IFRS 2: share-based payment

Many companies pay staff, directors and suppliers in shares or share options instead of cash. No cash leaves the business, so it can look as if the arrangement costs nothing. But the company has received something of value, the work or the goods, and has given something in return, a claim on its own equity. If a cash bonus is an expense, a share bonus must be one too.

International Financial Reporting Standard (IFRS) 2, Share-based Payment, makes sure of this.

This topic covers the scope and types of share-based payment, the key dates, equity-settled awards and vesting conditions, cash-settled awards, awards with a choice of settlement, modifications, cancellations and replacements, group schemes, the deferred tax effect and disclosure. The next topic covers fair value measurement under IFRS 13, which does not apply to IFRS 2 itself. The two latest Pathfinders had no stand-alone IFRS 2 question that we could identify.

Key terms in plain English

Syllabus check

IFRS 2 is examinable under syllabus area B. This topic covers:

• classification as equity-settled, cash-settled or with a choice of settlement;
• measurement dates, vesting conditions and recognition over the vesting period;
• modifications, cancellations and replacements;
• group and treasury share arrangements, and deferred tax;
• disclosure.

CAMA 2020 and share-based payment

The Companies and Allied Matters Act 2020 (CAMA 2020) requires statements that follow IFRS and give a true and fair view.

Scope and the three types

IFRS 2 applies to all share-based payment transactions, with three exclusions: transactions with a party acting only as a shareholder (for example a rights issue), shares issued to acquire a business (IFRS 3), and certain contracts for non-financial items that fall under International Accounting Standard (IAS) 32 or IFRS 9.

Goods or services are recognised as they are received. They are an expense unless they qualify as an asset under another standard.

Fair value under IFRS 2 is not the IFRS 13 fair value. IFRS 2 has its own measurement rules, so IFRS 13 does not apply to share-based payments.

Equity-settled awards

How and when to measure

• Employees (and similar): measure indirectly, using the fair value of the equity instruments granted at the grant date.
• Other suppliers: measure directly, using the fair value of the goods or services received at the date they are received, unless that cannot be measured reliably. Then use the fair value of the equity instruments.

Fair value of shares and options

Shares: the market price (adjusted for terms such as no dividends before vesting). Options: an option-pricing model (such as Black-Scholes or a binomial model) using the exercise price, share price, expected volatility, expected life, expected dividends and the risk-free rate. The fair value of an option has two parts: intrinsic value (the gain if exercised now) and time value (the chance of a greater gain before expiry). In the exam you are normally given the fair value.

Recognition

• If the award vests immediately, recognise the full cost at once.
• If it has vesting conditions, spread the cost over the vesting period.
• At each year end, cumulative expense = best estimate of the number of awards expected to vest × grant-date fair value × the fraction of the vesting period that has passed. The charge for the year is the cumulative expense less the amount already recognised. Credit equity.

Types of condition

After vesting, total equity is not adjusted if vested awards lapse unexercised. A transfer between components of equity is allowed.

Note: ICAN’s notes call all of these “vesting conditions”, but IFRS 2 treats non-vesting conditions separately.

Cash-settled awards

Examples are share appreciation rights and rights to redeemable shares. The entity records the services received and a liability at its fair value. The liability is remeasured at each reporting date and at settlement, with changes in profit or loss. The cost is spread over the vesting period in the same way as for equity-settled awards, and vesting conditions are handled in the same way.

Each year: liability at year end = expected number to vest × current fair value × fraction of vesting period elapsed (for rights still unvested). After vesting, the liability is rights outstanding × current fair value. Expense for the year = closing liability + cash paid in the year − opening liability.

Net settlement for tax

If the entity withholds shares to pay the employee’s tax to the tax authority, the whole award is still classified as equity-settled if it would have been without the net settlement feature.

Change from cash-settled to equity-settled

At the date of modification, measure the equity-settled award at the fair value of the equity instruments granted, derecognise the liability, recognise equity for the services rendered to that date, and take any difference to profit or loss immediately.

Choice of settlement

On settlement, if shares are issued the liability is transferred to equity. If cash is paid, any equity component stays in equity. If the entity chooses the alternative with the higher fair value, the excess is an additional expense.

Modifications, cancellations and replacements

• Modification that increases fair value (for example repricing): keep recognising the original grant-date fair value over the original vesting period, and recognise the incremental fair value (fair value of the modified award less fair value of the original, both at the modification date) over the remaining vesting period.
• Modification that reduces fair value, or reduces the number of options: ignore the reduction and keep recognising the original grant-date cost. (A reduction in the number is a partial cancellation.)
• Cancellation or settlement during the vesting period: treat as accelerated vesting. Recognise immediately the amount that would have been recognised over the rest of the vesting period. This applies whoever cancels (entity or employee).
• Payment on cancellation: deduct it from equity as a repurchase, up to the fair value of the options repurchased. Any excess is an expense.
• Replacement: if new awards are identified as replacing the cancelled ones, treat it as a modification. The incremental fair value is the fair value of the replacement less the net fair value of the cancelled award at the date of replacement.

