The objective of IFRS 2 is to specify the financial reporting by an entity when it undertakes a share-based payment transaction. In particular, it requires an entity to reflect in its profit or loss and financial position the effects of share-based payment transactions, including expenses associated with transactions in which share options are granted to employees.
Prior to the issuance of IFRS 2, there was no IFRS covering the recognition and measurement of these types of transactions. Issued in February 2004, IFRS 2 prescribed the measurement and recognition principles for all the share-based payment awards within the scope of the standard.
IFRS 2 applies to share-based payment transaction with employees and third parties wether settled in cash, equity instruments or other less common assets. The general principle of IFRS 2 is that an entity recognises an expense or assets for goods or services, with the credit entry recognised either in equity or as a liability (depending on how the share-based payment award is required to be settled).
After long discussions, the IASB settled on a grant date model to measure share-based payment awards to employees. Under the grant date model, an entity measures the fair value of share based payment award issued to an employee on the grant date.
Scope of the standard
IFRS covers these 3 types of transactions:-
- Equity-settled share-based payment transactions in which the entity receives goods or services as consideration for its own equity instruments or those of another entity in the same group or a shareholder of any group entity
- Cash-settled share-based payments transactions, also referred to as liability awards, in which the entity receives goods or services and incurs a liability based on the value of the entity’s share or another equity instruments of the entity or another group entity
- Share-based payment transactions with cash alternatives in which the entity received goods or services and either the entity (or another group entity) or the supplier of the goods or services (the counterparty) has a choice of the entity settling the transaction in cash, other assets, or by issuing equity instruments
IFRS 2 however, does not cover the following list of transactions;
- Transactions with shareholders that are acting solely in their capacity as shareholders
- Goods and services received by the entity that are settled by entities or shareholders not within the group
- Transactions within the scope of IAS 32 and IAS 39 (or IFRS 9)
- Share-based payment transactions to acquire goods as part of a business combination to which IFRS 3 Business Combinations applies, in a combination of entities or businesses under common control, or the contribution of a business on the formation of a joint venture, as defined by IFRS 11 Joint Arrangements
- Transfer of assets in certain group restructuring arrangements
Now let’s discuss the above stated there types of transactions
Equity settled awards
The general rule in IFRS 2 is that an entity measures the fair value of goods obtained or services received, and recognises a corresponding increase in equity. But, if an entity cannot reliably estimate the fair value, it must measure their value indirectly using the fair value of the equity instrument granted.
IFRS 2 requires that:
- For awards to employees, an entity must us the fair value of the equity instruments, measured at the grant date
- For awards to non-employees, there is s rebuttable presumption that the fair value of the goods or services is more reliably determinable, which is measured when the goods or services are received or obtained
The grant date determination is critical to the measurement of equity-settled share-based payment transactions with employees. The grant date is the date on which the reporting entity and the employee have a shared understanding of the terms f the arrangement, based on a legally binding agreement. In practice, the following issues are important
- How precise the shared understating of the terms of the award must be
- What level of combination between the reporting entity and the counterparty is sufficient to ensure the appropriate degree of shared understanding
As per IFRS 2, the point where the cost is recognised for goods or services depends on the vesting conditions. A vesting condition determines whether an entity receives the services that entitle counterparty to receive the share-based payment award. A share-based payment award generally vests upon meeting specified conditions. Vesting conditions can either be:
- Service conditions, which requires the counterparty to complete a specified period of service during which the services are provided to the entity, or
- Performance conditions, which requires the counterparty to complete a specified period of services and involves specified performance targets to be met while counterparty is rendering the requires service
A performance condition is distinguished from a non-vesting condition in that it has an explicit or implicit services requirement whereas a non0-vesting condition does not. The classification of a condition as vesting or non-vesting is a critical step in accounting for share-based payment transaction.
For cash settled awards, the general principle in IFRS 2 is that an entity measures the fair value of the goods or services received based on the fair value of the liability. IFRS 2 does not specifically address the impact of vesting condition within the context of cash-settled share-based payment transaction. However, the following should be kept in mind:
- The effect of a market condition or a non-vesting condition must be reflected in the estimation of the fair value of the cash-settled share-based payments both at the grant date and subsequently
- Vesting conditions must not be taken into account when estimating the fair value of cash-settled share-based payments. Instead, these must be taken into account in the measurement of the liability incurred by adjusting the number of awards that are expected to vest. Such estimate must be revised when the liability is remeasured each reporting date and until the vesting date
- Cumulatively, no amount is recognised for goods or services received if the awards granted do not vest because of failure to satisfy a vesting condition or a non-vesting condition
Share based payment with a cash alternative
If counterparty chooses settlement of the award in either shares or cash, IFRS 2 treats it as a compound award. A compound award is split into two components: a liability component and an equity component. Once split, the entity accounts for the two components separately.
Among other things, IFRS 2 requires entities to disclose the following:
- The type and scope of agreement existing during the reporting period
- Description of each type of arrangement, including general terms and conditions of the arrangement
- The number and weighted average exercise price of share options (outsourcing at the beginning of the reporting period and at the end of the reporting period, granted, vested, exercised, expired and forfeited during the period)
- The average share price of exercised options
- The range of exercise prices and weighted average remaining contractual life of options outstanding at the end of the reporting period
- The valuation method used to estimate the fair value of the awards
- The impact on the income statement and the financial position of share based payments awards
IFRS 2 requires significant analysis in terms if classification, measurement and disclosers. It is therefore crucial that those involved in designing plans are familiar with IFRS 2 and the related expense ramification to avoid unexpected accounting consequences. Decision-makers must also consider “hidden” share-based payments awards that may fall within the scope of IFRS 2.
Various vesting conditions affect the expense charged to the income statement differently. If an option has a market vesting condition, an entity might still recognise an expense even if that condition is not met and the option does not vest. By contrast, an award subject only to a non-market vesting condition does not result is an expenses under IFRS 2 if the condition is not met.
Entities offering share-based payment awards should keep abreast of new development as and when they arise involve accounting, tax and human resource professionals.