Accounting Considerations
What is a share-based payment arrangement?
IFRS 2 defines a share-based payment arrangement as “an agreement between the entity (or another group entity or any shareholder of any group entity) and another party (including an employee) that entitles the other party to receive:
- cash or other assets of the entity 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, or
- equity instruments (including shares or share options) of the entity or another group entity, provided the specified vesting conditions, if any, are met.”
IFRS 2 should be applied to every share-based payment. In practice, the identification of arrangements that fall within the scope of IFRS 2 is not always straightforward.
Does a share-based payment arrangement always involve an employer and an employee?
No, entities typically use share option plans for the purpose of employee remuneration, but the scope of the standard is much broader than this. A share-based payment arrangement only requires the exchange of equity instruments, or cash amounts based on the value of these equity instruments, with another party in return for goods or services.
A common example of a share-based payment arrangement not between an employer and an employee is in cases where a shareholder of an entity (rather than the entity itself) grants shares to an employee of the entity. In such a scenario, the shareholder has transferred equity instruments of the entity to a party that has supplied services to the entity.
Unless it is clear that the transaction is a result of some other relationship between the shareholder and the employee that is unrelated to his employment, the award will be reflected as a share-based payment expense in the entity’s financial statements.
Do the accounting requirements apply to all types of transactions with employees?
No, a transaction with an employee is not within the scope of IFRS 2 if:
- It is not related to the receipt of goods or services; or
- The amount paid to the employee is not based on the market price of that entity’s equity instruments.
Are all share-based payments accounted for in the same manner?
No, there are three types of share-based payment arrangements:
- Equity-settled share-based payments – transactions in which the entity (a) receives goods or services as consideration for its own equity instruments (including shares or share options); or (b) receives goods or services but has no obligation to settle the transaction with the supplier.
- Cash-settled share-based payments – transactions 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.
- Choice of settlement – transactions in which the entity receives or acquires goods or services, and the terms of the arrangement provide either the entity or the supplier of those goods or services with a choice of whether the entity settles the transaction in cash (or other assets) or by issuing equity instruments. A number of other considerations apply in determining classification in these cases.
The measurement of a share-based payment expense depends on how the arrangement is classified. Correct classification is critical to determining the appropriate accounting and understanding the impact of share-based payments on an entity’s financial statements.
I like the idea of increasing employee loyalty with share-based payments. Are there accounting complications I need to be aware of?
Accounting for share-based payment arrangements may prove challenging in practice because almost no two share-based payment arrangements are the same. Management needs to understand the conditions of the share-based payments with employees and other parties to properly apply the guidance in IFRS 2.
Management must determine the fair value of a share-based payment at the grant date, the period over which this fair value should be recognised (the vesting period), and the charge that should be recognised in each reporting period.
The goods or services received or acquired in a share-based payment are recognised when the goods are obtained or as the services are received. A corresponding increase in equity is recognised if the goods or services are received in an equity-settled transaction. A liability is recognised if the goods or services are acquired in a cash-settled transaction.
Fair value changes over time. Must these changes be reflected in the company’s income statement?
This depends on the classification of the share-based payment. However, the initial measurement of the fair value of the share-based payment is at the grant date. The grant date is the date that the entity and the counterparty have a shared understanding of the terms and conditions of the arrangement and all required approvals have been obtained.
In some cases, the grant date might occur after the employees have begun rendering services.
How are share-based payments measured?
The fair value of goods or services received in exchange for a share-based payment is measured directly unless the fair value cannot be estimated reliably. In this case, the fair value is measured by reference to the fair value of the equity instruments granted as consideration. Services provided by employees are always measured by reference to the fair value of the equity instruments granted.
The measurement date for equity settled share-based payments depends on the other party to the transaction. For example, if the share-based payment is between the entity and:
- Employees or others providing similar services, the expense is measured at fair value at the grant date;
- Parties other than employees (and those providing similar services), the measurement date is the date that the entity obtains the goods or the counterparty render the service
For cash-settled share-based payments, the goods or services acquired and the liability incurred is measured at the fair value of the liability. Only cash-settled awards are subsequently re-measured.
A number of assumptions and valuation methods are used when calculating the fair value of a share-based payment.
When does an entity recognise the cost of a share-based payment scheme in its income statement?
IFRS 2 requires the expense to be recognised on the date that services are provided. Typically, it will be a question of fact as to when this occurs but, as in the case of employee services, it will not always be obvious, as explained below.
Vesting conditions affect the measurement and recognition of a share-based payment.
IFRS 2 defines vesting conditions as the criteria that 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. Vesting conditions include:
- Service conditions, which require the other party (such as an employee) to complete a specified period of service; and
- Performance conditions, which require that specified performance conditions are met before the counterparty becomes entitled to the grant. Performance conditions can be market-based (such as those that relate to the market price of the entity’s equity) or non-market-based (such as those that relate to the entity’s profit).
Other conditions attached to the award are referred to as non-vesting conditions.
The vesting period is the period during which all the specified vesting conditions of a share-based payment are to be satisfied. The services are accounted for as they are rendered by the counterparty during the vesting period. The expense is recognised over the vesting period with a corresponding increase in either equity or a liability.
Would there be accounting implications if the scheme is modified?
Entities may find the share-based payment requirements around modifications, cancellations and forfeitures to be counter-intuitive. Management have often been surprised by the accounting result.
When a share-based payment is modified, management should determine whether the modification:
- Affects the fair value of the instruments granted;
- Affects the number of equity instruments granted; or
- Is otherwise beneficial to the employee.
The effect of the modification on the company’s accounting on the result of this determination.
Does anything change if the awards are granted by the group’s parent company directly to the subsidiary’s employees?
In group share-based payment transactions, the entity receiving the goods or services should account for awards as equity-settled when:
- the awards granted are the entity’s own equity instruments; or
- the entity has no obligation to settle the share-based payment transaction.
In all other situations, the entity receiving the goods or services should account for the award as cash settled.
An example of a typical group scheme award is when the group awards shares in the parent entity to employees in its subsidiary. In such scenario, it is the parent entity that has the obligation to deliver the shares.
In the consolidated financial statements, on the assumption that the arrangement is equity-settled, the transaction is treated as an equity-settled share-based payment, as the group has received services in consideration for the group’s equity instruments. An expense is recognised in the group income statement for the grant date fair value of the share-based payment over the vesting period, with a credit recognised in equity.
In the subsidiaries’ financial statements, the award is treated as an equity-settled share-based payment. An expense for the grant date fair value of the award is recognised over the vesting period, with a credit recognised in equity. The credit to equity is treated as a capital contribution, as the parent is compensating the subsidiaries’ employees with no cost to the subsidiaries.
In the parent’s separate financial statements, there is no share-based payment charge, as no employees are providing services to the parent. The parent would therefore record a debit, recognising an increase in the investment in the subsidiaries as a capital contribution from the parent and a credit to equity.
Different considerations apply should the parent request compensation from its subsidiary.
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