock at a future date, typically after a vesting period. During the vesting period, the employee may not sell, transfer, or pledge the RSUs.
3. Performance shares: A company may grant its employees performance shares, which represent a right to receive shares of the company's stock based on the achievement of certain performance criteria, such as hitting specific revenue targets or achieving certain profitability levels.
4. Stock/Share appreciation rights (SARs): A company may grant its employees SARs, which entitle the employee to receive cash or stock equal to the increase in the company's stock price above a certain level. Unlike stock options, SARs do not require the employee to pay an exercise price.
5. Employee stock purchase plans (ESPPs): A company may offer its employees the opportunity to purchase the company's stock at a discount through an ESPP. The employee can contribute a portion of their salary to purchase the stock, typically at a discount of up to 15% off the market price.

Double entry/Accounting for share-based payments in the financial statements

The double entry/accounting for share-based payments in the financial statements depends on the type of share-based payment and when the expense is recognized. Here are some examples of the double entry for share-based payments:

1. Stock options: When stock options are granted, no entry is required. When the options are exercised, the company debits cash for the amount received and credits the common stock account for the par value of the shares issued. If the exercise price is higher than the fair value of the shares at the exercise date, the company must also recognize a compensation expense equal to the fair value of the shares issued minus the exercise price.
2. Restricted stock units (RSUs): When RSUs are granted, no entry is required. When the RSUs vest and the shares are issued, the company debits common stock for the par value of the shares issued and credits additional paid-in capital for the fair value of the shares at the vesting date. The fair value of the shares is recognized as compensation expense over the vesting period.
3. Performance shares: When performance shares are granted, no entry is required. When the performance criteria are met and the shares are issued, the company debits common stock for the par value of the shares issued and credits additional paid-in capital for the fair value of the shares at the issuance date. The fair value of the shares is recognized as compensation expense over the performance period.
4. Stock/Share appreciation rights (SARs): When SARs are granted, no entry is required. When the SARs are exercised, the company debits cash for the amount paid or shares issued and credits additional paid-in capital for the fair value of the SARs at the exercise date. The fair value of the SARs is recognized as compensation expense over the vesting period.
5. Employee stock purchase plans (ESPPs): When employees participate in an ESPP, the company debits cash for the amount received and credits a liability account for the amount due to employees. When the shares are issued, the company debits the liability account and credits common stock for the par value of the shares issued and additional paid-in capital for the discount offered. Any discount offered is recognized as compensation expense over the offering period.

Disclosures requirements for share-based payments

IFRS 2 requires certain disclosures related to share-based payments in a company's financial statements. These disclosures aim to provide information about the nature and extent of the company's share-based payment arrangements and the impact of these arrangements on the company's financial statements. Here are some of the disclosure requirements for share-based payments:

1. Nature and terms of the share-based payment arrangements: A company must disclose the nature and terms of its share-based payment arrangements, including the types of awards, vesting periods, exercise prices, and expiration dates.
2. Fair value of the share-based payments: A company must disclose the fair value of the share-based payments granted during the period, either individually or in aggregate.
3. Accounting policy: A company must disclose its accounting policy for share-based payments, including the method used to determine the fair value of the awards and the expense recognition period.
4. Total compensation expense: A company must disclose the total compensation expense recognized for the share-based payments during the period.
5. Vesting conditions: A company must disclose the vesting conditions for the share-based payments, including the criteria that must be met for the awards to vest.
6. Reconciliation of the fair value of the share-based payments: A company must disclose a reconciliation of the fair value of the share-based payments granted during the period, showing how the fair value was determined and the impact on the financial statements.
7. Effect on earnings per share: A company must disclose the effect of share-based payments on earnings per share, both basic and diluted.
8. Information about the employees and directors who participate in the share-based payment arrangements, including the number of individuals participating in the arrangements, the number and types of awards granted, and the aggregate fair value of the awards granted.