Prepared by: Jan Hájek

Accounting 2

Lecture no 6

Share-based Payment

Related standards IFRS 2 Current GAAP comparisons Looking ahead End-of-chapter practice

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Related Standards

FAS 123 Share-based Payment

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IFRS 2 – Overview

Objective and scope Recognition Equity-settled share-based payment

transactions Cash-settled share-based payment

transactions Share-based payment transactions with cash

alternatives Summary Disclosures 4

IFRS 2 – Objective and Scope

Deals with transactions where equity instruments are used as consideration

Entities must recognize these types of transactions If they create liabilities, they must be remeasured after the transaction date

Examples of share-based payment transactions Remunerative option plans such as employee stock options plans Acquisitions where shares are used as consideration Situations where services are paid for with equity instruments

Accounting for employee remuneration plans can be complex These plans often span numerous reporting periods Cost to the entity may be difficult to measure depending on the terms of the plans

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IFRS 2 – Objective and Scope

The standard puts all share-based transactions into three categories The definitions for the first two categories follow

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IFRS 2 – Objective and Scope

The third category is where there is a choice to settle in cash or equity

Either the entity has the option to determine whether to settle the transaction in cash or equity, or the counterparty has this option

Share-based payment transactions Defined as transactions in which the entity receives goods or services as

consideration for equity instruments of the entity (including shares or share options), or

Acquires goods or services by incurring liabilities to the supplier of those goods or services for amounts that are based on the price of the entity’s shares or other equity instruments of the entity

Situations where the employee is dealing with the entity as a shareholder Not covered by IFRS 2

When the transaction in question is a business combination Covered by IFRS 3

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IFRS 2 – Objective and Scope

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IFRS 2 – Recognition

In general, the standard requires that the transaction be recognized when the goods are received or services rendered

The credit is booked to equity in an equity-settled transaction and the liability in a cash-settled transaction

The debit is booked to expense or asset (if the definition of an asset is met)

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IFRS 2 – Equity-settled Share-based Payment TransactionsOverview For equity-settled transactions

Transaction is measured at the fair value of the goods or services received If the fair value cannot be reliably measured, then the fair value of the equity

instrument is used

There is a rebuttable presumption that the fair value of the goods and services may be reliably measured In most cases, the fair value of the equity instruments would not be used

An exception to this is where the transaction involves employees rendering services Transactions are measured by reference to the fair value of the equity instruments May be too difficult to measure the services if the equity instruments are given to

the employee as part of the compensation/remuneration package for services normally rendered as an employee

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IFRS 2 – Equity-settled Share-based Payment TransactionsTransactions in which services are received

Accounting might be affected by the vesting provisions

Share-based transactions such as options have conditions attached to them Must be met before the counterparty has legal entitlement to them Legal entitlement is referred to as vesting

Vesting If the equity instruments vest upfront when the contract is entered into

○ The entity assumes that the services have already been provided and recognizes the full amount of the transaction at that date

If the equity instruments vest over time○ The transaction is accrued and recognized over time

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IFRS 2 – Equity-settled Share-based Payment TransactionsTransactions in which services are received (continued)

Options granted conditional upon the employee achieving certain goals Vesting period must also be conditional upon achieving those goals Entity must estimate the vesting period in order to calculate the amount of expense

to recognize in each period Estimate may be revised in a subsequent period as a change in estimate If the condition is a market condition (such as the shares reaching a certain price)

no subsequent revision is allowed ○ Market would have already included expectations about the future share price into the

current share price

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IFRS 2 – Equity-settled Share-based Payment TransactionsTransactions measured by reference to the fair value of the equity

instruments granted

Determining the fair value of equity instruments granted

Estimated as at the measurement date based on market conditions and prices

Measurement date Generally the grant date for transactions with employees For other transactions, is the date that the goods are received or the services

rendered

Grant date Generally the date that the contract is agreed to by both parties

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IFRS 2 – Equity-settled Share-based Payment Transactions

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IFRS 2 – Equity-settled Share-based Payment TransactionsDetermining the fair value of equity instruments granted (continued)

Market values If the equity instruments are publicly traded shares, they are available If they are stock options, they may or may not be available

Options pricing models Valuation techniques - often used E.g., Black-Scholes and binomial models

Model inputs(a) Exercise price

(b) Life of the option

(c) Current price of the shares

(d) Expected volatility of the share price

(e) Dividends expected on the shares

(f) Risk-free interest rate.

