Advanced Financial Accounting I

Chapter Two

Share-based Compensation
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Share-based Compensation
1. Overview of Share-based Payments
2. Share-based Payments Settled with Equity
3. Share-based Payments Settled with Cash
4. Share-based Payments with Cash Alternatives
5. Counterparty Has Choice of Settlement
6. Issuer Has Choice of Settlement
7. Share-based Payment Disclosures
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 Overview of Share-based Payments
Background
Historically, the range of specific requirements for the accounting for share-based
payments in national GAAPs has been diverse. Some countries have a relatively
long tradition of accounting for share-based payments.
Share-based payments were first observed in the 1960s, primarily in the US.
Consequently, the history of international requirements for the accounting for share-
based payments is relatively short compared with other areas of accounting.
The development phase of these requirements internationally was accompanied by
controversial discussions about whether the recognition of cost for share-based
payments that are settled in own equity instruments is justified at all – i.e. whether
such accounting would meet the objectives of financial reporting.

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 Background ……………con’t
• Some argued that transactions settled in equity are transactions between the
shareholders and the third party, rather than between the entity and the third
party.

• Some people still express concerns about accounting entries that result in a
debit to expense and a credit to equity.

• Previously, IAS 19 Employee Benefits contained disclosure requirements

for equity compensation issued to employees, but there were no recognition
or measurement requirements in IFRS for such transactions before the
publication of IFRS 2 Share-based Payment.
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 What is share-based compensation ??
• In simple words – payment based on shares or shares options.

• Share-based compensation also called Stock-based compensation or share-based payments

(SBP).
• It refers to the rewards given by the company to its employees by way of giving them the
equity ownership rights in the company with the motive of aligning the interest of the
management, shareholders, and the employees of the company.

• A ‘share-based payment’ is either a payment in equity instruments. Or

• A payment in cash or other assets.

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 What is Share-based Payment (compensation) ?

An agreement between the entity and another party (including

an employee) that entitles the other party to receive :

(a) equity instruments (including shares or share options) of

the entity or another group entity, provided the specified
vesting conditions, if any, are met.

(b) cash or other assets of the entity or by incurring liabilities for

amounts that are based on the price (or value) of equity
instruments of the entity.

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 Reasons for granting share-based payments
1. Principal-agent theory: To align the interests of principal and agent, or
shareholders and employees (including management), and to mitigate the conflict,
employees are granted share-based payments as part of their remuneration
package. In this way, both the employees and the shareholders participate in value
increases.
2. Reward for past services: Share-based payments are also granted for past
services – e.g. to acknowledge good services of an employee by giving them a
participation in the entity (e.g. free or discounted shares). In this case, the share-
based payment would be granted without the condition to provide future services.
3. Other reasons: Another important reason for granting equity-settled share-based
payments is to receive goods or services without affecting the entity’s liquidity.
This form of remuneration is often found in high-growth industries – e.g. the hi-
tech area. It is also used to preserve cash.
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 Share-based payment transactions include:

Grants to employees and others providing similar services,

e.g. non-executive directors.

Grants to non-employees, e.g. consultants, suppliers

Employee share purchase plans.

Certain share-based payments settled by an entity in, or an

external shareholder of, the same group.

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 Terminologies related to SBP

Grant date is the date at which the entity and the supplier agree to the SBP arrangement. It
is the date at which employees agree, shareholders approve, agreement is signed or
approval recorded in a company minute.

Vesting period is the period during which all the specified vesting conditions are to be
satisfied. It is the period during which commitment is required to enable exercise.

Vest means to become entitled to.

Exercise date is the date at which option turns into cash or share.
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 Terminologies related to SBP
• Vesting conditions determine whether the entity receives the services that entitle the
supplier to receive the SBP – they are service or performance (including market)
conditions.

• Vesting condition: term of employment or financial target achieved.

