unexpensed element of the grant date fair value of 100 options (i.e. recognition of an additional amount
of £300 (100 × £9 × 1/3)) The grant date fair value of the remaining 100 options continues to be recognised over
the remainder of the vesting period together with their incremental fair value following the modification. Therefore,
in year 3, there would be an expense of £300 (for the remaining grant date fair value) plus £500 (100 × (£10 – £5))
for the incremental fair value of 100 options. In total, therefore, an expense of £2,300 is recognised.
View 2 is that the total number of options exchanged is the more appropriate unit of account. In this case, the
cancellation of the original options and the grant of replacement options are accounted for as one
modification. There would therefore be no acceleration of expense in respect of the reduction in the number
of options from 200 to 100 and the grant date fair value of the original award would continue to be recognised
over the vesting period. In this case, the total expense recognised would be £1,800 (200 × £9).
Example 30.26: Modification where number of equity instruments is reduced but
total fair value of award is increased
At the beginning of year 1, an entity granted to its employees 1,000 share options with an exercise price equal to
the market price of the shares at grant date. There is a two year vesting period and the grant date fair value is
£10 per option. The entity’s share price has declined significantly so that the share price is currently significantly
less than the exercise price. At the end of year 1, the entity decides to reduce the exercise price of the options and,
as part of the modification, it also reduces the number of options from 1,000 to 800. At the date of modification,
the fair value of the original options is £7 per option and that of the modified options £11 per option.
View 1 is that the unit of account is an individual option. Taking this approach, the decrease in the number of
options from 1,000 to 800 will be accounted for as a cancellation of 200 options with an acceleration at the
modification date of any remaining grant date fair value relating to those 200 options. The total expense recognised
in year 1 is £6,000 ((800 × £10 × ½) + (200 × £10)). The grant date fair value of the remaining 800 options
continues to be recognised over the remainder of the vesting period together with the incremental fair value of
those options as measured at the modification date. In total the entity will recognise an expense of £13,200
(original grant date fair value of £10,000 (1,000 × £10) plus incremental fair value of £3,200 (800 × £(11 – 7)).
View 2 is that the unit of account is the total number of options as there are linked modifications forming one
package. In this case, the incremental fair value is calculated as the difference between the total fair value before
and after the modification. In total the entity will recognise an expense of £11,800 (original grant date fair value
of £10,000 (1,000 × £10) plus incremental fair value on modification of £1,800 ((800 × £11) – (1,000 × £7)).
In both Examples above, the first view is based on paragraph B44(b) of IFRS 2 which states
that ‘if the modification reduces the number of equity instruments granted to an employee,
that reduction shall be accounted for as a cancellation of that portion of the grant, in
accordance with the requirements of paragraph 28’. This is perhaps further supported by
paragraph B43(a) which, in providing guidance on accounting for a modification that
increases the fair value of an equity instrument, appears only to refer to individual equity
instruments when it states that ‘the incremental fair value granted’ in a modification is ‘the
difference between the fair value of the modified equity instrument and that of the original
equity instrument, both estimated as at the date of modification’. [IFRS 2.B43-44].
The second view is based on the overriding requirement in paragraph 27 of IFRS 2 for
the grant date fair value of the equity instruments to be recognised unless the awards do
not vest due to a failure to meet a vesting condition (other than a market condition) that
was specified at grant date. This requirement is applicable even if the award is modified
after the grant date. The same paragraph also requires an entity to recognise the effect
of modifications ‘that increase the total fair value of the share-based payment
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arrangement or are otherwise beneficial to the employee’. This reference to ‘total fair
value’ supports the view that the total award is the unit of account and is reiterated in
paragraphs B42 and B44 which provide guidance, respectively, for situations where the
total fair value decreases or increases as a consequence of the modification of an award.
Supporters of view 2 further consider that, in contrast to the cancellation accounting
approach that is required in the very specific case where part of the award is, in effect,
settled for no consideration (see 7.3.2.B above), a modification that reduces the number
of equity instruments but maintains or increases the overall fair value of the award
clearly provides the counterparty with a benefit. As a consequence, it is considered that
no element of the grant date fair value should be accelerated as a cancellation expense.
[IFRS 2.27, B42, B44].
Given the lack of clarity in IFRS 2, we believe that an entity may make an accounting
policy choice as to whether it considers the unit of account to be an individual equity
instrument or an award as a whole. However, once made, that accounting policy choice
should be applied consistently to all modifications that reduce the number of equity
instruments but maintain or increase the overall fair value of an award. Whichever
policy is chosen, the general requirements of IFRS 2 will still need to be applied in order
to determine whether or not the amendments to the arrangement are such that it is
appropriate to treat the changes as a modification (in IFRS 2 terms) rather than as a
completely new award (see 7.4.2 and 7.4.4 below).
