Shared-based payments
This article covers a key IFRS® Accounting Standard: IFRS 2 Share-based Payment. It looks at the following issues:
- equity-settled share-based payments
- cash-settled share-based payments
- share-based payments with a choice of settlement, and
- share-based payments and deferred tax.
Equity-settled share-based payments
Definition
An equity-settled share-based payment transaction is where an entity receives goods or services and pays for these using its own equity instruments, such as shares or share options.
Share options give the holder the right to subscribe to the entity’s equity shares at a fixed or determinable price. Share options are typically priced so that the holder will pay a lower amount per share than the current market price.
Measurement
There are two ways of measuring an equity-settled share-based payment:
- at the fair value of the goods or services received; or
- if the fair value of the goods or services received cannot be estimated reliably, then at the fair value of equity instruments granted.
It is not normally possible to estimate the fair value of the services provided to an entity by its employees. Therefore, share-based payments with employees are measured using the fair value of the equity instruments granted.
Recognition
The recognition of share-based payment transactions is dependent on whether there are vesting conditions.
If there are no conditions attached to the arrangement, then the instruments vest immediately. In this case, the entity recognises the goods or services received in full.
However, many share-based payments specify ‘vesting conditions’ which must be met before the counterparty is entitled to the awards. For example, in transactions with employees, there are often service conditions attached to share-based payment arrangements. These typically specify that the employees must complete a set number of years of service before becoming entitled to the shares or share options. In these cases, the transaction is accounted for, with a corresponding increase to equity, over the vesting period (the period over which vesting conditions are to be satisfied).
Vesting conditions, other than market conditions (see below), are taken into account by adjusting the number of equity instruments included in the measurement of the transaction. This should be based on the best estimate of the number of equity instruments expected to vest, with the estimate being revised as more information becomes available.
A market condition is a vesting condition which is dependent on the market price of the entity’s equity instruments, such as the attainment of a specified share price. Market conditions are taken into account when estimating the fair value of the shares or share options at the measurement date. As such, a share-based payment transaction with a market condition is recognised irrespective of whether the market condition is, or is expected to be, satisfied.
| EXAMPLE 1 On 1 January 20X5, Tribula Co (Tribula) buys a new head office building with a fair value of $30 million. The consideration transferred for the building was 20 million of Tribula’s $1 ordinary equity shares. On 1 January 20X5, the shares had a fair value of $1.50 each. The building has an estimated useful life of 40 years. Requirement Explain, with calculations and in accordance with IFRS 2, how to account for the above transaction in Tribula’s financial statements for the year ended 31 December 20X5. Solution The transaction is an equity-settled share-based payment because Tribula is receiving a building in exchange for its own equity-shares. The fair value of the building can be measured reliably at $30 million. Therefore, the transaction is measured at $30 million. In this situation, the fair value of Tribula’s own equity shares is irrelevant. There are no vesting conditions and so the transaction is recognised immediately. The building is a head office and so will be recognised as property, plant and equipment at its fair value of $30 million. A corresponding credit is posted to equity:
The building will be depreciated over its useful life of 40 years. This will give rise to a depreciation charge of $0.75 million ($30m/40 years) in the operating category of the statement of profit or loss for the year ended 31 December 20X5.
At the reporting date, the building has a carrying amount of $29.25 million ($30m - $0.75m). |
EXAMPLE 2
On 1 January 20X5, Heaphy Co (Heaphy) granted 1,000 share options to each of its 9,000 employees. The share options will vest if the employees still work for Heaphy on 31 December 20X7, and if Heaphy’s share price on that date exceeds $7 per share.
Of the eligible employees, 230 had left the company by 31 December 20X5. It was estimated that another 480 employees will leave prior to 31 December 20X7.
The fair value of a share option was as follows:
| $ | |
| 1 January 20X5 | 4.20 |
| 31 December 20X5 | 3.90 |
Heaphy’s share price on 31 December 20X5 was $6. The directors believed it was unlikely that the share price target would be met.
Requirement
Explain, with calculations and in accordance with IFRS 2, how to account for the above transaction in Heaphy’s financial statements for the year ended 31 December 20X5.
Solution
The transaction is an equity-settled share-based payment because Heaphy is receiving employee services in exchange for its own share options.
The fair value of the employee services received cannot be measured reliably and so the transaction should be measured using the fair value of the share options at the grant date. This is $4.20 per option.
The cost of the scheme should be recognised as an expense over the three-year vesting period. The expense should be based on the number of options expected to vest. The vesting condition based on the share price target is a market-based vesting condition, meaning that is has already been taken into account when measuring the fair value of the share options at the grant date, and so an expense is recognised irrespective of whether the market-based condition is expected to be met.
