International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards
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component at modification date) is recognised as a transfer from equity to liabilities, the entry being:
$
$
Equity 166,667
Liability
166,667
In year 3 an expense of $110,000 is recognised as the final portion of the original grant date fair value. In
addition to this, the liability is remeasured from its modification date value of $250,000 ($25 × 10,000 shares)
to its settlement date value of $220,000 ($22 × 10,000 shares) resulting in a credit of $30,000 to profit or loss.
This results in the following accounting entry for the expense in year 3:
$
$
Profit or loss
80,000*
Liability 53,333†
Equity 26,667‡
*
((10,000 shares × $33 × 3/3) – ($220,000 expensed to date)) less the remeasurement of $30,000.
†
Carried forward liability $220,000 (10,000 shares × year 3 fair value $22) less the brought forward
liability $166,667.
‡ Balancing
figure.
The implementation guidance to IFRS 2 analyses the $300,000 total expense over the three years as the grant
date fair value of the award ($330,000) less the movement in the fair value of the liability alternative ($30,000,
being the fair value of $250,000 at the end of year 2 less the fair value of $220,000 at vesting).
IG Example 9 only illustrates a situation where the grant date fair value of the equity-
settled award exceeds the modification date fair value of both the equity and cash
alternatives and the settlement date value of the cash alternative. In Example 30.39
at 9.4.1 above we consider alternative scenarios, including one where the modification
date fair value exceeds the grant date fair value.
Share-based
payment
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10.1.5
‘Backstop’ cash settlement rights
Some schemes may provide cash settlement rights to the holder so as to cover more or
less remote contingencies. For example, an employee whose nationality and/or country
of permanent residence is different from the jurisdiction of the reporting entity may be
offered the option of cash settlement in case unforeseen future events make the transfer
of equity from the entity’s jurisdiction, or the holding or trading of it in the employee’s
country, inconvenient or impossible.
If the terms of the award provide the employee with a general right of cash-settlement,
IFRS 2 requires the award to be treated as cash-settled. This is the case even if the right
of cash settlement is extremely unlikely to be exercised (e.g. because it would give rise
to adverse tax consequences for the employee as compared with equity settlement). If,
however, the right to cash-settlement is exercisable only in specific circumstances, a
more detailed analysis may be required (see 10.3 below).
10.1.6
Convertible bonds issued to acquire goods or services
In some jurisdictions entities issue convertible bonds to employees or other
counterparties in exchange for goods or services. When this occurs, the bond will
generally be accounted for under IFRS 2 rather than IAS 32 since it falls within the scope
of IFRS 2 as a transaction ‘in which the entity receives or acquires goods or services and
the terms of the arrangement provide either the entity or the supplier of those goods or
services with a choice of whether the entity settles the transaction in cash (or other assets)
or by issuing equity instruments’ (see 2.2.1 and 2.2.2 above). [IFRS 2.2(c)].
As noted at 10.1 above, the methodology for splitting such an instrument into its liability
and equity components under IFRS 2 differs from that under IAS 32. Moreover, under
IAS 32 a convertible instrument is (broadly) recognised at fair value on the date of issue,
whereas under IFRS 2 the fair value is accrued over time if the arrangement includes
the rendering of services after the date of grant.
It is therefore possible that, if an entity has issued to employees convertible bonds that
have also been issued in the market, the accounting treatment of the bonds issued to
employees will differ significantly from that of the bonds issued in the market.
Where a convertible instrument is issued to an employee, the IFRS 2 expense will be
based on the fair value of the instrument. However, if an entity issues a convertible
instrument to a non-employee in return for an asset, for example a property, the entity
will initially recognise a liability component at fair value and an equity component based
on the difference between the fair value of the property and the fair value of the liability
component. [IFRS 2.35]. If the fair value of the property were lower than the fair value of
the instrument as a whole then, in our view, the entity should also recognise the shortfall
in accordance with the requirements of IFRS 2 for unidentified goods or services.
[IFRS 2.13A]. In the case of the acquisition of an asset, it is possible that this additional
debit could be capitalised as part of the cost of the asset under IAS 16 – Property, Plant
and Equipment – but in other cases it would be expensed.