Group schemes and other points

• The entity that receives the services accounts for them, even if another group entity pays. It treats the arrangement as equity-settled if the award is in its own equity or it has no obligation to settle. Otherwise it is cash-settled.
• The entity that settles accounts for it as equity-settled if it settles in its own equity instruments, otherwise as cash-settled.
• If a parent grants its own shares to employees of a subsidiary, the subsidiary records an expense and a credit to equity (a capital contribution from the parent). The parent records an increase in its investment in the subsidiary and a credit to equity. In the consolidated statements the arrangement is equity-settled. If the parent pays cash, the parent and group show a liability, and the subsidiary records equity.
• If the fair value of identifiable goods or services received is less than the fair value of the equity instruments granted, the difference is treated as unidentifiable services received and expensed. An example is shares given to a charity.
• An employee benefit trust that holds shares for a scheme is consolidated by the sponsor under IFRS 10. The shares it holds are treated as treasury shares.

Note: ICAN’s notes refer to SIC 12 for the trust. That interpretation has been replaced by IFRS 10, so we refer to IFRS 10.

Deferred tax on share-based payments

Tax relief for options often depends on the intrinsic value at exercise, not on the IFRS 2 expense. This creates a temporary difference. Under IAS 12:

• The carrying amount of the services received is nil. The tax base is the estimated future deduction (intrinsic value × options expected to vest) × the fraction of the vesting period elapsed.
• Deferred tax asset = temporary difference × tax rate.
• The deferred tax credit goes to profit or loss up to the tax effect of the cumulative IFRS 2 expense. Any excess goes directly to equity.
• On exercise, the deferred tax asset is replaced by current tax, with the same split.

Disclosure

Three areas:

• (1) the nature and extent of the schemes (descriptions, vesting conditions, a reconciliation of the number and weighted average exercise price of options outstanding, granted, forfeited, exercised, expired and exercisable, and the range of exercise prices and remaining life)
• (2) how fair value was determined (the model, the inputs, whether market conditions were included)
• (3) the effect on profit or loss and financial position (total expense, split between equity-settled and cash-settled, and the closing liability for cash-settled awards)

The rules in more depth

Why measure equity awards once

The entity gave up equity at a particular price at the grant date. Later share price moves are a matter between shareholders and the employees. They do not change what the entity paid for the services. A cash liability, in contrast, moves with the share price, so it is remeasured.

Why market conditions are not trued up

The chance of missing the target is already priced into the fair value. If the employee serves for the full period, the cost stays even if the share price target is missed.

Why modifications that lower value are ignored

An entity cannot reduce its expense by making an award less valuable after the event. It must continue to recognise at least the original grant-date cost.

Effect on analysis

Share-based pay is a real cost. Earnings before interest, tax, depreciation and amortisation that add it back overstate cash profit. Dilution also reduces earnings per share.

Worked examples

1. 2020: 7m × ₦3 × 1/3 = ₦7,000,000.
2. 2021: 8m × ₦3 × 2/3 = ₦16,000,000 cumulative.
   Charge = ₦9,000,000.
3. 2022: 8m × ₦3 = ₦24,000,000 cumulative.
   Charge = ₦8,000,000.
4. Each year: Dr employee cost; Cr share-based payment reserve. Later changes in the share price are ignored.

1. Year 1: 70% × 3m × ₦13 × 1/3 = ₦9,100,000.
2. Year 2: 90% × 3m × ₦13 × 2/3 = ₦23,400,000 cumulative.
   Charge = ₦14,300,000.
3. The inventory days are a non-market condition, so the number is trued up. The share price target is a market condition, so it is not.

1. Options expected to vest.
   800 × 500 = 400,000.
2. Total cost.
   400,000 × ₦4 = ₦1,600,000.
3. Year 1 charge = ₦1,600,000 × 1/4 = ₦400,000.

Note: ICAN’s worked example on these facts shows an annual charge of ₦100,000 and a total of ₦400,000. On ICAN’s own assumptions (800 employees staying, 500 options each, ₦4 fair value) the total is ₦1,600,000 and the annual charge is ₦400,000, so our figure is different. In the exam, show the number of options, the fair value and the fraction of the period in your workings.