The expense to be recognised in the current year is calculated as follows:
(9,000 – 230 – 480 employees) x 1,000 share options x $4.20 x 1/3 = $11,606,000
This expense will be recognised in the operating category of the statement of profit or loss. A corresponding credit will be recognised in equity:
| Dr Operating expenses | $11.6m | |
| Cr Other components of equity | $11.6m |
Cash-settled share-based payments
A common form of cash-settled share-based payment is a share appreciation right (SAR). With a SAR, an employee or a supplier is entitled to a cash payment based on the increase in the entity’s share price.
Unlike with equity-settled share-based payment transactions, the entity does not recognise any accounting entries in equity. Instead, the credit entry is posted to liabilities. This is because the entity has an obligation to pay cash to the counterparty.
For cash‑settled share‑based payment transactions, the entity measures the fair value of the liability at the end of each reporting period and at the date of settlement, with any changes in fair value recognised in profit or loss for the period.
The entity recognises the services received, and a liability to pay for those services, over the period in which the employees provide that service. In other words, and in line with the principles for equity-settled share-based payments, the expense and the liability are recognised over any vesting period.
EXAMPLE 3
On 1 July 20X5, Pilau Co (Pilau) granted 2,000 share appreciation rights (SARs) to each of its 12,000 employees. The SARs entitle the holders to a cash payment based on Pilau’s share price. The SARs will vest if the employees still work for Pilau on 30 June 20X7.
As at 31 December 20X5, it was expected that 15% of the employees would leave prior to the vesting date.
The fair value of a SAR was as follows:
| $ | |
| 1 July 20X5 | 1.40 |
| 31 December 20X5 | 2.10 |
Requirement
Explain, with calculations and in accordance with IFRS 2, how to account for the above transaction in Pilau’s financial statements for the year ended 31 December 20X5.
Solution
The SARs are a cash-settled share-based payment because the holders are entitled to a cash payment based on Pilau’s share price. As a result, the liability should be measured at the reporting date of 31 December 20X5, using the fair value per SAR of $2.10.
The expense should be spread over the two-year vesting period. The SARs were granted on 1 July 20X5, so only six months’ worth of expense should be recognised in the current financial year. This is calculated as follows:
(12,000 employees x 85%) x 2,000 SARs x $2.10 x 6/24 = $10,710,000
The expense will be recognised in the operating category of the statement of profit or loss. A corresponding credit will be recognised in non-current liabilities.
| Dr Operating expenses | $10.7m | |
| Cr Liabilities | $10.7m |
Choice of settlement
If an entity grants instruments which allow the employee or supplier to choose whether to take settlement in cash or in the form of equity instruments, then the entity has granted a compound financial instrument. This means that there is a debt component (the obligation to pay cash) and an equity component (the counterparty’s right to receive a fixed number of shares).
If the fair value of the goods or services received can be measured reliably (ie the transaction is not with employees), then the equity component is measured as the difference between:
- The fair value of the goods or services received, and
- The fair value of the debt component at the date the goods or services are received.
| EXAMPLE 4 On 31 December 20X5, Sator Co (Sator) purchases an investment property with a fair value of $1 million. It pays for this by issuing an instrument which allows the counterparty to receive 400,000 of Sator’s equity shares on 31 December 20X6, or cash to the value of 350,000 of Sator’s equity shares on 31 December 20X6. On 31 December 20X5, the fair value of the cash alternative is $950,000. On 31 December 20X6, the fair value of the cash alternative is $1,100,000. The supplier chooses to take the cash payment. Requirement Explain, with calculations and in accordance with IFRS 2, how to account for the above transaction in Sator’s financial statements for the years ended 31 December 20X5 and 31 December 20X6. Solution The share-based payment is a compound instrument because Sator has an obligation to issue cash and the counterparty has the right to receive a fixed number of equity shares. The fair value of the building can be measured reliability. Therefore, the equity component is measured as the difference between the fair value of the building, which is $1 million, and the fair value of the debt component at the date the building was received by Sator, which is $950,000. Therefore, the equity component is $50,000. The accounting entry required on 31 December 20X5 is:
Until settlement, the liability component must be remeasured to fair value at each reporting date. At 31 December 20X6, the liability must be remeasured to $1,100,000. This will give rise to an expense of $150,000 in the operating category of the statement of profit or loss. The accounting entry required is:
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If the fair value of the goods or services received cannot be measured reliability (ie the transaction is with employees), then the fair value of the liability component and the fair value of the equity component must be measured separately.
