below), an award of options. However, an award of shares is no more than an award of
options with an exercise price of zero. Moreover, the treatment outlined in the previous
paragraph is broadly consistent with the rationale given by IFRS 2 for the treatment of
an award vesting in instalments (see 6.2.2 above).
In Example 30.10 above, the vesting period, although not known, is at least one of a
finite number of known possibilities. The vesting period for some awards, however, may
be more open-ended, such as is frequently the case for an award that vests on a trade
sale or flotation of the business. Such awards are discussed further at 15.4 below.
6.2.4
Transactions with variable number of equity instruments awarded
depending on non-market performance vesting conditions
More common than awards with a variable vesting period are those where the number
of equity instruments awarded varies, typically increasing to reflect the margin by which
a particular minimum target is exceeded. In accounting for such awards, the entity must
continuously revise its estimate of the number of shares to be awarded, as illustrated in
Example 30.11 below (which is based on IG Example 3 in the implementation guidance
to IFRS 2). [IFRS 2 IG Example 3].
Example 30.11: Award with non-market performance vesting condition and
variable number of equity instruments
At the beginning of year 1, an entity grants an option over a variable number of shares (see below), estimated
to have a fair value at grant date of £20 per share under option, to each of its 100 employees working in the
sales department. The share options will vest at the end of year 3, provided that the employees remain in the
entity’s employment, and provided that the volume of sales of a particular product increases by at least an
average of 5% per year. If the volume of sales of the product increases by an average of between 5% and 10%
per year, each employee will be entitled to exercise 100 share options. If the volume of sales increases by an
average of between 10% and 15% each year, each employee will be entitled to exercise 200 share options. If
the volume of sales increases by an average of 15% or more, each employee will be entitled to exercise
300 share options.
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By the end of the first year, seven employees have left and the entity expects that a total of 20 employees will
leave by the end of year 3. Product sales have increased by 12% and the entity expects this rate of increase to
continue over the next two years, so that 80 employees will be entitled to exercise 200 options each.
By the end of the second year, a further five employees have left. The entity now expects only three more
employees to leave during year 3, and therefore expects a total of 15 employees to have left during the
three year period. Product sales have increased by 18%, resulting in an average of 15% over the two years to
date. The entity now expects that sales will average 15% or more over the three year period, so that 85
employees will be entitled to exercise 300 options each.
By the end of year 3, a further seven employees have left. Hence, 19 employees have left during the three year
period, and 81 employees remain. However, due to trading conditions significantly poorer than expected,
sales have increased by a 3 year average of only 12%, so that the 81 remaining employees are entitled to
exercise only 200 share options.
The entity will recognise the following amounts during the vesting period for services received as
consideration for the options.
Cumulative
Expense for
Year Calculation of cumulative expense
expense (£)
period (£)
1 80 employees × 200 options × £20 × 1/3
106,667
106,667
2 85 employees × 300 options × £20 × 2/3
340,000
233,333
3 81 employees × 200 options × £20
324,000
(16,000)
This Example reinforces the point that, under the methodology in IFRS 2, it is quite
possible for an equity-settled transaction to give rise to a credit to profit or loss for a
particular period during the period to vesting.
6.2.5
Transactions with variable exercise price due to non-market
performance vesting conditions
Another mechanism for delivering higher value to the recipient of a share award so as
to reflect the margin by which a particular target is exceeded might be to vary the
exercise price depending on performance. IFRS 2 requires such an award to be dealt
with, in effect, as more than one award. The fair value of each award is determined, and
the cost during the vesting period based on the best estimate of which award will
actually vest, with the final cumulative charge being based on the actual outcome.
[IFRS 2.IG12, IG Example 4].
This is illustrated in Example 30.12 below.
Example 30.12: Award with non-market performance vesting condition and
variable exercise price
An entity grants to a senior executive 10,000 share options, conditional upon the executive’s remaining in the
entity’s employment for three years. The exercise price is CHF40. However, the exercise price drops to
CHF30 if the entity’s earnings increase by at least an average of 10% per year over the three year period.
