International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards
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but, in all other respects, the award remains unchanged. In our view, the accounting
following the change of status will depend on the entity’s assessment of whether or
not the counterparty is performing the same or similar services before and after the
change of status.
If it is concluded that the counterparty is providing the same or similar services before
and after the change of status, the measurement approach remains unchanged.
However, if the services provided are substantially different, the accounting following
the change of status will be determined by the counterparty’s new status, as follows:
• For a change from non-employee to employee status, the expense for periods
following the change should be measured as if the award had been granted at the
date of change of status. This revised measurement only applies to the expense for
the portion of the award that vests after the change of status and there is no effect
on the expense recognised in prior periods.
• For a change from employee to non-employee status, the expense for periods
following the change should be measured on the basis of the fair value of the
counterparty’s services as they are received – if this is reliably determinable.
Otherwise, the fair value used is that of the equity instruments granted but
measured at the date the services are received (see 5.4 above). There is no effect
on the expense recognised in prior periods.
If the status of the counterparty changes and the terms of the award are modified in
order to allow the award to continue to vest, the modification and change of status
should be assessed in accordance with the general principles in IFRS 2 relating to the
modification of awards (see 7.3 below).
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5.5
Determining the fair value of equity instruments
As discussed in 5.2 and 5.4 above, IFRS 2 requires the following equity-settled
transactions to be measured by reference to the fair value of the equity instruments
issued rather than that of the goods or services received:
• all transactions with employees (except where it is impossible to determine fair
value – see below); and
• transactions with non-employees where, in rare cases, the entity rebuts the
presumption that the fair value of goods or services provided is more reliably
measurable.
There will also be situations where the identifiable consideration received (if any) from
non-employees appears to be less than the fair value of consideration given. In such
cases, the cost of the unidentifiable goods or services received, if any, must be
accounted for in accordance with IFRS 2 by determining the fair value of the equity
instruments. This requirement is discussed at 2.2.2.C above.
For all transactions measured by reference to the fair value of the equity instruments
granted, IFRS 2 requires fair value to be measured at the ‘measurement date’ – i.e. grant
date in the case of transactions with employees and service date in the case of
transactions with non-employees. [IFRS 2 Appendix A]. Fair value should be based on
market prices if available. [IFRS 2.16]. In the absence of market prices, a valuation
technique should be used to estimate what the market price would have been on the
measurement date in an arm’s length transaction between informed and willing parties.
The technique used should be a recognised technique and incorporate all factors that
would be taken into account by knowledgeable and willing market participants.
[IFRS 2.17].
Appendix B to IFRS 2 contains more detailed guidance on valuation, which is discussed
at 8 below. [IFRS 2.18]. IFRS 2 also deals with those ‘rare’ cases where it is not possible to
value equity instruments reliably, where an intrinsic value approach may be used. This
is more likely to apply to awards of options than to awards of shares and is discussed
further at 8.8 below.
IFRS 2 rather confusingly states that the fair value of equity instruments granted must
take into account the terms and conditions on which they were granted, but this
requirement is said to be ‘subject to the requirements of paragraphs 19-22’. [IFRS 2.16].
When those paragraphs are consulted, a somewhat different picture emerges, since they
draw a distinction between:
• non-vesting conditions (i.e. those that are neither service conditions nor
performance conditions);
• vesting conditions which are market conditions (i.e. those related to the entity’s
share price); and
• other vesting conditions (i.e. service and non-market performance conditions).
These are discussed in more detail at 6.2 to 6.4 and at 8 below, but the essential
difference is that, while non-vesting conditions and market conditions must be taken
into account in any valuation, other vesting conditions must be ignored. [IFRS 2.19-21A].
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As we explain in the more detailed discussion later, these essentially arbitrary
distinctions originated in part as anti-avoidance measures.
The ‘fair value’ of equity instruments under IFRS 2 therefore takes account of some, but
not all, conditions attached to an award rather than being a ‘true’ fair value.
The approach to determining the fair value of share-based payments continues to be
that specified in IFRS 2 and share-based payments fall outside the scope of IFRS 13
which applies more generally to the measurement of fair value under IFRSs (see
Chapter 14). [IFRS 2.6A].
