Chapter 5: Share-based payments and distributable profits Flashcards
1.1 Objective and scope of IFRS 2 Share-based payments
Share-based transaction occurs when an entity transfers equity instruments, such as share options in exchange for goods and services supplied by employees or third parties. IFRS 2 applies to all share-based payments except:
- Transactions with employees in their capacity as a holder of equity instruments (when employee receives additional shares in a rights issue)
- Issue of equity instruments in exchange for control of another entity
- Contracts to buy or sell non-financial items that may be settled net in shares or rights to shares are covered by IFRS 9 Financial Instruments
IFRS 2 recognises three types of transactions according to the method of settlement:
- Equity-settled share-based payments: entity acquires goods or services in exchange for equity instruments of the entity.
- Cash-settled share-based payments: entity acquires goods or services in exchange for amounts of cash measured by reference to the entity’s share price.
- Transactions with a choice of settlement
2.1 Equity-settled transactions
Grant date is the date a share-based payment comes into existence. Vesting date is the date which the conditions associated with SBP are achieved, allowing access to the SBP. Vesting period from grant date to vesting date. Exercise date that an equity settled SBP is actually claimed. The total expense of the share option scheme is spread over the vesting period.
2.2 Accounting treatment
The double entry to record an equity settled SBP is as follows: Dr Expense or asset Cr Equity. The issues involves within this treatment are how the expense or asset can be measured and when the expense or asset should be recognised. There are two methods which are used for how the asset is measured:
- Direct method: used when transaction is with a third party.
- Indirect method: when transaction is with an employee. Measure the FV of the equity instrument at the date the option is granted using the option pricing model. This takes into account any expected market conditions.
2.3 When the expense or asset is recognised.
This depends on vesting conditions, which are conditions that must be met, in order for the employee or third party to be entitled to receive the share-based payment:
- No vesting conditions: recognised in the accounts immediately.
- Vesting conditions in place: expense spread over the vesting period.
2.4 Vesting conditions
As well as affecting when the expense is recognised, vesting conditions can also affect the value. There are two types:
- Non-market based: conditions unrelated to the market value of the share. These include completing a minimum service period required for employees, achieving sales or profit target or a specific earnings per share ratio and successfully completing a target. They impact the accounting treatment as fair value is still calculated at grant date. This FV is spread over the vesting period, but the value is revised each year to take into account the number of shares expected to vest. If the vesting conditions are not met, any recognised expense will be reversed.
- Market based: conditions linked to the price of the share. These include a minimum increase in the share price of the entity, minimum increase in shareholder return and a specific target price relative to an index of market prices. They impact the accounting treatment as market-based conditions are considered in the FV at the grant date and should be ignored when calculating the expense. This means, even if the market-based conditions is not expected to be met, an expense should continue to be recognised.
2.9 Exercising options.
When the options are exercised, the entity will receive cash from its employees, the value of the cash and the FV of the option together forms the value of the shares issued. The journal at the point of exercise is Dr Cash (proceeds at exercise price) Dr Equity (remove the balance created over the vesting period) Cr Share capital (nominal value of shares issued) Cr Share premium (balancing).
If the options are not exercised, then the balance in equity can be transferred to retained earnings: Dr Equity (remove the balance created over the vesting period) Cr Retained earnings.
2.10 Modifications/repricing
Equity instruments may be modified before they vest if, there is a change in the exercise price as a result of the share price being less than expected or a general fall in the stock market. The change in the exercise price will affect the FV of the option. If the fair value increases as a result of the change, then this increase must be recognised over the period from the modification date to the vesting date.
if modification occurs after the vesting date, then the additional fair value must be recognised immediately unless there is, an additional service period, in which case the difference is spread over the additional period.
2.11 Cancellation and settlement
Step One: if an equity instrument is settled or cancelled during the vesting period: the FV not yet recognised in the SPL should be recognised at that date.
Step Two: if on cancellation/settlement the entity makes a payment to the employees. This payment is treated as a share buyback: Dr Equity Cr Cash
If the payment is greater than FV of the option at date of cancellation, the excess should be recognised in the SPL. The excess above FV is considered compensation for the FV of the shares, and not for the options granted, so an extra expense is incurred. Dr Equity Dr SPL Cr Cash.
3.1 Cash-settled transactions
With a cash-settled transaction, the employee receives a bonus based upon the entity’s share price. This bonus is also referred as share appreciation rights. The double entry is Dr Expense in SPL and Cr Liability.