On grant date, the entity estimates that the fair value of the share options, with an exercise price of CHF30,
is CHF16 per option. If the exercise price is CHF40, the entity estimates that the share options have a fair
value of CHF12 per option. During year 1, the entity’s earnings increased by 12%, and the entity expects that
earnings will continue to increase at this rate over the next two years. The entity therefore expects that the
earnings target will be achieved, and hence the share options will have an exercise price of CHF30.
During year 2, the entity’s earnings increased by 13%, and the entity continues to expect that the earnings
target will be achieved. During year 3, the entity’s earnings increased by only 3%, and therefore the
earnings target was not achieved. The executive completes three years’ service, and therefore satisfies the
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service condition. Because the earnings target was not achieved, the 10,000 vested share options have an
exercise price of CHF40.
The entity will recognise the following amounts during the vesting period for services received as
consideration for the options.
Cumulative
expense
Expense for
Year Calculation of cumulative expense
(CHF)
period (CHF)
1 10,000 options × CHF16 × 1/3
53,333
53,333
2 10,000 options × CHF16 × 2/3
106,667
53,334
3 10,000 options × CHF12
120,000
13,333
At first sight this may seem a rather surprising approach. In reality, is it not the case that
the entity in Example 30.12 has made a single award, the fair value of which must lie
between CHF12 and CHF16, as a function of the weighted probabilities of either
outcome occurring? Economically speaking, this is indeed the case. However, under the
accounting model for equit
y-settled share-based payments in IFRS 2, the probability of
achieving non-market performance conditions is not taken into account in valuing an
award. If this is required to be ignored, the only approach open is to proceed as above.
6.3 Market
conditions
6.3.1
What is a ‘market condition’?
IFRS 2 defines a market condition as follows:
‘A performance condition upon which the exercise price, vesting or exercisability of
an equity instrument depends that is related to the market price (or value) of the
entity’s equity instruments (or the equity instruments of another entity in the same
group), such as:
(a) attaining a specified share price or a specified amount of intrinsic value of a share
option; or
(b) achieving a specified target that is based on the market price (or value) of the
entity’s equity instruments (or the equity instruments of another entity in the same
group) relative to an index of market prices of equity instruments of other entities.
‘A market condition requires the counterparty to complete a specified period of service
(i.e. a service condition); the service requirement can be explicit or implicit.’
[IFRS 2 Appendix A].
A market condition is a type of performance condition and the above definition should
be read together with the definition of a performance condition (see 3.1 above). If there
is no service requirement, the condition will be a non-vesting condition rather than a
performance vesting condition (see 3.2 above).
The ‘intrinsic value’ of a share option means ‘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’. [IFRS 2 Appendix A]. In other
words, an option to pay $8 for a share with a fair value of $10 has an intrinsic value
of $2. A performance condition based on the share price and one based on the
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intrinsic value of the option are effectively the same, since the values of each will
obviously move in parallel.
An example of a market condition is a condition based on total shareholder return
(TSR). TSR is a measure of the increase or decrease in a given sum invested in an entity
over a period on the assumption that all dividends received in the period had been used
to purchase further shares in the entity. The market price of the entity’s shares is an
input to the calculation.
However, a condition linked to a purely internal financial performance measure such as
profit or earnings per share is not a market condition. Such measures will affect the
share price, but are not directly linked to it, and hence are not market conditions.
A condition linked to a general market index is a non-vesting condition rather than a
market condition (see 3.2 above and 6.4 below). For example, suppose that an entity
engaged in investment management and listed only in London grants options to an
employee responsible for the Far East equities portfolio. The options have a condition
linked to movements in a general index of shares of entities listed in Hong Kong, so as
to compare the performance of the portfolio of investments for which the employee is
responsible with that of the overall market in which they are traded. That condition
would not be regarded as a market condition under IFRS 2, because even though it
relates to the performance of a market, the reporting entity’s own share price is not
relevant to the satisfaction of the condition.
However, if the condition were that the entity’s own share price had to outperform a
general index of shares of entities listed in Hong Kong, that condition would be a market
condition because the reporting entity’s own share price is then relevant to the
satisfaction of the condition.