• Non-vesting conditions need to be satisfied for the supplier to become entitled to the
SBP.
Does the Condition determine whether the entity receives the services that
entitles the counterparty (supplier) to the share-based payments?
• If No – Non-vesting Condition
• If Yes – Vesting Condition i.e., Either Service Condition or
Performance Condition

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 Terminologies related to SBP
Fair Value * The amount for which an asset could be exchanged, a liability
settled, or an equity instrument granted could be exchanged, between
knowledgeable, willing parties in an arm’s length transaction.

Intrinsic value The difference between the fair value of the shares to which
the counterparty has the (conditional or unconditional) right to subscribe or
which it has the right to receive, and the price (if any) the counterparty is
(or will be) required to pay for those shares.
For example, a share option with an exercise price of Rs. 15, on a share with
a fair value of Rs. 20, has an intrinsic value of Rs. 5.
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 Terminologies related to SBP

• Equity instrument A contract that evidences a residual interest in

the assets of an entity after deducting all of its liabilities.

• Equity instrument granted The right (conditional/unconditional)

to an equity instrument of the entity conferred by the entity on
another party, under a share-based payment arrangement.

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 Measurement Date
The date at which the fair value of the equity instruments
granted is measured for the purposes of accounting.

For transactions with For transactions with parties

employees and others other than employees
providing similar services

Measurement Date is the

Measurement Date Is date on which the goods or
the grant Date with services are received or
reference to FV of equity acquired, with reference to
instrument – indirectly FV of goods or services -
directly
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 Three Types of Share based payment
Share-based payments
–(SBP)

Equity- Share-based
settled Cash-settled payments
share-based
share-based payments with cash
payments alternatives

Entity receives Entity receives Either entity or the

goods/services as goods/services by counterparty has a
consideration for incurring a liability to choice to settle in equity
instruments or in cash or
equity instruments. transfer cash or other
other assets.
assets to the supplier for
amounts that are based on
Equity
the price (or value) of the
entity’s shares.
Equity or
Liability
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Liability
1. Equity-settled share-based payment transactions
 For equity-settled share-based payment transactions, the entity shall
measure the goods or services received, and the corresponding
increase in equity, directly, at the fair value of the goods or services
received, unless that fair value cannot be estimated reliably.
 If the entity cannot estimate reliably the fair value of the goods or
services received, the entity shall measure their value, and the
corresponding increase in equity, indirectly, by reference to the fair
value of the equity instruments granted.

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 Example 1: Provision of goods by a supplier in
exchange for equity instruments
On 1 July 2011, Supplier X provides Reporting Entity Ltd with some inventory,
which has a fair value of $140 000. In exchange for the inventory, Reporting
Entity Ltd provides Supplier X with 10,000 shares in Reporting Entity Ltd

As it is considered that the fair value of the inventory can be determined

‘reliably’, this is deemed to be the value of the shares being issued. The
accounting entry would be:

Inventory 140, 000

Share capital 140, 000

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 Example 2 Share options for goods.
A company issues share options in order to pay for the purchase of inventory.
The share options were issued on June, 1, 2010. The inventory was eventually
sold on December, 3, 2012. The value of the inventory on June,1, 2010 was Br.
6 million and this value was unchanged up to the date of sale. The sale
proceeds were Br. 8 million. The shares issued have a market value of Br. 6.3
million.
Requirement: How will this transaction be dealt with in the financial
statements?
Solution: IFRS 2 states that the FV of the goods and services received should
be used to value the share options unless the FV of the goods cannot be
measured reliably.
Thus equity would be increased by Br. 6 million and inventory increased by
Br. 6 million. The inventory value Compiled
will by:beAshuexpensed
G. on sale.
Transactions with employees and others providing similar services
• FV of the services received are referred to the FV of the equity
granted, as it is not possible to estimate reliably the FV of the services
received.
• FV of equity should be measured at the grant date
• Typically, share options are granted to employees as part of their
remuneration package
• Usually, it is not possible to measure directly the services received for
particular components of the employee’s remuneration package
• It might also not be possible to measure the FV of the total
remuneration package independently without measuring directly the
FV of equity instruments granted.

