for, by analogy, in accordance with the compound instrument approach set out in
paragraphs 35 to 40 of IFRS 2, noting that this would also be consistent with the
requirements for contingent settlement provisions in IAS 32.32
The topic was discussed again by the IASB in April 2014 when, notwithstanding the
diversity in practice, the Board decided not to propose an amendment to IFRS 2 for this
issue. Some IASB members were concerned that the suggested amendment would
introduce a principle for distinguishing between a liability and equity in IFRS 2 that
would be inconsistent with the requirements of IAS 32 and also noted that the definition
of a liability was being discussed as part of the Conceptual Framework project (see
Chapter 2).33
The IASB revised the Conceptual Framework in 2018 without addressing this specific
issue; the boundary between liabilities and equity will be further explored by the IASB
in its research project on Financial Instruments with Characteristics of Equity (see 1.4.1
above). Until such time as any revised guidance is issued, we expect Approach 1 or
Approach 2, as outlined at 10.3.1 and 10.3.2 above, to continue to be applied.
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payment
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10.4 Cash settlement alternative where cash sum is not based on
share price or value
Some awards may provide a cash-settlement alternative that is not based on the share
price. For example, an employee might be offered a choice between 500 shares or
€1,000,000 on the vesting of an award. Whilst an award of €1,000,000, if considered in
isolation, would obviously not be a share-based payment transaction, it nevertheless falls
within the scope of IFRS 2, rather than – say – IAS 19, if it is offered as an alternative to
a transaction that is within the scope of IFRS 2. The Basis for Conclusions to IFRS 2 states
that the cash alternative may be fixed or variable and, if variable, may be determinable in
a manner that is related, or unrelated, to the price of the entity’s shares. [IFRS 2.BC256].
11
REPLACEMENT SHARE-BASED PAYMENT AWARDS
ISSUED IN A BUSINESS COMBINATION
11.1 Background
It is frequently the case that an entity (A) acquires another (B) which, at the time of the
business combination, has outstanding employee share options or other share-based
awards. If no action were taken by A, employees of B would be entitled, once any
vesting conditions had been satisfied, to shares in B. This is not a very satisfactory
outcome for either party: A now has non-controlling (minority) shareholders in
subsidiary B, which was previously wholly-owned, and the employees of B are the
owners of unmarketable shares in an effectively wholly-owned subsidiary.
The obvious solution, adopted in the majority of cases, is for some mechanism to be put
in place such that the employees of B end up holding shares in the new parent A. This
can be achieved, for example, by:
• A granting options over its own shares to the employees of B in exchange for the
surrender of the employees’ options over the shares of B; or
• changing the terms of the options so that they are over a special class of shares in B
which are mandatorily convertible into shares of A.
This raises the question of how such a substitution transaction should be accounted for
in the consolidated financial statements of A (the treatment in the single entity financial
statements of B is discussed at 11.4 below).
IFRS 3 addresses the accounting treatment required in a business combination where
an acquirer:
• replaces acquiree awards on a mandatory basis (see 11.2.1 below);
• replaces acquiree awards on a voluntary basis, even if the acquiree awards would
not expire as a consequence of the business combination (see 11.2.2 below); or
• does not replace acquiree awards (see 11.3 below).
Section 11 relates only to business combinations. Share-based payment arrangements in
the context of group reorganisations are addressed at 12.8 below.
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11.2 Replacement awards in business combinations accounted for
under IFRS 3
A more comprehensive discussion of the requirements of IFRS 3 may be found in
Chapter 9.
IFRS 3 requires an acquirer to measure a liability or an equity instrument related to the
replacement of an acquiree’s share-based payment awards in accordance with IFRS 2,
rather than in accordance with the general principles of IFRS 3. References to the ‘fair
value’ of an award in the following discussion therefore mean the fair value determined
under IFRS 2, for which IFRS 3 uses the term ‘market-based measure’. The fair value
measurement is to be made as at the acquisition date determined in accordance with
IFRS 3. [IFRS 3.30].
IFRS 3 notes that a transaction entered into by or on behalf of the acquirer or
primarily for the benefit of the acquirer or the combined entity, rather than that of the
acquiree (or its former owners) before the combination, is likely to be a transaction
separate from the business combination itself. This includes a transaction that
remunerates employees or former owners of the acquiree for future services.
