Share-based payments and distributable profits

Question 1

Objective and scope of IFRS 2 Share-based Payments

Answer 1

1.1 Objective
A 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 (e.g. suppliers).
IFRS 2 Share-based Payments requires an entity to reflect the effects of share-based
payments in its financial statements.
1.2 Scope
IFRS 2 Share-based Payments applies to all share-based payment transactions
except:
 Transactions with employees in their capacity as a holder of equity
instruments e.g. where an employee receives additional shares in a rights
issue to all shareholders.
 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 Share-based Payments recognises and addresses three types of
transactions according to the method of settlement:
 Equity-settled share-based payments – the entity acquires goods or services
in exchange for equity instruments of the entity.
 Cash-settled share-based payments – the 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.
IFRS 13 Fair Value Measurement does not apply to share-based payment
transactions within the scope of IFRS 2 Share-based Payments.

Question 2

Share-based payments and distributable profits: Equity-settled transactions 2.1 Definitions – share option schemes

Answer 2

Grant date – date that a share-based payment (typically options) comes into existence.
Vesting date – date from which the conditions associated with SBP are achieved, allowing access to the SBP.
Vesting period – period from grant date to vesting date.
Exercise date – date that an equity-settled SBP is actually claimed (exercised).

The total expense of the share option scheme is spread over the vesting period

Question 3

Share-based payments and distributable profits: Equity-settled transactions 2.1 Definitions – share option schemes 2.2 Accounting treatment

Answer 3

The double entry to record an equity-settled share-based payment is as follows:
Dr Expense or asset
Cr Equity

The issues involved within this treatment are:
 How should the expense or asset be measured?
 When should this expense or asset be recognised?

Question 4

Share-based payments and distributable profits: Equity-settled transactions 2.1 Definitions – share option schemes 2.3 How should the expense or asset be measured?

Answer 4

Is it direct or indirect?

There are two methods that can be used when valuing share-based payments
Direct method – this is used when the transaction is with a third
party (e.g. supplier).
Indirect method – this is used when the transaction is with an
employee

Question 5

Share-based payments and distributable profits: Equity-settled transactions 2.1 Definitions – share option schemes 2.4 Transactions with third parties

Answer 5

An example of a transaction with third parties would be if, instead of paying a supplier
in cash, an entity grants share options to the supplier. The share options are valued
by the direct method, which is the fair value of goods or services provided by the third
party.

Share option scheme with 3rd party? -> Direct method

Question 6

Share-based payments and distributable profits: Equity-settled transactions 2.1 Definitions – share option schemes 2.5 Transactions with employees

Answer 6

With employees it is much more difficult to measure directly the service received –
how much revenue does each individual employee add?
Therefore the indirect method is used:

Measure the fair value of the equity instrument at the date the option is granted
using the ‘option pricing model’, this takes into account any expected market
conditions.

Note: The fair value of the option at the grant date will be provided in the exam.

Share option scheme with employee? -> Indirect method

Question 7

Share-based payments and distributable profits: Equity-settled transactions 2.1 Definitions – share option schemes 2.6 When is the expense or asset recognised?

Answer 7

Recognition depends upon whether there are ‘vesting conditions’ in place.
Vesting conditions are the 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 – the expense or asset is recognised in the financialstatements immediately.

Vesting conditions in place – the expense must be spread over the ‘vesting period’

Question 8

Share-based payments and distributable profits: Equity-settled transactions 2.1 Definitions – share option schemes 2.7 Impact of vesting conditions

Answer 8

As well as affecting when the expense is recognised, vesting conditions can also
affect the value. There are two types of vesting condition:

1. Non-market based – which are conditions unrelated to the market value of the
share
Completing a minimum service period required for employees
Achieving a minimum sales or profit target
Achieving a specific earnings per share ratio
Successfully completing a particular project.

They affect the accounting treatment as follows:
Fair value is still calculated at the grant date.
This fair value is still 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 subsequently not met, any previously recognised expense will be reversed.

2. Market based – which are conditions linked to the price of the share.
A minimum increase in the share price of the entity
A minimum increase in the shareholder return
A specific target price relative to an index of market prices.

They affect the accounting treatment as follows:
Market based conditions are already considered in the FV at the grant date and should be ignored when calculating the expense.
This means that, even if the market based condition is not expected to be met, an expense should continue to be recognised.

Question 9

Share-based payments and distributable profits: Equity-settled transactions 2.1 Definitions – share option schemes 2.8 Variable vesting date

Answer 9

Calculations should be based on the expected vesting date.

