Deloitte's 76-page book on IFRS 2 Share-based Payment provides a wealth of implementation guidance for IFRS 2, including: guidance on measurement of share-based payments, a benchmark study of key measurement variables, comparison with US SFAS 123, and illustrative disclosures. It also offers further illustrative examples and implementation guidance on applying IFRS 2. You can Download the IFRS 2 Publication (PDF 694k) free of charge. You can request printed copies from kmcglew@deloitte.co.uk. A nominal amount of US$3 per copy will be charged to cover shipping costs.

Special Edition of Our IAS Plus Newsletter

You will find a four-page summary of IFRS 2 in a special edition of our IAS Plus Newsletter (PDF 49k).

Definition of Share-based Payment

A share-based payment is a transaction in which the entity receives or acquires goods or services either as consideration for its equity instruments or by incurring liabilities for amounts based on the price of the entity's shares or other equity instruments of the entity. The accounting requirements for the share-based payment depend on how the transaction will be settled, that is, by the issuance of (a) equity, (b) cash, or (c) equity or cash.

Scope

The concept of share-based payments is broader than employee share options. IFRS 2 encompasses the issuance of shares, or rights to shares, in return for services and goods. Examples of items included in the scope of IFRS 2 are share appreciation rights, employee share purchase plans, employee share ownership plans, share option plans and plans where the issuance of shares (or rights to shares) may depend on market or non-market related conditions.

IFRS 2 applies to all entities. There is no exemption for private or smaller entities. Furthermore, subsidiaries using their parent's or fellow subsidiary's equity as consideration for goods or services are within the scope of the Standard.

There are two exemptions to the general scope principle.

• First, the issuance of shares in a business combination should be accounted for under IFRS 3 Business Combinations. However, care should be taken to distinguish share-based payments related to the acquisition from those related to employee services.

• Second, IFRS 2 does not address share-based payments within the scope of paragraphs 8-10 of IAS 32 Financial Instruments: Disclosure and Presentation, or paragraphs 5-7 of IAS 39 Financial Instruments: Recognition and Measurement. Therefore, IAS 32 and 39 should be applied for commodity-based derivative contracts that may be settled in shares or rights to shares.

Recognition and Measurement

The issuance of shares or rights to shares requires an increase in a component of equity. IFRS 2 requires the offsetting debit entry to be expensed when the payment for goods or services does not represent an asset. The expense should be recognised as the goods or services are consumed. For example, the issuance of shares or rights to shares to purchase inventory would be presented as an increase in inventory and would be expensed only once the inventory is sold or impaired.

The issuance of fully vested shares, or rights to shares, is presumed to relate to past service, requiring the full amount of the grant-date fair value to be expensed immediately. The issuance of shares to employees with, say, a three-year vesting period is considered to relate to services over the vesting period. Therefore, the fair value of the share-based payment, determined at the grant date, should be expensed over the vesting period.

As a general principle, the total expense related to equity-settled share-based payments will equal the multiple of the total instruments that vest and the grant-date fair value of those instruments. In short, there is truing up to reflect what happens during the vesting period. However, if the equity-settled share-based payment has a market related performance feature, the expense would still be recognised if all other vesting features are met. The following example provides an illustration of a typical equity-settled share-based payment.

Illustration – Recognition of Employee Share Option Grant

Company grants a total of 100 share options to 10 members of its executive management team (10 options each) on 1 January 20X5. These options vest at the end of a three-year period. The company has determined that each option has a fair value at the date of grant equal to 15. The company expects that all 100 options will vest and therefore records the following entry at 30 June 20X5 - the end of its first six-month interim reporting period.