7.3.5
Modification of award from equity-settled to cash-settled (and vice
versa)
Occasionally an award that was equity-settled when originally granted is modified so as
to become cash-settled, or an originally cash-settled award is modified so as to become
equity-settled. Such modifications are discussed at 9.4 below.
7.4
Cancellation and settlement
Where an award is cancelled or settled (i.e. cancelled with some form of compensation),
other than by forfeiture for failure to satisfy the vesting conditions:
(a) if the cancellation or settlement occurs during the vesting period, it is treated as an
acceleration of vesting, and the entity recognises immediately the amount that
would otherwise have been recognised for services received over the remainder
of the vesting period;
(b) where the entity pays compensation for a cancelled award:
(i) any compensation paid up to the fair value of the award at cancellation or
settlement date (whether before or after vesting) is accounted for as a deduction
from equity, as being equivalent to the redemption of an equity instrument;
(ii) any compensation paid in excess of the fair value of the award at cancellation
>
or settlement date (whether before or after vesting) is accounted for as an
expense in profit or loss; and
(iii) if the share-based payment arrangement includes liability components, the
fair value of the liability is remeasured at the date of cancellation or
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settlement. Any payment made to settle the liability component is accounted
for as an extinguishment of the liability; and
(c) if the entity grants new equity instruments during the vesting period and, on the
date that they are granted, identifies them as replacing the cancelled or settled
instruments, the entity is required to account for the new equity instruments as if
they were a modification of the cancelled or settled award. Otherwise it accounts
for the new instruments as an entirely new award. [IFRS 2.28, 29].
The treatment of the cancelled or settled award in (a) above is similar, in its effect on
profit or loss, to the result that would have occurred if:
• the fair value of the equity instruments issued had been recorded in full at grant
date with a corresponding debit to a prepayment for ‘services to be rendered’;
• the prepayment were written off on a periodic basis until cancellation or settlement;
and
• any remaining prepayment at the date of cancellation or settlement were written
off in full.
It should be noted that the calculation of any additional expense in (b) above depends
on the fair value of the award at the date of cancellation or settlement, not on the
cumulative expense already charged. This has the important practical consequence that,
when an entity pays compensation on cancellation or settlement of an award, it must
obtain a fair value for the original award, updated to the date of cancellation or
settlement. If the award had not been cancelled or settled, there would have been no
need to obtain a valuation for the original award after the date of grant.
These requirements raise some further detailed issues of interpretation on a number of
areas, as follows:
• the distinction between ‘cancellation’ and ‘forfeiture’ (see 7.4.1 below);
• the distinction between ‘cancellation’ and ‘modification’ (see 7.4.2 below);
• the calculation of the expense on cancellation (see 7.4.3 below); and
• replacement awards (see 7.4.4 and 7.5 below).
7.4.1
Distinction between cancellation and forfeiture
The provisions of IFRS 2 summarised at 7.4 above apply when an award of equity
instruments is cancelled or settled ‘other than a grant cancelled by forfeiture when the
vesting conditions are not satisfied’. [IFRS 2.28]. The significance of this is that the terms
of many share-based awards provide that they are, or can be, ‘cancelled’, in a legal sense,
on forfeiture. IFRS 2 is clarifying that, where an award is forfeited (within the meaning
of that term in IFRS 2 – see 6.1.2 above), the entity should apply the accounting
treatment for a forfeiture (i.e. reversal of expense previously recognised), even if the
award is legally cancelled as a consequence of the forfeiture.
7.4.1.A
Termination of employment by entity
Based on the guidance in paragraph 28 of IFRS 2 referred to at 7.4.1 above, it might not
always be immediately clear whether cancellation or forfeiture has occurred,
particularly where options lapse as the result of a termination of employment by the
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entity. For example, an entity might grant options to an employee at the beginning of
year 1 on condition of his remaining in employment until at least the end of year 3.
During year 2, however, economic conditions require the entity to make a number of
its personnel, including that employee, redundant, as a result of which his options lapse.
Is this lapse a forfeiture or a cancellation for the purposes of IFRS 2?
The uncertainty arises because it could be argued either that the employee will be
unable to deliver the services required in order for the options to vest (suggesting a
forfeiture) or that the options lapse as a direct result of the employer’s actions
(suggesting a cancellation).