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 Example: Share options for employee services

A company granted a total of 100 share options to 10 members of its executive

management team (10 options each) on 1 January 2012. These options vest at the end
of a three-year period. The company has determined that each option has a FV at the
date of grant equal to €15. The company expects that all 100 options will vest and
therefore records the following entry at 30 June 2012 (the end of its first six-month
interim reporting period).

Salaries……… €250
Equity …………250

[(100 x €15) / 6 periods = €250 per period]

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 Accounting for employee services received
Overview of conditions
♦ Conditions

− Vesting conditions are service related, i.e. they determine whether the
entity receives the services that entitle the counterparty to the share-based
payment.
− Service conditions; with or without …
− Performance conditions
» Market performance conditions or
non-market performance conditions
» Performance conditions by definition always require
a service condition

− Non-vesting conditions are not service related, i.e. they do not determine
whether the entity receives the services that entitle the counterparty to the
share-based payment

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 Accounting for employee services received (continued)
Overview of conditions
Vesting conditions

Service conditions Performance conditions

Market conditions Non-market conditions

Service condition Service condition

Requirement to complete a + +
specified period of service condition that is related condition that is a
to the market price of performance condition, but
the equity instrument not market price related
•Employee has to stay • Share price must • Revenue must increase by
employed for example , increase by 15%
10%
• TSR (total shareholder
for 3 three years after • Percentage increase in
return) must increase
grant date by 10% market share
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 Accounting for employee services received (continued)
Overview of conditions

Non-vesting conditions

Conditions that the

Conditions that the entity can choose to
Conditions that neither the
counterparty can meet
entity nor the counterparty
choose to meet
can choose to meet

• Inflation must not be higher • Holding participation • Continuation of the

than 5% shares over the holding plan by the entity
period.
• Price of gold must increase
• Paying monthly
by more than 3 %
contributions to a share
purchase plan.

Basically Not related

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AshuServices
G.
 Example : Share options with vesting conditions
A company grants 2,000 share options to each of its three directors on Jan, 1, 2012 subject to the
directors being employed on Dec, 31, 2014. The options vest on Dec,31, 2014. The FV of each
option on Jan,1, 2012 is €10 and it is anticipated that all of the share options will vest on Dec,31
2014.The options will only vest if the company’s share price reaches €14 per share. The price at
Dec,31, 2012 was €8 and it is not anticipated that it will rise over the next two years. It is
anticipated that there will only be two directors employed on Dec,31, 2014.

Requirement How will the share options be treated in the financial statements for the year ended
Dec,31, 2012?

Solution
The market based condition i.e. the increase in the share price can be ignored for the purpose of the
calculation. However, the employment condition must be taken into account. The options will be
treated as follows:

2,000 options x 2 directors x €10 x 1/3 years = €13,333. Equity will be increased by this amount
and an expense for the year ended Dec,31, 2012.

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 Equity-settled share-based payments
with non-employees
 Measured directly at the fair value of goods and services received
If the fair value of goods and services cannot be estimated reliably, measure
the fair value of equity instrument.
If the fair value of the equity instrument granted cannot be estimated reliably
(only in very rare cases), equity instruments are measured at their intrinsic
value.
 Measured at the date the goods or services are obtained
As opposed to grant date – in case of employees
Means “daily” if services are rendered
Simplification method: “regular intervals”
 Expense immediately (means no vesting conditions) unless
Goods or services qualify for capitalisation as asset (e.g. inventory); or
Vesting conditions exist
 Expense when services areCompiled
rendered over the vesting period
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 2. Cash-settled share-based payment transactions
A share-based payment transaction 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 the entity’s
shares or other equity instruments of the entity.

• The expense is the cash paid by the company.

• Goods and services acquired and liability incurred should be measured at the
FV of the liability.
• Until the liability is settled, the entity should re-measure the fair value of the
liability at each reporting date and at the date of settlement, with any changes in
fair value recognised.
• The services received, and the liability incurred, should be recognised as the
services are rendered. Compiled by: Ashu G.
 Example 1
Red plc. granted 300 share appreciation rights to each of its 500 employees on
Aug,1, 2012. Management believe that as at July, 31, 2013, Red plc’s year end,
80% of the awards will vest on July, 31 2014. The fair value of each share
appreciation right on July, 31, 2013 is €15.