If all 100 shares vest, the above entry would be made at the end of each 6-month reporting period. However, if one member of the executive management team leaves during the second half of 20X6, therefore forfeiting the entire amount of 10 options, the following entry at 31 December 20X6 would be made:

Measurement Guidance

Depending on the type of share-based payment, fair value may be determined by the value of the shares or rights to shares given up, or by the value of the goods or services received:

• General fair value measurement principle. In principle, transactions in which goods or services are received as consideration for equity instruments of the entity should be measured at the fair value of the goods or services received. Only if the fair value of the goods or services cannot be measured reliably would the fair value of the equity instruments granted be used.
• Measuring employee share options. For transactions with employees and others providing similar services, the entity is required to measure the fair value of the equity instruments granted, because it is typically not possible to estimate reliably the fair value of employee services received.
• When to measure fair value - options. For transactions measured at the fair value of the equity instruments granted (such as transactions with employees), fair value should be estimated at grant date.
• When to measure fair value - goods and services. For transactions measured at the fair value of the goods or services received, fair value should be estimated at the date of receipt of those goods or services.
• Measurement guidance. For goods or services measured by reference to the fair value of the equity instruments granted, IFRS 2 specifies that, in general, vesting conditions are not taken into account when estimating the fair value of the shares or options at the relevant measurement date (as specified above). Instead, vesting conditions are taken into account by adjusting the number of equity instruments included in the measurement of the transaction amount so that, ultimately, the amount recognised for goods or services received as consideration for the equity instruments granted is based on the number of equity instruments that eventually vest.
• More measurement guidance. IFRS 2 requires the fair value of equity instruments granted to be based on market prices, if available, and to take into account the terms and conditions upon which those equity instruments were granted. In the absence of market prices, fair value is estimated using a valuation technique to estimate what the price of those equity instruments would have been on the measurement date in an arm's length transaction between knowledgeable, willing parties. The standard does not specify which particular model should be used.
• If fair value cannot be reliably measured. IFRS 2 requires the share-based payment transaction to be measured at fair value for both listed and unlisted entities. IFRS 2 permits the use of intrinsic value (that is, fair value of the shares less exercise price) in those "rare cases" in which the fair value of the equity instruments cannot be reliably measured. However this is not simply measured at the date of grant. An entity would have to remeasure intrinsic value at each reporting date until final settlement.
• Performance conditions. IFRS 2 makes a distinction between the handling of market based performance features from non-market features. Market conditions are those related to the market price of an entity's equity, such as achieving a specified share price or a specified target based on a comparison of the entity's share price with an index of share prices of other entities. Market based performance features should be included in the grant-date fair value measurement. However, the fair value of the equity instruments should not be reduced to take into consideration non-market based performance features or other vesting features.

Modifications, Cancellations, and Settlements

The determination of whether a change in terms and conditions has an effect on the amount recognised depends on whether the fair value of the new instruments is greater than the fair value of the original instruments (both determined at the modification date).

Modification of the terms on which equity instruments were granted may have an effect on the expense that will be recorded. IFRS 2 clarifies that the guidance on modifications also applies to instruments modified after their vesting date. If the fair value of the new instruments is more than the fair value of the old instruments (e.g. by reduction of the exercise price or issuance of additional instruments), the incremental amount is recognised over the remaining vesting period in a manner similar to the original amount. If the modification occurs after the vesting period, the incremental amount is recognised immediately. If the fair value of the new instruments is less than the fair value of the old instruments, the original fair value of the equity instruments granted should be expensed as if the modification never occurred.

The cancellation or settlement of equity instruments is accounted for as an acceleration of the vesting period and therefore any amount unrecognised that would otherwise have been charged should be recognised immediately. Any payments made with the cancellation or settlement (up to the fair value of the equity instruments) should be accounted for as the repurchase of an equity interest. Any payment in excess of the fair value of the equity instruments granted is recognised as an expense

New equity instruments granted may be identified as a replacement of cancelled equity instruments. In those cases, the replacement equity instruments should be accounted for as a modification. The fair value of the replacement equity instruments is determined at grant date, while the fair value of the cancelled instruments is determined at the date of cancellation, less any cash payments on cancellation that is accounted for as a deduction from equity.