After the initial IFRS 2 accounting outlined above, the question arises as to whether the
subsequent accounting for the convertible instrument should be in accordance with
IFRS 2 or IFRS 9. In our view, the instrument should generally continue to be accounted
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for under IFRS 2 until shares or cash are delivered to the counterparty. However, if the
vested instrument were freely transferable or tradeable prior to conversion or
settlement then a switch to IFRS 9 might be appropriate following transfer to a different
counterparty (if considered practical to apply) – see also the discussion at 2.2.2.E above.
10.2 Transactions where the entity has choice of settlement in equity
or in cash
The accounting treatment for transactions where the entity has choice of settlement is
quite different from transactions where the counterparty has choice of settlement, in that:
• where the counterparty has choice of settlement, a liability component and an
equity component are identified (see 10.1 above); whereas
• where the entity has choice of settlement, the accounting treatment is binary – in
other words the whole transaction is treated either as cash-settled or as equity-
settled, depending on whether or not the entity has a present obligation to settle in
cash, [IFRS 2.41], determined according to the criteria discussed in 10.2.1 below.
10.2.1
Transactions treated as cash-settled
IFRS 2 requires a transaction to be treated as a liability (and accounted for using the
rules for cash-settled transactions discussed in 9 above) if:
(a) the choice of settlement has no commercial substance (for example, because the
entity is legally prohibited from issuing shares);
(b) the entity has a past practice or stated policy of settling in cash; or
(c) the entity generally settles in cash whenever the counterparty asks for cash
settlement. [IFRS 2.41-42].
These criteria are fundamentally different from those in IAS 32 for derivatives over own
shares (which is what cash-settled share-based payment transactions are) not within the
scope of
IFRS 2. IAS 32 rejects an approach based on past practice or intention and
broadly requires all derivatives over own equity that could result in an exchange by the
reporting entity of anything other than a fixed number of shares for a fixed amount of
cash to be treated as giving rise to a financial instrument (see Chapter 43 at 4).
An important practical effect of the IFRS 2 criteria is that some schemes that may appear
at first sight to be equity-settled may in fact have to be treated as cash-settled. For example,
if an entity has consistently adopted a policy of granting ex gratia cash compensation to all
those deemed to be ‘good’ leavers (or all ‘good’ leavers of certain seniority) in respect of
partially vested share options, such a scheme may well be treated as cash-settled for the
purposes of IFRS 2 to the extent to which there are expected to be such ‘good’ leavers
during the vesting period. ‘Good leaver’ arrangements are also discussed at 5.3.9 above.
Another common example is that an entity may have a global share scheme with an
entity option for cash settlement which it always exercises in respect of awards to
employees in jurisdictions where it is difficult or illegal to hold shares in the parent. Such
a scheme should be treated as a cash-settled scheme in respect of those jurisdictions.
However, in our view, it would be appropriate to account for the scheme in other
jurisdictions as equity-settled (provided of course that none of the criteria in (a) to (c)
above applied in those jurisdictions).
Share-based
payment
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Where an entity has accounted for a transaction as cash-settled, IFRS 2 gives no specific
guidance as to the accounting treatment on settlement, but it is clear from other provisions
of IFRS 2 that the liability should be remeasured to fair value at settlement date and:
• if cash-settlement occurs, the cash paid is applied to reduce the liability; and
• if equity-settlement occurs, the liability is transferred into equity (see 10.1.3.B above).
10.2.1.A
Entity choice has no substance due to economic or other compulsion for
cash settlement (including unlisted entity awards with a presumption of
cash settlement)
Some awards may nominally give the reporting entity the choice of settling in cash or
equity, while in practice giving rise to an economic compulsion to settle only in cash. In
addition to the examples mentioned at 10.2.1 above, this will often be the case where an
entity that is a subsidiary or owned by a small number of individuals, such as members
of the same family, grants options to employees. In such cases there will normally be a
very strong presumption that the entity will settle in cash in order to avoid diluting the
existing owners’ interests. Similarly, where the entity is not listed, there is little real
benefit for an employee in receiving a share that cannot be realised except when
another shareholder wishes to buy it or there is a change in ownership of the business
as a whole.
In our view, such schemes are generally most appropriately accounted for as cash-settled
schemes from inception. In any event, once the scheme has been operating for a while, it
is likely that there will be a past practice of cash settlement such that the scheme is required
to be treated as a liability under the general provisions of IFRS 2 summarised above.
A similar conclusion is often reached even where the terms of the agreement do not
appear to offer the entity a choice of settling the award in cash but it has established a
constructive obligation or a past practice of so doing (see 9.2.1 above).