The equity component is measured as the difference between the fair value of the equity-settlement at the grant date and the fair value of the cash-settlement at the grant date. This is recognised as the entity receives the goods or services over the vesting period.
The liability component is measured and recognised in accordance with the requirements relating to cash-settled share-based payments.
| EXAMPLE 5 On 1 January 20X5, Upcall Co (Upcall) grants its chief executive officer (CEO) the right to choose 500,000 equity shares or cash equal to the value of 400,000 equity shares. This is conditional upon the CEO completing two further years of service. At the grant date, Upcall’s share price was $3.50. At 31 December 20X5, the share price was $3.90. As a result of restrictions on the equity shares, the fair value of the share alternative was $3.30 at the grant date. Requirement Explain, with calculations and in accordance with IFRS 2, how to account for the above transaction in Upcall’s financial statements for the year ended 31 December 20X5. Solution The share-based payment is a compound instrument because Upcall has an obligation to issue cash and the CEO has the right to receive a fixed number of equity shares. The equity component is measured as the difference between the fair value of the equity-settlement at the grant date and the fair value of the cash-settlement at the grant date. The fair value of the equity component is $1,650,000 (500,000 x $3.30). The fair value of the cash alternative is $1,400,000 (400,000 x $3.50). The equity component is therefore $250,000 ($1,650,000 - $1,400,000). The equity component is recognised over the two-year vesting period. Therefore, the amount recognised in the year ended 31 December 20X5 is $125,000 ($250,000 x 1/2). The liability component is measured and recognised in accordance with the requirements relating to cash-settled share-based payments. This means that the fair value of the liability is measured at the reporting date, and that the amount is recognised over the two-year vesting period. This amounts to $780,000 (400,000 x $3.90 x 1/2) at 31 December 20X5. The accounting entry required is:
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Deferred tax
In some jurisdictions, the amount and timing of tax deductions relating to equity-settled share-based payment schemes with employees may differ from the amount and timing of any expense recognised in accordance with IFRS 2.
IAS 12 Income Taxes states that the difference between the tax base of the employee services received to date and the carrying amount of nil is a deductible temporary difference. As such, a deferred tax asset should be recognised.
If the amount of the estimated future tax deduction exceeds the cumulative share-based payment expense, this indicates that the tax deduction relates not only to a remuneration expense but also to an equity item. In this situation, the excess of the associated deferred tax is recognised directly in equity.
| EXAMPLE 6 On 1 January 20X5, Phaver Co (Phaver) granted 10,000 share options to 1,200 employees. The share options will vest if the employees complete three further years of service. The fair value of each share option at the grant date was $2.50. The exercise price was $1.00. At 31 December 20X5, it was estimated that 90% of the employees would satisfy the vesting conditions. Phaver’s share price at this date was $4.20. In Phaver’s jurisdiction, a tax deduction arises when the options are exercised, and the deduction is based on the options’ intrinsic value at exercise date. Intrinsic value is the difference between the share price and the exercise price of the options. The tax rate is 20%. Requirement Explain, with calculations, how to account for the above transaction in Phaver’s financial statements for the year ended 31 December 20X5. This is an equity-settled share-based payment with employees. In accordance with IFRS 2, the expense is measured using the $2.50 fair value of an option at the grant date. The expense is calculated based on the estimated number of options which will vest and is spread over the three-year vesting period. This is calculated as follows: (1,200 employees x 90%) x 10,000 options x $2.50 x 1/3 = $9,000,000 This expense will be recognised in the operating category of the statement of profit or loss. A corresponding credit will be recognised in equity:
For tax purposes, a tax deduction is not provided until the exercise date. This is based on the intrinsic value, which is $3.20 ($4.20 - $1.00) at the reporting date. The tax base of the employee service received to date is calculated as follows: (1,200 employees x 90%) x 10,000 options x $3.20 intrinsic value x 1/3 = $11,520,000 The carrying amount of the employee service received to date is nil, so this creates a deductible temporary difference of $11,520,000. A deferred tax asset should be recognised for $2,304,000 ($11,520,000 x 20%). The estimated tax deduction of $11,520,000 exceeds the cumulative expense recognised of $9,000,000. The excess of $2,520,000 ($11,520,000 - $9,000,000) is deemed to relate to an equity item, and so the related deferred tax should also be recognised in equity. Therefore, the accounting entry to account for the deferred tax asset is as follows:
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Conclusion
This article has been written to help candidates to understand the accounting principles relating to share-based payments, as well as some of the ways in which these principles might feature in the SBR exam. The article is not exhaustive, and candidates should use it in preparation with their other study resources.