The IASB addressed this question by amending the definition of ‘service condition’ in
IFRS 2 (see 3.1 above). The definition includes the following guidance:
‘... If the counterparty, regardless of the reason, ceases to provide service during the
vesting period, it has failed to satisfy the condition. ...’ [IFRS 2 Appendix A].
Therefore, IFRS 2 requires the failure to satisfy a service condition as the result of any
termination of employment to be accounted for as a forfeiture rather than as a
cancellation.
7.4.1.B
Surrender of award by employee
It is sometimes the case that an employee, often a member of senior management,
will decide – or be encouraged by the entity – to surrender awards during the
vesting period. The question arises as to whether this should be treated as a
cancellation or forfeiture for accounting purposes. IFRS 2 allows forfeiture
accounting, and the consequent reversal of any cumulative expense, only in
situations where vesting conditions are not satisfied. A situation where the
counterparty voluntarily surrenders an award, and therefore the opportunity to
meet the vesting conditions, is a decision within the control of the counterparty
rather than a failure to satisfy a vesting condition and should be accounted for as a
cancellation rather than as a forfeiture.
In its amendment of IFRS 2 (as discussed at 7.4.1.A above), we do not believe that the
IASB’s intention was to allow an employee to ‘fail’ to meet a service condition by
voluntarily surrendering an award. Such an action should therefore continue to be
treated as a cancellation rather than as a forfeiture.
7.4.2
Distinction between cancellation and modification
One general issue raised by IFRS 2 is where the boundary lies between ‘modification’
of an award in the entity’s favour and outright cancellation of the award. As a matter of
legal form, the difference is obvious. However, if an entity were to modify an award in
such a way that there was no realistic chance of it ever vesting (for example, by
introducing a requirement that the share price increase 1,000,000 times by vesting date),
some might argue that this amounts to a de facto cancellation of the award. The
significance of the distinction is that, whereas the cost of a ‘modified’ award continues
to be recognised on a periodic basis over the vesting period (see 7.3 above), the
remaining cost of a cancelled award is recognised immediately.
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7.4.3
Calculation of the expense on cancellation
The basic accounting treatment for a cancellation and settlement is illustrated in
Example 30.27 below.
Example 30.27: Cancellation and settlement – basic accounting treatment
At the start of year 1 an entity grants an executive 30,000 options on condition that she remain in employment
for three years. Each option is determined to have a fair value of $10.
At the end of year 1, the executive is still in employment and the entity charges an IFRS 2 expense of
>
$100,000 (30,000 × $10 × 1/3). At the end of year 2, the executive is still in employment. However, the
entity’s share price has suffered a decline which the entity does not expect to have reversed by the end of
year 3, such that the options, while still ‘in the money’ now have a fair value of only $6. Moreover, the entity
is under pressure from major shareholders to end option schemes with no performance criteria other than
continuing employment.
Accordingly, the entity cancels the options at the end of year 2 and in compensation pays the executive $6.50
per option cancelled, a total payment of $195,000 (30,000 options × $6.50).
IFRS 2 first requires the entity to record a cost as if the options had vested immediately. The total cumulative
cost for the award must be $300,000 (30,000 options × $10). $100,000 was recognised in year 1, so that an
additional cost of $200,000 is recognised.
As regards the compensation payment, the fair value of the awards cancelled is $180,000 (30,000 options ×
$6.00). Accordingly, $180,000 of the payment is accounted for as a deduction from equity, with the remaining
payment in excess of fair value, $15,000, charged to profit or loss.
The net effect of this is that an award that ultimately results in a cash payment to the executive of only $195,000
(i.e. $6.50 per option) has resulted in a total charge to profit or loss of $315,000 (i.e. $10.50 per option,
representing $10 grant date fair value + $6.50 compensation payment – $6.00 cancellation date fair value).
Example 30.27 illustrates the basic calculation of the cancellation ‘charge’ required by
IFRS 2. In more complex situations, however, the amount of the ‘charge’ may not be so
clear-cut, due to an ambiguity in the drafting of paragraph 28(a) of the standard, which
reads as follows:
‘the entity shall account for the cancellation or settlement as an acceleration of
vesting, and shall therefore recognise immediately the amount that would
otherwise have been recognised for services received over the remainder of the
vesting period.’ [IFRS 2.28(a)].
There is something of a contradiction within this requirement as illustrated by
Example 30.28.
Example 30.28: Cancellation and settlement – best estimate of cancellation expense
At the beginning of year 1, entity A granted 150 employees an award of free shares, with a grant date fair
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 519