Question 10

Share-based payments and distributable profits: Equity-settled transactions 2.9 Exercising options double entries

Answer 10

Cash, Equity, SC & SP (bal)

When the options are exercised, the entity will receive cash from its employees, the value of the cash and the fair value of the option together forms the value of the shares issued.

The journal at the point of exercise is as follows:

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 (β)

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

Question 11

Share-based payments and distributable profits: Equity-settled transactions 2.1 Definitions – share option schemes 2.10 Modifications/repricing

Answer 11

Over period to VESTING (ofc if after then, then immediately)

Equity instruments may be modified before they vest if, for example, 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 fair value of the option.

1. 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.
2. If modification occurs after the vesting date, then the additional fair value must be recognised immediately unless there is, for example, an additional service period, in which case the difference is spread over the additional period.

Question 12

Share-based payments and distributable profits: Equity-settled transactions 2.1 Definitions – share option schemes 2.11 Cancellation and settlement

Answer 12

STEP 1:
If an equity instrument is settled or cancelled during the vesting period:
The fair value not yet recognised in the statement of profit or loss should be recognised at that date.

STEP 2:
A. If on cancellation/settlement the entity makes a payment to the employees:
This payment is treated as a share buy back

Dr Equity
Cr Cash

B. If the payment is greater than the fair value of the option at the date of cancellation, the excess should be recognised in the statement of profit or loss. (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 Statement of profit or loss
Cr Cash

Question 13

Share-based payments and distributable profits: Equity-settled transactions Cash-settled transactions

Answer 13

With a cash-settled transaction, the employee receives a bonus based upon the entity’s share price. This bonus may also be referred to as ‘share appreciation rights’.

Accounting treatment
The double entry to record a cash-settled share-based payment is as follows:

Dr Expense in statement of profit or loss
Cr Liability

The amount is calculated as follows:
Value the liability at the fair value that is expected to be incurred when the share-based payment vests. This value is then spread over the vesting period.
At each year end, re-estimate the fair value of the liability and post the entries accordingly.

Basic treatment. Just fair value reviewed each year.

Question 14

Share-based payments and distributable profits: Choice of settlement

Answer 14

The accounting for share-based transactions with a choice of settlement depends
upon which party has the choice:
 The entity has the choice
 The counterparty has the choice.

Question 15

Share-based payments and distributable profits: Choice of settlement 4.1 Choice of settlement – entity choice

Answer 15

Is it going to be settled with CASH or not?

The accounting treatment is determined by whether there is an obligation to deliver cash:

1. Obligation to deliver cash – treat as cash-settled.
2. No obligation to deliver cash – treat as equity-settled.

Obligation typically arises due to past practice regarding similar options leading to the entity settling with cash.

Question 16

Share-based payments and distributable profits: Choice of settlement 4.2 Choice of settlement – third party choice

Answer 16

Compound instrument

The transaction is treated as a compound instrument.
Split accounting is used, treat part as a liability and treat part as equity:

Equity element – Recipient may demand settlement in equity instruments. The equity element is calculated as the fair value per the equity-settled method at the grant date less the fair value of the cash method at the grant date.

Liability element – Recipient may demand cash. The liability element is calculated as the fair value per the cash-settled method (at the year-end).

Each value will be separately spread over the vesting period of the options.

Steps
1 Calculate fair value per the equity-settled method at the grant date = A.
Calculate fair value of the cash-settled method at the grant date = B.
Fair value of equity-settled element = A – B.

2 Recognise the cash-settled scheme across the vesting period, recognising the liability based on year-end fair values, and updating the expected number of vesters.

3 Spread the fair value of the equity-settled element at grant date (calculated in step 1) across the vesting period, updating the expected number of vesters.

*Indirect v direct method: choice of settlement *
When the indirect method is applied (i.e. employee scheme) item A (in Step 1 above) is the fair value of the scheme at the grant date if equity-settled.
For the direct method, item A is the fair value of the goods or services received.

Question 17

Share-based payments and distributable profits: Disclosures

Answer 17

Share-based payments require the following disclosures:
 ‘description of each type of share-based payment
arrangement that existed any time in the accounting period’
(IFRS 2, para 45 (a))
– ‘number and weighted average exercise prices of share
options for each of the following groups of options:
(i) outstanding at the beginning of the period
(ii) granted during the period
(iii) forfeited during the period
(iv) exercised during the period
(v) expired during the period
(vi) outstanding at the end of the period, and
(vii) exercisable at the end of the period.’
(IFRS 2, para 45(b))
 Basis of fair value measurement for new and existing instruments.
 Total expense for the year arising from share-based payment transactions.

