|
Pages: 5 pages
Issued: April 2010
Author: Process Knowhow
Email us at service@processknowhow.com if you require further information
Free download at the end of this page - 'IFRS in your pocket 2009' by Deloitte. This provides further information on IFRS 2 and other financial reporting standards."
What are share based payments
The transactions around share incentive schemes such as the granting, vesting, forfeiture and exercise of options or conditional share awards are generally referred to as share based payment transactions. The accounting treatment for these transactions in the financial statements of an entity is primarily governed by international financial reporting standard IFRS 2 with which UK companies comply.
IFRS 2 covers share based payment arrangements with employee and non-employee third parties. Broadly, a share based payment arrangement involves an agreement under which an entity acquires goods or services that are rendered by a counterparty either:
- for consideration consisting of equity instruments of the entity (including shares or share options), or
- where the amount of consideration is based on the price of the entity’s shares or other equity instruments of the entity.
An example of the latter is cash-settled Share Appreciation Rights (SARs) which are also sometimes referred to as ‘phantom option schemes’.
General treatment in the financial statements
The general principle of IFRS 2 is that an entity should recognise in its financial statements the fair value of goods and services as they are received based on the fair value measured as at the date the goods or services are received. Typically, this entails an annual or periodic charge being made to the profit and loss account for the value of the goods and services consumed. This charge is known as the IFRS 2 expense. In some cases, where accounting standards permit, the expense is capitalised and recognised as an asset in the balance sheet.
When the fair value of goods or services rendered is uncertain then measurement is made indirectly by reference to the fair value of the equity instruments granted. The default position is that measurement is made as at the date the entity receives the relevant goods or services.
A credit balance needs to be recognised in the financial statements to balance the IFRS 2 expense. This credit is recognised:
- as an increase of equity reserves, in the case of goods and services being acquired using equity of the entity, or
- as an increase of liabilities if the goods or services are settled with a cash amount that depends on the price of the entity’s shares.
The share based payments credit balance typically accumulates over several accounting periods and is released at the time of settling the arrangement.
Vesting conditions and vesting
A share-based payment arrangement vests on the date when the counterparty becomes entitled to receive cash, other assets, or equity instruments of the entity. This requires all the vesting conditions specified under the arrangement to be satisfied. The vesting period is the period during which all the specified vesting conditions are to be satisfied.
IFRS 2 defines two types of vesting conditions, namely
- service conditions which require the counterparty to complete a specified period of service, and
- performance conditions which require specified performance targets to be met. Performance conditions are subdivided as
- market conditions such a requirement for the price of an entity’s shares to reach a target, and
- non-market conditions such as a requirement for the earnings of the entity to reach a target.
If a vesting condition is categorised as a market condition it can have a material impact on profit and loss. IFRS 2 defines that a market condition is: “a condition upon which the exercise price, vesting or exercisability of an equity instrument depends that is related to the market price of the entity’s equity instruments, such as attaining a specified share price or a specified amount of intrinsic value of a share option, or achieving a specified target that is based on the market price of the entity’s equity instruments relative to an index of market prices of equity instruments of other entities.”.
Non-market conditions are performance conditions that are not market conditions.
In addition there are non-vesting conditions which are terms of a share based payment arrangement requiring to be satisfied that are neither service nor performance conditions. Examples of non-vesting conditions where the entity does not receive a service in return for the conditions being satisfied are where an employee is required to make savings into a sharesave scheme or for a restraint of trade agreement with a former director.
Accounting for employee related share based payments
Equity settled share based payments
For employees (which for the purposes of IFRS 2 includes other parties who provide similar services to employees), share based incentives are normally granted to the employee by an entity or its shareholders in return for something of value such as continuous service of the employee or enhanced performance of the entity.
Typically, the fair value of services rendered by an employee can not be measured reliably. IFRS 2 requires that the fair value of services rendered by employees is measured indirectly by reference to the fair value of equity instruments granted, measured as at the grant date of the equity instruments.
The fair value of the equity instruments granted is calculated as the product of a multiplicand and a multiplier, namely
- (multiplicand) an estimate of the number of units of equity instruments that are expected to vest taking account of vesting conditions other than market conditions. The number of units expected to vest is re-estimated at the end of each accounting period and this is multiplied by
- (multiplier) the fair value of units of the equity instruments granted, measured at the date of grant. Where the fair value of units of the equity instruments can not be derived reliably based on the share price of the entity at the time of grant then it is calculated using an acceptable pricing method such as the Black-Scholes-Merton or Binomial Models or the Monte Carlo method. Significantly,
- the calculation of the unit fair value takes into account market conditions but does not take account of non-market or service conditions, and
- for equity settled transactions, the unit fair value is fixed at the time of granting even if calculations as at a later date would result in changes to the unit fair value.
The fair value of the equity instruments granted (the product of the multiplier and multiplicand) is accrued in the financial statement as the IFRS 2 expense over the period to vesting of the equity instruments granted. For accounting purposes, this is achieved by adjusting the accumulated share based payments credit balance in the balance sheet to the amount that would be expected taking account of the extent that services have been rendered by employees to date, with any difference being taken to profit and loss.