Requirement.
What is the fair value of the liability to be recorded in the financial statements
for the year ended July, 31, 2013?

Solution
300 rights x 500 employees x 80% x €15 x 1year/2year = €900,000.

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 Example 2:
• On 1 July 2012 Coogee Ltd provides its managing director with a share-based incentive
according to which she is offered a bonus that is calculated as 200, 000 times the increase
in the fair value of the entity’s share price above $2.50. When the bonus was offered the
share price was $2.25.
• If the managing director does not leave the organisation the accrued entitlement will be
paid after three years. However, if she leaves the organisation the accrued entitlement will
be paid out upon departure—that is, the benefit will not be forfeited.
Other information
• The share price at 30 June 2013 is $3.00, at 30 June 2014 is $2.90, at 30 June 2015 is $4.10
and the managing director stays for three years and is paid the bonus on 1 July 2015.
REQUIRED
Prepare the journal entries that would appear in the accounting records of Coogee Ltd to
account for the issue of the share appreciation rights.
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 Solution
Year end Calculation Remuneration expense for period

30 June 2013 200, 000 × ($3.00 – $2.50) $100 000

30 June 2014 200, 000 × ($2.90 – $2.50) – $100 000 ($20 000)
30 June 2015 200, 000 × ($4.10 – $2.50) – $80 000 $240 000
30 June 2013 30 June 2015
Employee benefits expense …….100 000 Employee benefits expense ……….240 000
Accrued salaries payable ……….100 000 Accrued salaries payable …….240 000

30 June 2014 1 July 2016

Accrued salaries payable …………….20 000 Accrued salaries payable …….320 000
Employee benefits expense recouped (revenue) Bank …. …………….320 000
……….20 000

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3. Share-based payment transactions with cash
alternatives.
• Where the terms of the arrangement provide either the entity or the counterparty
with the choice of whether the entity settles the transaction in cash (or other assets)
or by issuing equity instruments.

• The entity should account for that transaction, or the components of that transaction,
as a cash-settled share-based payment transaction if, and to the extent that, the
entity has incurred a liability to settle in cash or other assets, or as an equity-settled
share-based payment transaction if, and to the extent that, no such liability has been
incurred.
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3.1. The counterparty has a choice of settlement

• Paragraphs IFRS 2.35-40 cover share-based payment transactions with cash

alternatives in which the terms of the arrangement provide the counterparty with a
choice of settlement.

• Such transactions are quite common in share-based payment arrangements with

employees.

• Entities need to recognize separate debt and equity components in such

transactions in accordance with requirements for cash settled and equity
settled share-based payment transactions, respectively.

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 Transaction with non-employee

• In transactions with parties other than employees, where fair value of

goods or services is measured directly, the entity measures the equity
component as the difference between the fair value of the goods or
services received and the fair value of the debt component (i.e. cash
alternative), at the date when the goods or services are received.

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 Transaction With employees

• For transactions where fair value of goods or services is measured with

reference to instruments issued (most often to employees) entities need to
measure fair value of two components.

• Such measurement starts with debt component (i.e. cash alternative), then
the fair value of the equity component is measured taking into account
that the counterparty will not receive cash in order to receive the equity
instrument.
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• On settlement, the liability needs to be remeasured so that it equals the
payment amount.

• If the entity issues equity instruments on settlement rather than paying

cash, the remeasured liability is transferred directly to equity.

• All previously recognized equity components remain within equity

(transfers within equity are allowed).

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 Example: Share-based payment transaction
with cash alternative
• On 1 January 20X1, Entity A grants 100 shares to each of its 200
employees provided they will remain employed until 31 December
20X3. These shares will then be locked-in for another two years (i.e.
employees would not be able to sell them until 31 Dec 20X5).