Question 18

Share-based payments and distributable profits: Group and treasury share
transactions 6.1 Entity chooses or is required to purchase its own shares

Answer 18

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 always be accounted for as equity-settled share-based
payment transactions under IFRS 2 Share-based Payments.

Question 19

Share-based payments and distributable profits: Group and treasury share
transactions 6.2 Parent grants rights to its equity instruments to employees of its
subsidiary

Answer 19

Assuming the transaction is accounted for as equity-settled in the consolidated
financial statements, the subsidiary must measure the services received using the
requirements for equity-settled transactions in IFRS 2 Share-based Payments, and
must recognise a corresponding increase in equity as a contribution from the parent.

Note: there is an example of this in the open book text. See IFRS book B, IFRS 2 IG, IG Example 14

Question 20

Share-based payments and distributable profits: Group and treasury share
transactions 6.3 Subsidiary grants rights to equity instruments of its parent to its
employees

Answer 20

The subsidiary accounts for the transaction as a cash-settled share-based payment
transaction.

Therefore, in the subsidiary’s individual financial statements, the accounting treatment of transactions in which a subsidiary’s 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 (being a liability to transfer equity instruments of its parent to its employees).

Question 21

Share-based payments and distributable profits: Audit and assurance implications of
accounting for share-based payments: Audit tests

Audit risks

FV of the option is difficult to
determine

Answer 21

 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

Question 22

Share-based payments and distributable profits: Audit and assurance implications of
accounting for share-based payments: Audit tests

Audit risks

Number of options is incorrect

Answer 22

 Vouch the number of options to the scheme

Question 23

Share-based payments and distributable profits: Audit and assurance implications of
accounting for share-based payments: Audit tests

Audit risks

Number of expected vesters is
based on an estimate

Answer 23

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

Question 24

Share-based payments and distributable profits: Audit and assurance implications of
accounting for share-based payments: Audit tests

Audit risks

Undisclosed schemes

Answer 24

Obtain written representation that there are
no undisclosed schemes
 Review board minutes for any modifications
to schemes

Question 25

Share-based payments and distributable profits: Distributable profits

Answer 25

Introduction
All companies, including private companies, are prohibited from paying dividends (making a distribution) except out of profits available for that purpose. Profits available for dividend (i.e. distributable profits) are accumulated, realised
profits less accumulated, realised losses.

The key words are:
Accumulated – which means that the balance of profit or loss from previous years must be taken into account as well as profits in the current period
Realised – when realised in the form of cash or when the realisation to cash is reasonably certain.

Generally distributable profits equate to the retained earnings balance but some adjustment may be required.
The distributable profit figure is calculated based on individual company financial statements rather than consolidated financial statements.

Question 26

Share-based payments and distributable profits: Distributable profits 8.2 Rules for all companies

Answer 26

The following are detailed rules from the Companies Act
2006:
 A provision made in the accounts is a realised loss.
 A revaluation surplus is an unrealised profit.
 If non-current assets are revalued and, as a result,
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.
 Note that 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.

Question 27

Share-based payments and distributable profits: Distributable profits 8.3 Revaluations

Answer 27

Gains: UNREALISED. Losses: REALISED. Unless reversing other type.

When a revaluation of non-current assets takes place:
 Gains are unrealised unless they reverse a loss previously treated as realised.
 Losses are realised except where the loss:
– Offsets a surplus on that asset
– Arises from a reassessment of the value of all non-current assets
– Arises from a reassessment of some non-current assets where the assets
not revalued are worth at least their book value.

Question 28

Share-based payments and distributable profits: 8.4 Additional rules for public companies

Answer 28

In addition to the rules set out above, a public company may not reduce its net assets below the aggregate amount of its called-up share capital and undistributable reserves.
i.e.

1. Net assets
   Less: Called-up share capital
   Less: Undistributable reserves

Undistributable reserves are:
The share premium account
Excess unrealised profits over unrealised losses
Any other reserve which the company is prohibited from distributing by any statute or by its memorandum or articles of association.

2. Distributable profits for a public company can also be calculated as follows:

Distributable profits for a private co (accumulated realised profits less accumulated realised losses)
Less: Excess of unrealised losses over unrealised profits (if any)

Both methods will get you to the same answer