10.2.2
Transactions treated as equity-settled
A transaction not meeting the criteria in 10.2.1 above to be treated as cash-settled should
be accounted for as an equity-settled transaction using the rules for such transactions
discussed in 4 to 8 above. [IFRS 2.43].
However, when the transaction is settled the following approach is adopted:
(a) if the entity chooses to settle in cash, the cash payment is accounted for as the
repurchase of an equity interest, i.e. as a deduction from equity, except as noted in
(c) below;
(b) if the entity chooses to settle by issuing equity instruments, no further accounting
is required (other than a transfer from one component of equity to another, if
necessary), except as noted in (c) below;
(c) if the entity chooses the settlement alternative with the higher fair value, as at the
date of settlement, the entity recognises an additional expense for the excess value
given, i.e. the difference between the cash paid and the fair value of the equity
instruments that would otherwise have been issued, or the difference between the
fair value of the equity instruments issued and the amount of cash that would
otherwise have been paid, whichever is applicable. [IFRS 2.43].
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This is illustrated in Examples 30.43 and 30.44 below.
Example 30.43: Settlement of transaction treated as equity-settled where fair
value of cash settlement exceeds fair value of equity settlement
An entity has accounted for a share-based payment transaction where it has the choice of settlement as an
equity-settled transaction, and has recognised a cumulative expense of £1,000 based on the fair value at
grant date.
At settlement date the fair value of the equity-settlement option is £1,700 and that of the cash-settlement
option £2,000. If the entity settles in equity, no further accounting entry is required by IFRS 2. However,
either at the entity’s discretion or in compliance with local legal requirements, there may be a transfer within
equity of the £1,000 credited to equity during the vesting period.
If the entity settles in cash, the entity must recognise an additional expense of £300, being the difference
between the fair value of the equity-settlement option (£1,700) and that of the cash-settlement option (£2,000).
The accounting entry is:
£
£
Profit or loss (employee costs)
300
Equity 1,700
Cash
2,000
Example 30.44: Settlement of transaction treated as equity-settled where fair
value of equity settlement exceeds fair value of cash settlement
As in Example 30.43, an entity has accounted for a share-based payment transaction where it has the choice
of settlement as an equity-settled transaction, and has recognised a cumulative expense of £1,000 based on
the fair value at grant date.
In this case, however, at settlement date the fair value of the equity-settlement option is £2,000 and that of
the cash-settlement option £1,700. If the entity chooses to settle in equity, it must recognise an additional
expense of £300, being the difference between fair value of the equity-settlement option (£2,000) and that of
the cash-settlement option (£1,700). The accounting entry is:
£
£
Profit or loss (employee costs)
300
Equity
300
No further accounting entry is required by IFRS 2. However, either at the entity’s discretion or in compliance
with local legal requirements, there may be a transfer within equity of the £1,300 credited during the vesting
period and on settlement.
If the entity settles in cash, no extra expense is recognised, and the accounting entry is:
£
£
Equity 1,700
Cash
1,700
It can be seen in this case that, if the transaction is settled in equity, an additional
expense is recognised. If, however, the transaction had simply been an equity-settled
transaction (i.e. with no cash alternative), there would have been no additional expense
on settlement and the cumulative expense would have been only £1,000 based on the
fair value at grant date.
Share-based
payment
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10.2.3
Change in entity’s settlement policy or intention leading to change in
classification of award after grant date
IFRS 2 does not specify whether a transaction where the entity has a choice of
settlement in equity or cash should be assessed as equity-settled or cash-settled only at
the inception of the transaction or also at each reporting date until it is settled.
However, in describing the accounting treatment IFRS 2 states several times that the
accounting depends on whether the entity ‘has a present obligation to settle in cash’. In
our view, this suggests that IFRS 2 intends the position to be reviewed at each reporting
date and not just considered at the inception of the transaction.
IFRS 2 does not specify how to account for a change in classification resulting from a
change in the entity’s policy or intention. In our view, the most appropriate treatment
is to account for such a change as if it were a modification of the manner of settlement
of the award (see 9.4 above). Where the entity is able to choose the manner of
settlement, the substance of the situation is the same as a decision to modify the manner
of settlement of an award which does not already give the entity a choice. These
situations are distinct from those where the manner of settlement depends on the
outcome of a contingent event outside the entity’s control (see 10.3 below).
10.3 Awards requiring cash or equity settlement in specific
circumstances (awards with contingent cash or contingent