Cash settled share based payments
The treatment for cash-settled employee share-based payment arrangements is similar to equity settled arrangements but
- the share based payment credit balance is recognised as a liability in the balance share rather than within equity reserves, and
- the fair value of the liability and the goods or services acquired is re-measured as at each accounting reporting date with reference to the fair value of equity instruments for which the arrangement provides a cash substitute. The fair value is calculated by applying an option pricing model as would be done for an equity settled arrangement, taking into account the terms and conditions upon which awards are granted and the extent to which the employees have rendered service to date. Any changes in fair value are recognised in profit or loss for the period.
Consequences of different vesting conditions
For equity settled arrangements, only the multiplier (see above) takes account of market conditions and, once equity instruments have been granted, the multiplier is fixed. For example
- for share options with a market condition that in three years time the share price of the entity must grow by a set percentage and all other vesting conditions are achieved:
- a bullish forecast for share price growth of the entity at the time of granting might produce a high estimated fair value for the options. This estimate sets the IFRS 2 expense even if share prices subsequently fall and the options do not vest;
- a conservative forecast for share price growth at the time of granting might produce a low fair value estimate. If share prices rise faster than assumed and the options subsequently vest then the total IFRS 2 expense might be less than the final value of the options which are satisfied.
The multiplicand (see above) can vary as predictions are revised for the final outcomes of non-market and service conditions. For example
- for share options with a service condition that employees must remain in employment for a fixed period
- a higher assumption for the number of employees who would remain when options vest will increase the estimate for the number of options that are likely to need satisfying. The share based payment credit balance accumulated in the balance sheet would need to be recalculated to take account of the expected higher number of options to be satisfied. This which would result in an increased IFRS 2 expense.
- If more employees ceased to be employed than assumed this would cause the accumulated credit balance to be too great given the extent of services rendered to date. The excess credit would be released to profit and loss reducing the IFRS 2 expense.
Early termination of share based payment arrangements
Where vesting has not occurred, the general principle of IFRS 2 is that
- an arrangement can lapse because of failure to satisfy a vesting condition (other than a market condition that was specified at grant date). In this case, the grants made of equity instruments are forfeited and the number of equity instruments that vest is nil. The accumulated share based payment creditor is released immediately to profit and loss;
- an arrangement can be cancelled other than because of failure to satisfy a vesting condition (other than a market condition that was specified at grant date). In this case, the cancellation is treated as an acceleration of vesting. A charge is made immediately to profit and loss based on the number of equity instruments that would have vested had the cancellation not occurred. A cancellation by a counterparty is treated in the same way as a cancellation by the entity.
The detailed wording of share based incentive scheme terms needs to be examined to determine which accounting treatment applies when share based incentives are terminated. Based on the scheme wording and how the termination is implemented, the fair value of awards could be charged in full or fully reversed out of profit and loss.
IFRS 2 specifies treatments that apply when an existing share based payment arrangement is replaced with a new one. Care is needed with implementing the new arrangement to avoid the old one being treated as a cancelled with the resulting charge to profit and loss.
The treatment of non-vesting conditions varies depending upon the nature of the condition. Where conditions are similar to market vesting conditions they are considered when estimating the fair value of a share-based payment. Failure to satisfy some non-vesting conditions can be treated as a cancellation of an arrangement.
Balance sheet accounting
Equity settled share based payments
The accumulated credit balance accumulated in equity is disclosed within reserves in the financial statements. The exact disclosure depends on the accounting policies of the entity but typically a separately labelled reserved is used.
Settling a share based payment arrangement that has vested usually involves delivering shares to the counterparty. The general accounting treatment is to deduct the cost of the shares from equity reserves although the exact treatment depends on how the shares are delivered and the accounting policies for the entity. Common methods of providing a counterparty with shares include:
- allotment of new shares
- listed companies that qualify may buy their own shares in the market to hold as treasury shares and may use these to satisfy the exercise of share incentives
- the entity might establish an Employee Stock Option Plan (ESOP) trust or Employee Share Option Trust (ESOT) to buy and hold shares of the entity to be use for satisfying share incentive schemes
Any payment made to an employee on cancellation or settlement is accounted for as a repurchase of an equity interest (i.e. as a deduction from equity) except to the extent that the payment exceeds the fair value of the equity instrument granted, measured at the repurchase date. Any such excess is recognised as an expense in the profit and loss.
If vested equity instruments are repurchased from employees, the payment made is accounted for as a deduction from equity, except to the extent that the payment exceeds the fair value of the repurchased instruments, measured at the repurchase date. Any such excess is recognised as an expense in the profit and loss.
Cash settled share based payments
The share based payment liability is revalued to fair value at the settlement date and cash paid to the counterparty is treated as settlement of the liability.
Other disclosures in the financial statements
There is a significant number of technical disclosures required in the financial statements to help users understand the nature and extent of share based payment arrangements that existed during an accounting period.
Specific disclosures are required in the Directors Remuneration report which provides information on the share based and other incentives provided to directors.
Disclosures typically found in the notes to the financial statements include:
- a description of each type of share-based payment arrangement that existed at any time during the period, including the general terms and conditions such as the vesting requirements; the maximum term of options granted and the method of settlement (e.g. whether in cash or equity).
- the effect of share-based payment transactions on the profit or loss and financial position
- details on options granted during the year and information about any modifications made during the year to share-based payment arrangements
- information on how the fair value of the goods or services received, or of the fair value of the equity instruments granted, during the period was determined. This includes details of the valuation method used and the assumptions made in calculations.
- analysis of numbers and weighted average prices for share options split in various ways
- information on liabilities arising from share-based payment transactions
Click below to download 'IFRS in your pocket 2009' by Deloitte
|