• Employees have also a right to receive cash instead of shares (so called
‘phantom shares’), the payment will be based on the market price of
these shares as at 31 Dec 20X3 and payment will be made immediately.
However, the cash alternative will be based on 80 shares only.
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 Example …..cont’d
Moreover, at the grant date:
 it is estimated that 90% out of 200 employees will meet the service condition
 fair value of phantom shares granted is $30 (cash alternative)
 fair value of shares granted is $28 (share alternative)

• The measurement of such a share-based payment arrangement starts with debt component
(i.e. cash alternative), then the fair value of the equity component is measured taking into
account that the counterparty will not receive cash in order to receive the equity instrument.

• The liability component as of the grant date amounts to $432,000 (200*80*30*90%),

whereas the equity component amounts to $72,000 ((200*100*28*90%) - 432,000).
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Solution……….. Year 20X1
Entity A starts recognizing the expense relating to both components over
the vesting period. Entries for year 20X1 are as follows:

Employee benefits expense…168,000

Equity…………..24,000
Liability…………. 144,000

Where, 24,000=72,000/3 yrs.

144,000=432,000/3 yrs.
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 Year 20X2
Market price of Entity A shares increases. This is reflected only in liability
component which increases to $32. Fair value of equity instruments is not
subsequently remeasured. Entries recognized for year 20X2 are as follows:

Employee benefits expense…187,200

Equity…………..24,000
Liability…………. 163,200

24,000 = 72,000/3yrs
163,200 = 200*80*32*90%*2/3yrs - 144,000
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 Year 20X3
• 85% of employees (170) remained in the workforce as at 31 December 20X3. 120
employees chose the share alternative and 50 employees chose the cash alternative.
The market price of shares increased further so that the fair value of the cash
alternative is now $35.
• First, Entity A recognizes expense for year 3 taking into account the actual number of
employees that fulfilled service conditions and the final market price of shares (the
latter impacts liability component only). This is recognized for year 20X3 as follows:

Employee benefits expense…188,800

Equity…………..20,000
Liability…………. 168,800

20,000 = (72,000*85%/90%) - 24,000 - 24,000

168,800 = (200*80*35*85%) - 163,200 -144,000
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• Payment to 50 employees who choose cash alternative is booked as follows:

Liability…..175,000
Cash………175,000

(Liability=175,000 = 50*35*100)

• Issuance of shares to 120 employees who chose share alternative transfers the remaining
liability balance to equity:

Liability …..301,000
Equity …………301,000

Liability = 301,000= (144,000 1st yr. +163,2002nd yr+168,8003rd yr ) - 175,000

.

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3.2.The entity has a choice of settlement
• Paragraphs IFRS 2.41-43 cover share-based payment transactions with cash
alternatives in which the terms of the arrangement provide the reporting entity with
a choice of settlement. For this type of transactions, the entity needs to determine
whether to use general equity settled or cash settled basis of IFRS 2. Such a
transaction is accounted for as cash-settled if, for example:

 Settlement in equity instruments has no commercial or economic substance,

 Settlement in equity instruments is impracticable due to legal or other constraints,
 Entity has a past practice or a stated policy of settling in cash whenever it can,
 Entity has created a constructive obligation to settle in cash.

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 ………Cont’d

• When actual equity instruments are issued, no changes in equity is

recognized other than a transfer within equity if needed.

• If entity, despite the original choice of approach, settles in cash, the payment
is treated as a deduction of equity.

• But if the entity, on settlement, chooses the alternative that has a higher fair
value at the settlement date, the difference between settlement date fair
values is recognized as an additional expense.
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 Share-based Payment Disclosures

IFRS 2 requires extensive disclosure requirements under three main headings:

1. Information that enables users of financial statements to understand the nature and
extent of the share based payment transactions that existed during the period.

2. Information that allows users to understand how the FV of the goods or services
received or the FV of the equity instruments which have been granted during the period
was determined.

3. Information that allows users of financial statements to understand the affect of

expenses which have arisen from share based payment transactions on the entities
income statement in the period.
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End of chapter two

Thank you !!
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