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IFRS 2 – Equity-settled Share-based Payment TransactionsTreatment of vesting conditions There may be certain conditions attached to the transaction that must be met before

the counterparty or employee has legal entitlement (i.e., before the instruments vest)

At the grant date The transaction is recognized and measured but the vesting conditions are not factored

into the measurement

After the grant date The transaction is remeasured for the change in the number of equity instruments due

to the conditions being met/not met, but not for the fair value of the equity instrument itself

Subsequent remeasurements are treated as a change in estimate in subsequent periods

Where the vesting condition is a market condition (such as a target share price) this is taken into account at the measurement date and the transaction is not subsequently remeasured

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IFRS 2 – Equity-settled Share-based Payment TransactionsTreatment of non-vesting conditions Uncertainty might also be introduced with non-vesting conditions

Number of equity instruments to be issued might vary depending on some future event

In these cases, the transaction is recognized and measured at the grant date and the uncertainty is factored in at that point No remeasurement after the vesting date

Treatment of a reload feature Contract may allow the entity to automatically issue new options when an old one is

exercised using shares to satisfy the exercise price These are treated as new option grants and reload features are not taken into account

when estimating fair value

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IFRS 2 – Equity-settled Share-based Payment TransactionsAfter vesting date After initial recognition upon vesting

Equity-settled transactions are not remeasured even if the equity instruments are forfeited

Entity may transfer amounts from one category of equity to another

If the fair value of the equity instrument cannot be reliably estimated Where the entity is required to measure the transaction at fair value, it may use the

intrinsic value

Intrinsic value Difference between the fair value of the shares to which the counterparty has the right to

subscribe or which it has the right to receive, and the price the counterparty is required to pay for those shares

Transaction continues to be remeasured until the equity instrument is settled/exercised (or forfeited or lapses/expires)

Costs related to forfeitures after the vesting date would be reversed 18

IFRS 2 – Equity-settled Share-based Payment TransactionsModifications to the terms and conditions

If the equity instrument is modified afterwards and the total fair value of the transaction is increased, then this additional amount is recognized

If the entity cancels or settles the grant of the equity instrument during the vesting period Treats this as an acceleration of the vesting period Recognizes all remaining amounts

Any cash payments are treated as a repurchase of equity (deducted from equity) Only exception is where the payment is greater than the fair value of the equity

instruments granted Excess is charged to expense

Additional guidance is provided where new or replacement equity instruments are granted

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IFRS 2 - Equity-settled Share-based Payment Transactions - Example 1

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:

Dr Inventory 140 000

Cr Share capital 140 000

Employee X provides her services to Reporting Entity Ltd in exchange for 10 000 options in the entity. All services have been performed and the options have been granted to Employee X. The options are considered to have a market value of $1.50 each

In this case, which involves an employee, the reporting entity would not determine the fair value of the services being provided but instead would consider the fair value of the options

Dr Employee benefits expense 15 000Cr Share capital 15 000

If the goods or services were received in an equity-settled share-based payment transaction, an increase in equity is recognised. If they were received as part of a cash-settled share-based transaction, a liability is to be recognised

IFRS 2 - Equity-settled Share-based Payment Transactions – Example 2

IFRS 2 – Cash-settled Share-based Payment Transactions Where the transaction will eventually be settled in cash

Liability is recognized Transaction is measured at the fair value of the liability at the measurement date Liability is subsequently remeasured at every reporting date Additional expenses/income due to the remeasurement are booked to profit and loss

Share appreciation rights (SARs)

For transactions involving options/share appreciation rights the fair value of the liability is measured at the fair value of the options/SAR

Under this type of contract, an employee is granted a certain number of rights as remuneration for services

Rights allow the employee to be paid the excess of the market value of a share over a certain base price

Excess may be paid in cash (which is most often the case) or in shares22

IFRS 2 – Cash-settled Share-based Payment TransactionsShare appreciation rights (SARs) continued

Accounting may be inconsistent with IAS 32 In cases where the SAR may be settled in shares (according to the terms of the SAR)