The amount is calculated as:
- Value the liability at the FV that is expected to be incurred when the share-based payment vests.
- This value is then spread over the vesting period.
- At year end, re-estimate the FV of the liability and post the entries accordingly.
4.1 Choice of settlement
The accounting treatment depends upon which party has the choice (the entity or the counterparty). When the entity has the choice, the treatment is determined whether there is an obligation to deliver cash:
- Obligation to deliver cash – treat as cash-settled.
- Obligation typically arises due to past practice regarding similar options leading to the entity settling with cash.
- No obligation to deliver cash – treated as equity-settled.
When the settlement is a third-party choice, the transaction is treated as a compound instrument. Split accounting is used, treat part as a liability and part equity:
- Equity element: recipient may demand settlement in equity instruments. Equity element is calculated as the FV per the equity-settled method at the grant date less the FV of the cash method at the grant date.
- Liability element: recipient may demand cash. Liability element is calculated as the FV per the cash-settled method (at the year-end)
Each value will be separately spread over the vesting period of the options. The steps are:
- Calculate FV per the equity-settled method at the grant date (A)
- Calculate FV of cash-settled method at the grant date (B)
- Fair value of equity-settled element (A-B)
- Recognise the cash-settled scheme across the vesting period, recognising the liability based on year-end FVs, and updating the expected number of vesters.
- Spread the FV of the equity-settled element at grant date (calculated in step 1) across the vesting period, updating the expected number of vestors.
When the indirect method is applied item A (in step 1) is the FV of the scheme at the grant date if equity settled. For the direct method, item A is the FV of the goods or services received.
5.1 Group and treasury share transactions: entity chooses/required to purchase its own shares.
An entity may grant rights to its own equity instruments to employees, and then either chooses to, or is required to buy those equity instruments from another party, in order to satisfy its obligations to its employees. These transactions should be accounted for as equity-settled share-based payment transactions under IFRS2.
5.2 Parent grants rights to its equity instruments to employees of its subsidiary
Assuming the transaction is equity-settled in the consolidated accounts, the subsidiary must measure the services received using the requirements for equity-settled transactions in IFRS 2 and must recognise a corresponding increase in equity as a contribution from the parent.
5.3 Subsidiary grants rights to equity instruments of its parent to its employees
The subsidiary accounts for the transaction as a cash-settled share-based payment transaction. Therefore, in its individual accounts, employees are granted rights to equity instruments of its parent would differ, depending on whether the parent or the subsidiary granted those rights to the subsidiary’s employees.
This is because, when the parent grants the rights, the subsidiary has not incurred a liability to transfer cash or other assets of the entity to its employees. When the subsidiary grants the rights, the subsidiary has incurred such a liability.
6.1 Audit and assurance implications of accounting for share-based payments
Audit risks Audit tests
FV of the option is difficult to determine Determine the basis on which the FV of the option has been calculated. If an option pricing model has been used, check it is appropriate and reflects the nature of the options. Obtain written representation from the directors to confirm the model is appropriate. Review correspondence with any external specialists. Recalculate the FV using the same inputs as the entity. Gain supporting evidence for the inputs to the model, e.g., share price, exercise price, time to expiry, volatility, interest rates
Number of options is incorrect Vouch the number of options to the scheme
Number of expected vesters is based on an estimate Ensure relevant employees are still employed and qualify for the scheme. Staff turnover should be discussed with HR. Compare last year’s estimate to actual leavers to ascertain accuracy of entity’s estimates
Undisclosed schemes Obtain written representation that there are no undisclosed schemes. Review board minutes for any modifications to schemes
7.1 Distributable profits
Profits available for dividend (distributable profits) are accumulated, realised profits less accumulated, realised profits.
- Accumulated: means the balance of profit or loss from previous years as well as profits from the current year
- Realised: when realised in the form of cash or when the realisation to cash is reasonably certain
The following are detailed rules from the CA 2006:
- A provision made in the accounts is a realised loss.
- A revaluation surplus is an unrealised profit.
- If NCA are revalued, and as a results depreciation increases, the additional depreciation may be treated as part of the realised profit for dividend purposes.
- On the disposal of a revalued asset, any unrealised surplus or loss on valuation immediately becomes realised.
- For financial instruments measured at FV, the gains/losses are considered to be realised if the FV was determined from an active market or using valuation techniques solely based on observable data.