[IFRS 3.52]. Target entities will therefore need to consider carefully whether any
modifications to existing share-based payment arrangements in the period leading up
to the business combination are straightforward modifications by the target entity for
its own benefit or that of its owners at the time (and hence fully within the scope of
IFRS 2) or whether the changes need to be assessed under the guidance in IFRS 3
because they are for the benefit of the acquirer or the combined entity. The indicators
in paragraph B50 of IFRS 3 should be used to determine when the modification should
be measured and recognised. [IFRS 3.B50].
The Application Guidance in Appendix B to IFRS 3 and the illustrative examples
accompanying the standard explain how the general principle of paragraph 52 is to be
applied to replacement share-based payment transactions. Essentially, however, IFRS 3
appears to view an exchange of share options or other share-based payment awards in
conjunction with a business combination as a form of modification (see 7.3 above).
[IFRS 3.B56].
11.2.1
Awards that the acquirer is ‘obliged’ to replace
Where the acquirer is ‘obliged’ to replace the acquiree awards (see below), either all or
a portion of the fair value of the acquirer’s replacement awards forms part of the
consideration transferred in the business combination. [IFRS 3.B56].
IFRS 3 regards the acquirer as ‘obliged’ to replace the acquiree awards if the acquiree
or its employees have the ability to enforce replacement, for example if replacement is
required by:
• the terms of the acquisition agreement;
• the terms of the acquiree’s awards; or
• applicable laws or regulations. [IFRS 3.B56].
The required treatment of replacement awards may be summarised as follows:
Share-based
payment
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(a) at the date of acquisition, the fair values of the replacement award and the original
award are determined in accordance with IFRS 2;
> (b) the amount of the replacement award attributable to pre-combination service (and
therefore included as part of the consideration transferred for the business) is
determined by multiplying the fair value of the original award by the ratio of the vesting
period completed, as at the date of the business combination, to the greater of:
• the total vesting period, as determined at the date of the business combination
(being the period required to satisfy all vesting conditions, including
conditions added to, or removed from, the original award by the replacement
award); and
• the original vesting period; and
(c) any excess of the fair value of the replacement award over the amount determined
in (b) above is recognised as a post-combination remuneration expense, in
accordance with the normal principles of IFRS 2 (see 3 to 7 above). [IFRS 3.B57-59].
The requirements summarised in (a) to (c) above have the effect that any excess of the
fair value of the replacement award over the original award is recognised as a post-
combination remuneration expense. The requirement in (b) above has the effect that, if
the replacement award requires service in the period after the business combination, an
IFRS 2 cost is recognised in the post-combination period, even if the acquiree award
being replaced had fully vested at the date of acquisition. It also has the effect that if a
replacement award requires no service in the post-combination period, but the acquiree
award being replaced would have done so, a cost must be recognised in the post-
combination period. [IFRS 3.B59].
There is no specific guidance in IFRS 3 on how and when to recognise the post-
combination remuneration expense in the consolidated financial statements of the
acquirer. In our view, the expense should be recognised over the post-combination
vesting period of the replacement award in accordance with the general principles of
IFRS 2 (see 6.2 to 6.4 above).
The portions of the replacement award attributable to pre- and post-combination service
calculated in (b) and (c) above are calculated, under the normal principles of IFRS 2, based
on the best estimate of the number of awards expected to vest (or to be treated as vesting
by IFRS 2). Rather than being treated as adjustments to the consideration for the business
combination, any changes in estimates or forfeitures occurring after the acquisition date
are reflected in remuneration cost for the period in which the changes occur in
accordance with the normal principles of IFRS 2. Similarly, the effects of other post-
acquisition events, such as modifications or the outcome of performance conditions, are
accounted for in accordance with IFRS 2 as part of the determination of the remuneration
expense for the period in which such events occur. [IFRS 3.B60]. The application of these
requirements is discussed in more detail at 11.2.3 below.
The requirements above to split an award into pre-combination and post-combination
portions apply equally to equity-settled and cash-settled replacement awards. All changes
after the acquisition date in the fair value of cash-settled replacements awards and their
tax effects (recognised in accordance with IAS 12 – Income Taxes) are recognised in the
post-combination financial statements when the changes occur. [IFRS 3.B61-62]. IFRS 3 does
2684 Chapter 30
not specify where in the income statement any changes in the pre-combination element
of a cash-settled award should be reflected and, in the absence of clear guidance, an entity
will need to consider whether this is remuneration expense or whether it is closer to a
change in a liability for contingent consideration.
The treatment of the income tax effects of replacement share-based payment
transactions in a business combination is discussed further in Chapter 29 at 10.8.5.
