Share-based payment

Supplementary reading

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1 Background to IFRS 2
It has become increasingly common for entities to pay for goods or services by issuing shares or
share options. Share schemes are a common feature of director and executive remuneration.
Companies whose shares or share options are regarded as a valuable 'currency' commonly use
share-based payments to obtain employee and professional services.
The increasing use of share-based payments raised questions about the accounting treatment of such
transactions in the financial statements.
Share options are often granted to employees at an exercise price that is equal to or higher than the
market price of the shares at the date the option is granted. Consequently, the options have no
intrinsic value and so prior to IFRS 2 Share-based Payment, no transaction was recorded in the
financial statements.
That led to an anomaly: if a company pays its employees in cash, an expense is recognised in profit
or loss, but if the payment is in share options, no expense is recognised. The omission of expenses
arising from share-based payment transactions with employees was believed to cause economic
distortions and corporate governance concerns.
IFRS 2 was issued to address these issues and requires an entity to reflect the effects of share-based
payment transactions in its financial statements.

1.1 Arguments against recognition of share-based payment in the

financial statements
There are a number of arguments against recognition of share-based payments in the financial
statements. The IASB has considered and rejected the arguments below.
(a) No cost therefore no charge
There is no cost to the entity because the granting of shares or options does not require the
entity to sacrifice cash or other assets. Therefore, a charge should not be recognised.
This argument is unsound because it ignores the fact that a transaction has occurred. The
employees have provided valuable services to the entity in return for valuable shares or
options.
(b) Earnings per share is hit twice
It is argued that the charge to profit or loss for the employee services consumed reduces the
entity's earnings, while at the same time there is an increase in the number of shares issued.
However, the dual impact on earnings per share simply reflects the two economic events that
have occurred.
(i) The entity has issued shares or options, thus increasing the denominator of the earnings
per share calculation.
(ii) It has also consumed the resources it received for those shares or options, thus reducing
the numerator.
(c) Adverse economic consequences
It could be argued that entities might be discouraged from introducing or continuing employee
share plans if they were required to recognise them on the financial statements. However, if
this happened, it might be because the requirement for entities to account properly for
employee share plans had revealed the economic consequences of such plans.
A situation where entities are able to obtain and consume resources by issuing valuable shares
or options without having to account for such transactions could be perceived as a distortion.

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2 Scope of IFRS 2
IFRS 2 applies to all share-based payment transactions (IFRS 2: para. 2).
IFRS 2 was amended in June 2009 to address situations in those parts of the world where, for public
policy or other reasons, companies give their shares or rights to shares to individuals, organisations
or groups that have not provided goods or services to the company. An example is the issue of
shares to a charitable organisation for less than fair value, where the benefits are less tangible than
usual goods or services.
(IFRS 2: paras. 1–6)

2.1 Share-based payment among group entities

Payment for goods or services received by an entity within a group may be made in the form of
granting equity instruments of the parent company, or equity instruments of another group company.
IFRS 2 states that this type of transaction qualifies as a share-based payment transaction within the
scope of IFRS 2.
In 2009, the standard was amended to clarify that it applies to the following arrangements:
(a) Where the entity's suppliers (including employees) will receive cash payments that are linked
to the price of the equity instruments of the entity.
(b) Where the entity's suppliers (including employees) will receive cash payments that are linked
to the price of the equity instruments of the entity's parent.
Under either arrangement, the entity's parent had an obligation to make the required cash payments
to the entity's suppliers. The entity itself did not have any obligation to make such payments. IFRS 2
applies to arrangements such as those described above even if the entity that receives goods or
services from its suppliers has no obligation to make the required share-based cash payments.

2.2 Transactions outside the scope of IFRS 2

Certain transactions are outside the scope of the IFRS:
(a) Transactions with employees and others in their capacity as a holder of equity instruments of
the entity (for example, where an employee receives additional shares in a rights issue to all
shareholders)
(b) The issue of equity instruments in exchange for control of another entity in a business
combination

3 Equity-settled share-based payment – further practice

Activity 1: Share options

During its financial year ended 31 January 20X6, an entity issued share options to several of its
senior employees. The options vest immediately upon issue.
What is the double entry required to recognise the options?

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Activity 2: Share-based payment

On 1 January 20X3 an entity grants 250 share options to each of its 200 employees. The only
condition attached to the grant is that the employees should continue to work for the entity until
31 December 20X6. Five employees leave during the year and management estimates that a total of
20 employees will leave during the 4 year vesting period.
The market price of each option was $12 at 1 January 20X3 and $15 at 31 December 20X3.
Required
Explain how this transaction will be reflected in the financial statements for the year ended
31 December 20X3.

4 Equity-settled compared to cash-settled share-based

payment
The following illustration shows the differences in accounting for an equity-settled transaction and a
cash-settled transaction.

Illustration 1
Share-based payment
J&B granted 200 options on its $1 ordinary shares to each of its 800 employees on 1 January
20X1. Each grant is conditional upon the employee being employed by J&B until 31 December 20X3.
J&B estimated at 1 January 20X1 that:
(i) The fair value of each option was $4 (before adjustment for the possibility of forfeiture).
(ii) Approximately 50 employees would leave during 20X1, 40 during 20X2 and 30 during 20X3
thereby forfeiting their rights to receive the options. The departures were expected to be evenly
spread within each year.
The exercise price of the options was $1.50 and the market value of a J&B share on 1 January 20X1
was $3.
In the event, only 40 employees left during 20X1 (and the estimate of total departures was revised
down to 95 at 31 December 20X1), 20 during 20X2 (and the estimate of total departures was
revised to 70 at 31 December 20X2) and none during 20X3, spread evenly during each year.
Required
The directors of J&B have asked you to illustrate how the scheme is accounted for under IFRS 2
Share-based Payment.
(a) Show the double entries for the charge to profit or loss for employee services over the three
years and for the share issue, assuming all employees entitled to benefit from the scheme
exercised their rights and the shares were issued on 31 December 20X3.
(b) Explain how your solution would differ had J&B offered its employees cash based on the share
value rather than share options.