5.5.1 Reload
features
A ‘reload feature’ is a feature in a share option that provides for an automatic grant of
additional share options (reload options) whenever the option holder exercises
previously granted options using the entity’s shares, rather than cash, to satisfy the
exercise price. [IFRS 2 Appendix A]. IFRS 2 requires reload features to be ignored in the
initial valuation of options that contain them. Instead any reload option should be
treated as if it were a newly granted option when the reload conditions are satisfied.
[IFRS 2.22]. This is discussed further at 8.9 below.
6
EQUITY-SETTLED TRANSACTIONS – ALLOCATION OF
EXPENSE
6.1 Overview
Equity-settled transactions, particularly those with employees, raise particular
accounting problems since they are often subject to vesting conditions (see 3.1 above)
that can be satisfied only over an extended vesting period. This raises the issue of
whether a share-based payment transaction should be recognised:
• when the relevant equity instrument is first granted;
• when it vests;
• during the vesting period; or
• during the life of the option.
An award of equity instruments that vests immediately is presumed, in the absence of
evidence to the contrary, to relate to services that have already been rendered, and is
therefore expensed in full at grant date. [IFRS 2.14]. This may lead to the immediate
recognition of an expense for an award to which the employee may not be legally
entitled for some time, as illustrated in Example 30.5.
Example 30.5: Award with non-vesting condition only
; An entity grants a director share options, exercisable after three years provided the director does not compete
with the reporting entity for a period of at least three years. The ‘non-compete’ clause is considered to be a
non-vesting condition (see 3.2 above and 6.4 below). As this is the only condition to which the award is
subject, the award has no vesting conditions and therefore vests immediately. The fair value of the award at
the date of grant, including the effect of the ‘non-compete’ clause, is determined to be €150,000. Accordingly,
the entity immediately recognises a cost of €150,000.
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This cost can never be reversed, even if the director goes to work for a competitor and loses the award. This
is discussed more fully at 3.2.3 above and at 6.1.2 and 6.4 below.
Where equity instruments are granted subject to vesting conditions (as in many cases
they will be, particularly where payments to employees are concerned), IFRS 2 creates
a presumption that they are a payment for services to be received in the future, during
the ‘vesting period’, with the transaction being recognised during that period, as
illustrated in Example 30.6. [IFRS 2.15].
Example 30.6: Award with service condition only
An entity grants a director share options on condition that the director remain in employment for three years.
The requirement to remain in employment is a service condition, and therefore a vesting condition, which
will take three years to fulfil. The fair value of the award at the date of grant, ignoring the effect of the vesting
condition, is determined to be €300,000. The entity will record a cost of €100,000 a year in profit or loss for
three years, with a corresponding increase in equity.
In practice, the calculations required by IFRS 2 are unlikely to be as simple as that in
Example 30.6. In particular:
• the final number of awards that vest cannot be known until the vesting date
(because employees may leave before the vesting date, or because relevant
performance conditions may not be met); and/or
• the length of the vesting period may not be known in advance (since vesting may
depend on satisfaction of a performance condition with no, or a variable, time-
limit on its attainment).
In order to deal with such issues, IFRS 2 requires a continuous re-estimation process as
summarised in 6.1.1 below.
6.1.1
The continuous estimation process of IFRS 2
The overall objective of IFRS 2 is that, at the end of the vesting period, the cumulative
cost recognised in profit or loss (or, where applicable, included in the carrying amount
of an asset), should represent the product of:
• the number of equity instruments that have vested, or would have vested, but for
the failure to satisfy a market condition (see 6.3 below) or a non-vesting condition
(see 6.4 below); and
• the fair value (excluding the effect of any non-market vesting conditions, but
including the effect of any market conditions or non-vesting conditions) of those
equity instruments at the date of grant.
It is essential to appreciate that the ‘grant date’ measurement model in IFRS 2 seeks
to capture the value of the contingent right to shares promised at grant date, to the
extent that that promise becomes (or is deemed by IFRS 2 to become – see 6.1.2
below) an entitlement of the counterparty, rather than the value of any shares finally
delivered. Therefore, if an option vests, but is not exercised because it would not be
in the counterparty’s economic interest to do so, IFRS 2 still recognises a cost for
the award.