11.2.1.A
Illustrative examples of awards that the acquirer is ‘obliged’ to replace
IFRS 3 provides some examples in support of the written guidance summarised above,
the substance of which is reproduced as Examples 30.45 to 30.48 below. [IFRS 3.IE61-71].
These deal with the following scenarios.
Is post-combination service required Has the acquiree award being
Example
for the replacement award?
replaced vested before the
combination?
Not required
Vested
30.45
Not required
Not vested
30.46
Required Vested
30.47
Required Not
vested
30.48
In all the examples, it is assumed that the replacement award is equity-settled.
Example 30.45: Replacement award requiring no post-combination service
replacing vested acquiree award
Entity A acquires Entity B and issues replacement awards with a fair value at the acquisition date of
€1.1 million for awards of Entity B with a fair value at the acquisition date of €1.0 million. No post-
combination services are required for the replacement awards and Entity B’s employees had rendered all of
the required service for the acquiree awards as of the acquisition date.
The amount attributable to pre-combination service, and therefore included in the consideration transferred
in the business combination, is the fair value of Entity B’s awards at the acquisition date (€1.0 million). The
amount attributable to post-combination service is €0.1 million, the difference between the total value of the
replacement awards (€1.1 million) and the portion attributable to pre-combination service (€1.0 million).
Because no post-combination service is required for the replacement awards, Entity A immediately
recognises €0.1 million as remuneration cost in its post-combination financial statements.
Example 30.46: Replacement award requiring no post-combination service
replacing unvested acquiree award
Entity A acquires Entity B and issues replacement awards with a fair value at the acquisition date of
€1.0 million for awards of Entity B also with a fair value at the acquisition date of €1.0 million. When
originally granted, the awards of Entity B had a vesting period of four years and, as of the acquisition date,
the employees of Entity B had rendered two years’ service. The replacement award vests in full immediately.
The portion of the fair value of the replacement awards attributable to pre-combination services is the fair
value of the award of Entity B being replaced (€1 million) multiplied by the ratio of the pre-combination
vesting period (two years) to the greater of the total vesting period (now two years) and the original vesting
period of Entity B’s award (four years). Thus, €0.5 million (€1.0 million × 2/4 years) is attributable to pre-
combination service and therefore included in the consideration transferred for the acquiree. The remaining
€0.5 million is attributable to post-combination service, but, because no post-combination service is required
for the replacement award to vest, Entity A recognises the entire €0.5 million immediately as remuneration
cost in the post-combination financial statements.
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Example 30.47: Replacement award requiring post-combination service replacing
vested acquiree a
ward
Entity A acquires Entity B and issues replacement awards with a fair value at the acquisition date of
€1.0 million for awards of Entity B also with a fair value at the acquisition date of €1.0 million. The
replacement awards require one year of post-combination service. The awards of Entity B being replaced had
a vesting period of four years. As of the acquisition date, employees of Entity B holding unexercised vested
awards had rendered a total of seven years of service since the grant date.
Even though the Entity B employees have already rendered all of the service for their original awards,
Entity A attributes a portion of the replacement award to post-combination remuneration cost, because the
replacement awards require one year of post-combination service. The total vesting period is five years – the
vesting period for the original Entity B award completed before the acquisition date (four years) plus the
vesting period for the replacement award (one year). The fact that the employees have rendered seven years
of service in total in the pre-combination period is not relevant to the calculation because only four years of
that service were necessary in order to earn the original award.
The portion attributable to pre-combination services equals the fair value of the award of Entity B being
replaced (€1 million) multiplied by the ratio of the pre-combination vesting period (four years) to the total
vesting period (five years). Thus, €0.8 million (€1.0 million × 4/5 years) is attributed to the pre-combination
vesting period and therefore included in the consideration transferred in the business combination. The
remaining €0.2 million is attributed to the post-combination vesting period and is recognised as remuneration
cost in Entity A’s post-combination financial statements in accordance with IFRS 2, over the remaining one
year vesting period.
Example 30.48: Replacement award requiring post-combination service replacing
unvested acquiree award
Entity A acquires Entity B and issues replacement awards with a fair value at the acquisition date of
€1.0 million for awards of Entity B also with a fair value at the acquisition date of €1.0 million. The
replacement awards require one year of post-combination service. When originally granted, the awards of
Entity B being replaced had a vesting period of four years and, as of the acquisition date, the employees had
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 535