6.3.2
Summary of accounting treatment
The key feature of the accounting treatment of an equity-settled transaction subject
to a market condition is that the market condition is taken into account in valuing
the award at the date of grant, but then subsequently ignored, so that an award is
treated as vesting irrespective of whether the market condition is satisfied, provided
that all service and non-market performance vesting conditions are satisfied.
[IFRS 2.21, IG13]. This can have rather controversial consequences, as illustrated by
Example 30.13.
Example 30.13: Award with market condition
An entity grants an employee an option to buy a share on condition of remaining in employment for three
years and the share price at the end of that period being at least €7. At the end of the vesting period, the share
price is €6.80. The share price condition is factored into the initial valuation of the option, and the option is
considered to vest provided that the employee remains for three years, irrespective of whether the share price
does in fact reach €7.
Therefore, IFRS 2 sometimes treats as vesting (and recognises a cost for) awards that do
not actually vest in the natural sense of the word. See also Example 30.15 at 6.3.4 below.
This treatment is clearly significantly different from that for transactions involving a
non-market vesting condition, where no cost would be recognised where the conditions
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were not met. The Basis for Conclusions indicates that the IASB accepted this
difference for two main reasons:
(a) it was consistent with the approach in the US standard FAS 123; and
(b) in principle, the same approach should have been adopted for all performance
conditions. However, whereas market conditions can be readily incorporated into
the valuation of options, other conditions cannot. [IFRS 2.BC183-184].
The methodology prescribed by IFRS 2 for transactions with a vesting condition other
than a market condition is therefore to determine the fair value of the option ignoring the
condition and then to multiply that fair value by the estimated (and ultimately the actual)
number of awards expected to vest based on the likelihood of that non-market vesting
condition being met (see 6.2 above). It is interesting to note, however, that the
January 2008 amendment to IFRS 2 (see 1.2 above) had the effect that certain conditions
previously regarded as non-market vesting conditions (and therefore ‘impossible’ to
incorporate in the determination of fair value) became non-vesting conditions (and
therefore required to be incorporated in the determination of fair value).
One of the reasons for adoption of this approach under US GAAP (not referred to in the
Basis for Conclusions in IFRS 2) was as an ‘anti-avoidance’ measure. The concern was
that the introduction of certain market conditions could effectively allow for the
reversal of the expense for ‘underwater’ options (i.e. those whose exercise price is
higher than the share price such that it is not in the holder’s interest to exercise the
option) for which all significant vesting conditions had been satisfied, contrary to the
general principle in US GAAP (and IFRS 2) that no revisions should be made to the
expense for an
already vested option.
For example, when the share price is £10 an entity could grant an employee an option,
exercisable at £10, provided that a certain sales target had been met within one year. If
the target were achieved, IFRS 2 would require an expense to be recognised even if the
share price at the end of the year were only £8, so that the employee would not
rationally exercise the option. If, however, the performance conditions were that (a) the
sales target was achieved and (b) the share price was at least £10.01, the effect would be
(absent specific provision for market conditions) that the entity could reverse any
expense for ‘underwater’ options.
It appears that it may be possible to soften the impact of IFRS 2’s rules for market
conditions relatively easily by introducing a non-market vesting condition closely
correlated to the market condition. For instance, the option in Example 30.13 above
could be modified so that exercise was dependent not only upon the €7 target share
price and continuous employment, but also on a target growth in earnings per share.
Whilst there would not be a perfect correlation between earnings per share and the
share price, it would be expected that they would move roughly in parallel, particularly
if the entity has historically had a fairly consistent price/earnings ratio. Thus, if the share
price target were not met, it would be highly likely that the earnings per share target
would not be met either. This would allow the entity to show no cumulative cost for the
option, since only one (i.e. not all) of the non-market related vesting conditions would
have been met.
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Similarly, entities in sectors where the share price is closely related to net asset value
(e.g. property companies and investment trusts) could incorporate a net asset value
target as a non-market performance condition that would be highly likely to be satisfied
only if the market condition was satisfied.
The matrices below illustrate the interaction of market conditions and vesting
conditions other than market conditions. Matrix 1 summarises the possible outcomes
for an award with the following two vesting conditions:
• the employee remaining in service for three years (‘service condition’); and
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 514