Under IFRS 2 If the SAR is to be settled with shares (i.e., a variable number of shares) it is

accounted for as equity

• Measured at the fair value of the SAR at the grant date

• Credited to equity

• Not subsequently remeasured after vesting date

Under IAS 32 If the number of shares is variable, the instrument would be accounted for as a

liability

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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 The share price at 30 June 2014 is $2.90 The share price at 30 June 2015 is $4.10 The managing director stays for three years and is paid the bonus on 1

July 2015

REQUIREDPrepare the journal entries that would appear in the accounting records of

Coogee Ltd to account for the issue of the share appreciation rights

IFRS 2 - Cash-settled Share-based Payment Transactions - Example

Remuneration Year end Calculation 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 2013Dr Employee benefits expense 100 000Cr Accrued salaries payable 100 000

30 June 2014Dr Accrued salaries payable 20 000Cr Employee benefits expense recouped (revenue) 20 000

30 June 2015Dr Employee benefits expense 240 000Cr Accrued salaries payable 240 000

1 July 2016Dr Accrued salaries payable 320 000Cr Bank 320 000

IFRS 2 - Cash-settled Share-based Payment Transactions - Example

IFRS 2 – Share-based Payment Transactions with Cash AlternativesShare-based payment transactions in which the terms of the arrangement

provide the counterparty with a choice of settlement

Where the counterparty has the option to dictate settlement, it is beyond the control of the entity and a liability may exist

In reality, this is a compound instrument Part debt (the right to demand payment in cash) Part equity (the right to demand payment in shares)

For transactions other than with employees and where the entire transaction is measured at fair value of the goods/services The equity component is the difference between the total transaction value and fair

value of the debt component

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IFRS 2 – Share-based Payment Transactions with Cash AlternativesShare-based payment transactions in which the terms of the arrangement provide the counterparty with a choice of settlement (continued)

For other transactions, where the equity instrument is used to value the transaction

• Measure fair value of debt component• Measure the equity component (considering that the entity must forfeit the right to the shares if the counterparty exercises the option to be paid in cash)

As an added complexity, the entity must split the transaction into two parts the debt part the equity part

The debit side of the journal entry (the expense) is also split into two parts The debt part is accounted for as a cash-settled transaction The equity part as an equity-settled transaction

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IFRS 2 – Share-based Payment Transactions with Cash AlternativesShare-based payment transactions in which the terms of the arrangement

provide the entity with a choice of settlement

Where the entity has the choice of settlement options, the entity determines whether it has a liability (a present obligation to settle in cash)

Where the choice has no commercial substance A liability exists The transaction is accounted for as a cash-settled transaction Otherwise, it is accounted for as an equity-settled transaction

If the entity assumes equity settlement and subsequently settles in cash This is treated as a share buyback or repurchase of an equity interest (debit equity) Unless the settlement alternative is the one with the higher fair value, in which case

the excess is booked as expense

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IFRS 2 – Disclosures The entity must disclose sufficient information for the users

To understand the nature and extent of these transactions To understand the impact on the profit or loss statement

Specific disclosures

(a) A description of each type of share-based payment arrangement that existed at any time during the period

(b) The number and weighted average exercise prices of share options for each of the following groups of options

(i) Outstanding at the beginning of the period

(ii) Granted during the period

(iii) Forfeited during the period

(iv) Exercised during the period

(v) Expired during the period

(vi) Outstanding at the end of the period

(vii) Exercisable at the end of the period

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IFRS 2 – Disclosures(c) For share options exercised during the period, the weighted average share price at

the date of exercise.

(d) For share options outstanding at the end of the period, the range of exercise prices and weighted average remaining contractual life.

Additional disclosures relating to fair value measurements and the impact on the profit or loss statement are required

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Current GAAP Comparisons

If fair value of received goods/services not reliably measurable, IFRS uses fair value of non-tradable equity instruments

Measurement dates for share-based payments differ

Treatment of vesting conditions differs

Current GAAP Comparisons

Differences in dealing with modifications of awards

Cash-settled share-based payments measured at fair value of liability under IFRS (intrinsic value under Canadian GAAP)

Where counterparty has choice of settlement, IFRS requires treatment as cash settled transaction if entity has incurred a liability – compound instrument