1. Year 1: (500 − 110) × 100 × ₦15 × 1/3 = ₦195,000.
2. Year 2: original (500 − 105) × 100 × ₦15 × 2/3 = ₦395,000.
   Incremental = 395 × 100 × (₦8 − ₦5) × 1/2 = ₦59,250.
   Cumulative ₦454,250.
   Charge = ₦259,250.
3. Year 3: original 397 × 100 × ₦15 = ₦595,500.
   Incremental 397 × 100 × ₦3 = ₦119,100.
   Cumulative ₦714,600.
   Charge = ₦260,350.

1. Year 1: 400 × 100 × ₦10 × 1/5 = ₦80,000.
   Year 2: cumulative ₦160,000, so charge ₦80,000.
2. Year 3: accelerate the whole cost for the 460 in the scheme: 460 × 100 × ₦10 = ₦460,000.
   Charge = ₦460,000 − ₦160,000 = ₦300,000.
3. If cash were paid to employees on cancellation, deduct it from equity up to the fair value of the options repurchased, and expense any excess.

Total expense = ₦448,750, which equals the total cash paid (56,250 + 70,000 + 322,500).

1. Cash alternative at grant.
   800 × ₦6 = ₦4,800.
   Share alternative = 1,000 × ₦6 = ₦6,000.
   Equity component = ₦6,000 − ₦4,800 = ₦1,200.
2. Year 1 equity charge = ₦1,200 × 1/3 = ₦400 (fixed, not remeasured).
3. Year 1 liability = 800 × ₦7 × 1/3 = ₦1,866.67 (remeasured each year).
4. Total year 1 expense = ₦2,266.67.

Note: ICAN’s worked example on a similar choice (20,000 phantom shares, year-end fair value ₦6.10, three-year vesting) shows a liability expense of ₦48,800. The correct figure is 20,000 × ₦6.10 × 1/3 = ₦40,667, so ours is slightly different.

1. 2022: tax base = 5,000 × ₦1.20 × 1/2 = ₦3,000.
   Deferred tax asset = ₦900.
   The IFRS 2 expense is ₦7,500, so the whole ₦900 is a credit to profit or loss.
2. 2023: tax base = 5,000 × ₦3.40 = ₦17,000.
   Deferred tax asset = ₦5,100, an increase of ₦4,200.
   Cumulative IFRS 2 expense = ₦15,000, so the tax effect covered by expense is 30% × ₦15,000 = ₦4,500.
   Profit or loss credit for 2023 = ₦4,500 − ₦900 = ₦3,600.
   The excess ₦600 (30% × ₦2,000) is a credit to equity.
3. On exercise, reverse the deferred tax asset of ₦5,100 and recognise current tax relief of ₦5,100: ₦4,500 in profit or loss and ₦600 in equity.

Note: the table in ICAN’s notes shows the 2023 credit to profit or loss as ₦4,200 and to equity as ₦600, which add up to ₦4,800 and not the movement of ₦4,200. The correct split is ₦3,600 and ₦600, so ours is slightly different.

How to score full marks

• Classify the award (equity, cash or choice) and the counterparty (employee or supplier).
• State the measurement date and the fair value to be used.
• List the conditions and say which are in fair value and which change the number.
• Use a cumulative table: number × fair value × fraction of the period, less amounts already recognised.
• For cash-settled awards, remeasure the liability each year and add back cash paid.
• For changes, separate the original cost from the incremental cost, and say what happens on cancellation.
• Give the journal and the effect on profit or loss and equity.

Common mistakes in the exam

• Remeasuring the fair value of an equity-settled award each year.
• Reversing the cost when a market condition is not met.
• Not trueing up for leavers and non-market performance.
• Using the exercise date price instead of the grant-date fair value.
• Forgetting to deduct the amount already recognised.
• Not remeasuring a cash-settled liability, or leaving out the cash paid when computing the expense.
• Treating a repricing that lowers value as a reduction in the expense.
• Spreading the cost of a cancelled award instead of accelerating it.
• Applying IFRS 13 to the fair value of the award.

Quick revision

• Equity-settled: grant-date fair value, no remeasurement, spread over vesting, trued up for the number expected to vest.
• Market and non-vesting conditions are in fair value. Service and non-market performance conditions change the number.
• Cash-settled: liability remeasured at each reporting date and at settlement, changes in profit or loss.
• Choice: counterparty chooses means compound. Entity chooses means a present obligation test.
• Modification that increases fair value: incremental cost over the remaining period. Cancellation: accelerate.
• Deferred tax: tax base from intrinsic value, profit or loss up to the expense effect, excess to equity.
• CAMA 2020: ss. 377(1), 378, 374(1), 385, 404(7).

Practice questions

These are original questions written in the style of the Institute of Chartered Accountants of Nigeria (ICAN) exam. Try each one before you open the answer. Full model answers follow the written questions.

Recall check: multiple choice

The real ICAN paper has no multiple-choice section. These questions are for quick recall. The written questions that follow are closer to the exam.

Written questions

Model answers

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