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Solution
(a) Accounting entries
31.12.X1 $ $
DEBIT Profit or loss (staff costs) 188,000
CREDIT Equity reserve ((800 – 95)  200  $4  1/3) 188,000
31.12.X2
DEBIT Profit or loss (staff costs) (W1) 201,333
CREDIT Equity reserve 201,333
31.12.X3
DEBIT Profit or loss (staff costs) (W2) 202,667
CREDIT Equity reserve 202,667
Issue of shares
DEBIT Cash (740  200  $1.50) 222,000
DEBIT Equity reserve 592,000
CREDIT Share capital (740  200  $1) 148,000
CREDIT Share premium (balancing figure) 666,000
Workings
1 Equity reserve at 31.12.X2
£$
Equity b/d 188,000
 P/L charge 201,333
Equity c/d ((800 – 70)  200  $4  2/3) 389,333

2 Equity reserve at 31.12.X3

Equity b/d 389,333
 P/L charge 202,667
Equity c/d ((800 – 40 – 20)  200  $4  3/3) 592,000

(b) Cash-settled share-based payment

If J&B had offered cash payments based on the value of the shares at vesting date rather than
options, in each of the three years an accrual would be shown in the statement of financial
position representing the expected amount payable based on the following:
No of  Number of  Fair value of  Cumulative
employees rights each each right at proportion of
estimated at year end vesting period
the year end elapsed
to be entitled
to rights at the
vesting date

The movement in the accrual would be charged to profit or loss representing further entitlements
received during the year and adjustments to expectations accrued in previous years.
The accrual would continue to be adjusted (resulting in a profit or loss charge) for changes in
the fair value of the right over the period between when the rights become fully vested and are
subsequently exercised. It would then be reduced for cash payments as the rights are exercised.

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5 Vesting conditions – further practice

Activity 3: Vesting conditions

On 1 October 20X1 Omega granted share options to 200 senior executives. The options will vest on
30 September 20X4 subject to the following conditions:
 Each executive will be entitled to 1,000 options if the cumulative profit in the three-year period
from 1 October 20X1 to 30 September 20X4 exceeds $30m. If the cumulative profit for this
period is between $35m and $40m, then 1,500 options will vest. If the cumulative profit for
the period exceeds $40m, then 2,000 options will vest.
 If an executive leaves during the three-year vesting period, then that executive would forfeit
any rights to share options.
 Notwithstanding the above, no options will vest unless the share price at 30 September 20X4
exceeds $5.
Details of the fair values of the shares and share options at relevant dates are as follows:
Fair value of
Date Omega share Option
$ $
1 October 20X1 4.00 0.50
30 September 20X2 4.40 0.60
30 September 20X3 4.60 0.75
The estimate of the cumulative profit for the three-year period ending 30 September 20X4 was
revised each year as follows:
Expected profit
for the three-year period
Date $m
1 October 20X1 32
30 September 20X2 39
30 September 20X3 45
On 1 October 20X1, none of the relevant executives were expected to leave in the three-year period
from 1 October 20X1 to 30 September 20X4 and none left in the year ended 30 September 20X2.
However, ten executives left unexpectedly on 30 June 20X3. None of the other executives are
expected to leave before 30 September 20X4.
Required
Prepare relevant extracts from the statement of financial position of Omega at 30 September 20X3
and its statement of profit or loss and other comprehensive income for the year ended 30 September
20X3. You should give appropriate explanations to support your extracts.

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Activity answers

Activity 1: Share options

DEBIT Profit or loss
CREDIT Equity
Under IFRS 2 a charge must be made to profit or loss.

Activity 2: Share-based payment 1

The remuneration expense for the year is based on the fair value of the options granted at the grant
date (1 January 20X3). Management estimates that 20 employees will leave during the 4 year
vesting period and that therefore 45,000 options (250 × 180) will actually vest.
Therefore, at 31 December 20X3 the entity recognises a remuneration expense of $135,000
(45,000 × 12 × ¼) in profit or loss and a corresponding increase in equity of the same amount.

Activity 3: Vesting conditions

STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE YEAR
ENDED 30 SEPTEMBER 20X3 (Extract)
Employee expense $76,667
STATEMENT OF FINANCIAL POSITION AT 30 SEPTEMBER 20X3 (Extract)
Equity (IFRS 2 reserve) $126,667
Explanation
The impact of the expected share price is a market-based vesting condition and is ignored in
calculating the IFRS 2 expense. The grant date fair value of the options is used in the calculation. The
number of options vesting for each executive is dependent on the expected cumulative profit over the
three year period. This is a non-market based performance condition and is taken into account in the
calculation of the IFRS 2 expense. At 30 September 20X2, the expected cumulative profit is $39m,
so 1,500 options per director are expected to vest. At 30 September 20X3, the expected cumulative
profit is increased to $45m, so 2,000 options per director are expected to vest. The expense should
be spread over the 3 year vesting period and be based on the latest estimate of the number of
directors expected to be in employment on the vesting date.
The calculations are as follows:

At 30 September 20X2 (year 1) $

Equity b/d 0
 Profit or loss expense 50,000
Equity c/d (200  1,500  $0.50  1/3) 50,000

At 30 September 20X3 (year 2) $

Equity b/d 50,000
 Profit or loss expense 76,667
Equity c/d (190  2,000  $0.50  2/3) 126,667

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