Does your company remunerate its top management by granting them own shares? Or, do employees receive bonuses based on the increase of the company’s share price?
Transactions whereby companies pay for the goods or services received by issuing shares or similar instruments are very common in these days.
In fact, their volume is rapidly increasing, because many people (including top management members) regard having shares of the company as very exclusive and rewarding.
To address the issue of share-based payment reporting, the standard IFRS 2 Share-based Payment was issued. Every other benefit paid to employees is reported in line with the standard IAS 19 Employee Benefits.
Why IFRS 2?
In the past, companies often did not reflect granting share options in their financial statements. Why?
For very simple reason: the options had no intrinsic value, so there was nothing to record in the financial statements.
And what happens in such a case?
If company paid its management by cash, the transaction was recorded as an expense. But if company paid its management by share options, nothing was recorded.
Therefore, standard IFRS 2 Share-based Payment is here to remove this inconsistency.
What is the objective of IFRS 2?
The objective of IFRS 2 Share-based payment is to specify the financial reporting by an entity when it undertakes a share-based payment transaction.
IFRS 2 requires an entity to reflect the effect of share-based payment transactions (including share options to employees) in its profit or loss and statement of financial position.
What is a share-based payment transaction?
Share-based payment transaction is a transaction in which the entity:
- receives goods or services from the supplier (including employee) in a share-based payment arrangement; or
- incurs an obligation to settle the transaction with the supplier in a share-based payment arrangement when another group entity receives those goods or services.
Share-based payment arrangement is an agreement between the entity and another party (including an employee) whereby the other party receives:
- 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.
This type of arrangement is cash-settled share-based payment transaction.
Alternatively, the other party can receive - equity instruments (including shares or share options) of the entity or another group entity.
This type is called equity-settled share-based payment.
If there are some specified vesting conditions, these must be met before receiving any share-based payment.
There’s also the third type of share-based payment arrangements: transactions in which either the entity or the supplier has a choice of settlement (to receive equity instruments or cash / other assets).
Vesting condition
Some share-based payment transactions include vesting conditions that must be met before any payment is made.
IFRS 2 recognizes 2 types of vesting conditions:
- Service conditions:they require the counterparty to complete a specified period or service;
- Performance conditions: they require the counterparty to complete a specified period of services AND specified performance targets to be met.
A performance condition might include a market condition that is linked to the market price of shares in some way, for example, vesting might depend on achieving a minimum increase in the share price of the entity.
How to recognize share-based payments
The basic recognition principle is to recognize goods or services received in a share-based payment transaction when the goods are obtained or as the services are received.
Goods or services acquired should be recognized as expenses in profit or loss unless they qualify for recognition as assets. That’s the debit side of an accounting entry.
The credit side depends on the type of share-based payment arrangement:
- If the goods or services were acquired in an equity-settled share-based payment transaction, then the corresponding increase is recognized in equity.
- If the goods or services were acquired in a cash-settled share-based payment transaction, then the corresponding increase is recognized as a liability.
Recognition of equity-settled share-based payment transactions
How to measure equity-settled share-based payment?
The key principle in IFRS 2 is to measure the amount of transaction at fair value of the goods or services received. This is relatively easy when the transaction is with parties other than employees.
However, sometimes (for example, when transaction is with employees), the fair value of goods or services received cannot be measured reliably. In such a case, the entity should measure their value by reference to fair value of the equity instruments granted.
And specifically for employees, the entity should measure the services received from employees at the grant date (not at the date of their receipt).
How to determine the fair value of equity instruments granted?
There’s a whole guidance on how to determine the fair value of equity instruments granted in IFRS 2 and IFRS 13 Fair Value Measurement, too.
Basically, when possible, the fair value should be based on the market prices if available. If not, then it is acceptable to use some valuation technique (for example, share option pricing model).
How to deal with vesting conditions?
Here, the principal question is whether vesting condition exists or not.
- NO: If the share-based payment IS vested immediately, or there are no vesting conditions, then IFRS 2 regards this transaction as granted in return for the supplier’s (employee’s) service in the past.
Therefore, an entity needs to recognize the services received immediately in full at the grant date, with the corresponding increase in equity. - YES: If the share-based payment DOES NOT vest until the counterparty meets some vesting conditions, then IFRS 2 regards this transaction as granted in return for the supplier’s (employee’s) service rendered during the vesting period.
In this case, an entity should recognize an amount for the goods or services received during the vesting period based on the best available estimate of the number of equity instruments expected to vest.
How to deal with changes?
Sometimes, an entity might change the terms of the share-based payment transaction.
Modification of the terms on which equity instruments were granted depends on the fair value of the new equity instruments:
- If the fair value of the new instruments is greater than the fair value of the old instruments, then the incremental amount is recognized over the remaining vesting period (or immediately if modification happens after the vesting period).
- If the fair value of the new instruments is lower than the fair value of the old instruments, the original fair value of the equity instruments granted should be expensed as if the modification never occurred.
If an entity cancels or settles the equity instruments, then it is recognized as an acceleration of the vesting period and any remaining unrecognized amount is recognized immediately.
Recognition of cash-settled share-based payment transactions
Typical examples of cash-settled share-based payment transactions are:
- Share appreciation rights: employee is entitled to the cash payment in the future based on the increase of entity’s share price over specified period of time from a specified level;
- Rights to redeemable shares: employee will receive the shares in the future that are redeemable in cash.
Similarly as in the equity-settled share-based payment transaction, the goods or services received are measured at the fair value of the liability.
The fair value of the liability has to be remeasured at each reporting date until this liability is settled and any changes of fair value are recognized in profit or loss.
Vesting conditions are treated in the similar manner as in the equity-settled share-based payment transactions.
Please watch the following video with the summary of IFRS 2 here:
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