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In order to achieve this outcome, IFRS 2 requires the following process to be applied:
(a) at grant date, the fair value of the award (excluding the effect of any service and
non-market performance vesting conditions, but including the effect of any market
performance conditions or non-vesting conditions) is determined;
(b) at each subsequent reporting date until vesting, the entity calculates a best estimate
of the cumulative charge to profit or loss at that date, being the product of:
(i) the grant date fair value of the award determined in (a) above;
(ii) the current best estimate of the number of awards that will vest (see 6.1.2
below); and
(iii) the expired portion of the vesting period;
(c) the charge (or credit) to profit or loss for the period is the cumulative amount
calculated in (b) above less the amounts already charged in previous periods. There
is a corresponding credit (or debit) to equity; [IFRS 2.19-20]
(d) once the awards have vested, no further accounting adjustments are made to the
cost of the award, except in respect of certain modifications to the award – see 7
below; and
(e) if a vested award is not exercised, an entity may (but need not) make a transfer
between components of equity – see 6.1.3 below.
The overall effect of this process is that a cost is recognised for every award that is granted,
except when it is forfeited, as that term is defined in IFRS 2 (see 6.1.2 below). [IFRS 2.19].
6.1.2
Vesting and forfeiture
In normal English usage, and in many share scheme documents, an award is described
as ‘vested’ when all the conditions needed to earn it have been met, and as ‘forfeited’
where it lapses before vesting because one or more of the conditions has not been met.
IFRS 2 uses the term ‘forfeiture’ in a much more restricted sense to mean an award that
does not vest in IFRS 2 terms. This is a particularly complex aspect of IFRS 2, which is
discussed in more detail at 6.2 to 6.4 below. Essentially:
• where an award is subject only to vesting conditions other than market conditions,
failure to satisfy any one of the conditions is treated as a forfeiture by IFRS 2;
• where an award is subject to both
• vesting conditions other than market conditions, and
• market conditions and/or non-vesting conditions,
failure to satisfy any one of the vesting conditions other than market conditions is
treated as a forfeiture by IFRS 2. Otherwise (i.e. where all the vesting conditions other
than market conditions are satisfied), the award is deemed to vest by IFRS 2 even if
the market conditions and/or non-vesting conditions have not been satisfied; and
• where an award is subject only to non-vesting conditions, it is always deemed to
vest by IFRS 2.
Where an award has been modified (see 7.3 below) so that different vesting conditions
apply to the original and modified elements of an award, forfeiture will not apply to the
original award if the service and non-market performance conditions attached to that
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element have been met. This will be the case even if the service and non-market
performance conditions attached to the modified award have not been met and so the
modified award is considered to have been forfeited (resulting in the reversal of any
incremental expense relating to the modification). Examples 30.23 and 30.24 at 7.3
below illustrate this point.
As a result of the interaction of the various types of condition, the reference in the
> summary at 6.1.1 above to the ‘best estimate of the number of awards that will vest’ really
means the best estimate of the number of awards for which it is expected that all service
and non-market vesting conditions will be met.
In practice, however, it is not always clear how that best estimate is to be determined,
and in particular what future events may and may not be factored into the estimate. This
is discussed further at 6.2 to 6.4 and at 7.6 below.
6.1.3 Accounting
after
vesting
Once an equity-settled transaction has vested (or, in the case of a transaction subject to
one or more market or non-vesting conditions, has been treated as vested under IFRS 2
– see 6.1.2 above), no further accounting entries are made to reverse the cost already
charged, even if the instruments that are the subject of the transaction are subsequently
forfeited or, in the case of options, are not exercised. However, the entity may make a
transfer between different components of equity. [IFRS 2.23]. For example, an entity’s
accounting policy might be to credit all amounts recorded for share-based transactions
to a separate reserve such as ‘Shares to be issued’. Where an award lapses after vesting,
it would then be appropriate to transfer an amount equivalent to the cumulative cost
for the lapsed award from ‘Shares to be issued’ to another component of equity.
This prohibition against ‘truing up’ (i.e. reversing the cost of vested awards that lapse) is
controversial, since it has the effect that a cost is still recognised for options that are
never exercised, typically because they are ‘underwater’ (i.e. the current share price is
lower than the option exercise price), so that it is not in the holder’s interest to exercise
the option. Some commentators have observed that an accounting standard that can
result in an accounting cost for non-dilutive options does not meet the needs of those
shareholders whose concerns about dilution were the catalyst for the share-based
payment project in the first place (see 1.1 above).
The IASB counters such objections by pointing out that the treatment in IFRS 2 is
perfectly consistent with that for other ‘contingent’ equity instruments, such as
warrants, that ultimately result in no share ownership. Where an entity issues warrants