Disclosure

Required disclosures include:

• the nature and extent of share-based payment arrangements that existed during the period;
• how the fair value of the goods or services received, or the fair value of the equity instruments granted, during the period was determined; and
• the effect of share-based payment transactions on the entity抯 profit or loss for the period and on its financial position.

Effective Date

IFRS 2 is effective for annual periods beginning on or after 1 January 2005. Earlier application is encouraged.

Transition

All equity-settled share-based payments granted after 7 November 2002, that are not yet vested at the effective date of IFRS 2 shall be accounted for using the provisions of IFRS 2. Entities are allowed and encouraged, but not required, to apply this IFRS to other grants of equity instruments if (and only if) the entity has previously disclosed publicly the fair value of those equity instruments determined in accordance with IFRS 2.

The comparative information presented in accordance with IAS 1 shall be restated for all grants of equity instruments to which the requirements of IFRS 2 are applied. The adjustment to reflect this change is presented in the opening balance of retained earnings for the earliest period presented.

IFRS 2 amends paragraph 13 of IFRS 1 First-time Adoption of International Financial Reporting Standards to add an exemption for share-based payment transactions. Similar to entities already applying IFRS, first-time adopters will have to apply IFRS 2 for share-based payment transactions on or after 7 November 2002. Additionally, a first-time adopter is not required to apply IFRS 2 to share-based payments granted after 7 November 2002 that vested before the later of (a) the date of transition to IFRS and (b) 1 January 2005. A first-time adopter may elect to apply IFRS 2 earlier only if it has publicly disclosed the fair value of the share-based payments determined at the measurement date in accordance with IFRS 2.

Differences with FASB Statement 123 Revised 2004

In December 2004, the US FASB published FASB Statement 123 (revised 2004) Share-Based Payment. Statement 123(R) requires that the compensation cost relating to share-based payment transactions be recognised in financial statements. Click for FASB Press Release (PDF 17k). Deloitte (USA) has published a special issue of its Heads Up newsletter summarising the key concepts of FASB Statement No. 123(R). Click to download the Download the Heads Up Newsletter (PDF 292k). While Statement 123(R) is largely consistent with IFRS 2, some differences remain, as described in a Q&A document FASB issued along with the new Statement:

March 2005: SEC Staff Accounting Bulletin 107

On 29 March 2005, the staff of the US Securities and Exchange Commission issued Staff Accounting Bulletin 107 dealing with valuations and other accounting issues for share-based payment arrangements by public companies under FASB Statement 123R Share-Based Payment. For public companies, valuations under Statement 123R are similar to those under IFRS 2 Share-based Payment. SAB 107 provides guidance related to share-based payment transactions with nonemployees, the transition from nonpublic to public entity status, valuation methods (including assumptions such as expected volatility and expected term), the accounting for certain redeemable financial instruments issued under share-based payment arrangements, the classification of compensation expense, non-GAAP financial measures, first-time adoption of Statement 123R in an interim period, capitalisation of compensation cost related to share-based payment arrangements, accounting for the income tax effects of share-based payment arrangements on adoption of Statement 123R, the modification of employee share options prior to adoption of Statement 123R, and disclosures in Management's Discussion and Analysis (MD&A) subsequent to adoption of Statement 123R. One of the interpretations in SAB 107 is whether there are differences between Statement 123R and IFRS 2 that would result in a reconciling item:

Click to download:

• SEC Press Release (PDF 30k)
• Staff Accounting Bulletin 107 (PDF 362k)

March 2005: Bear, Stearns Study on Impact of Expensing Stock Options in the United States

If US public companies had been required to expense employee stock options in 2004, as will be required under FASB Statement 123R Share-Based Payment starting in third-quarter 2005:

• the reported 2004 post-tax net income from continuing operations of the S&P 500 companies would have been reduced by 5%, and
• 2004 NASDAQ 100 post-tax net income from continuing operations would have been reduced by 22%.

November 2005: Standard & Poor's Study on Impact of Expensing Stock Options

In November 2005 Standard & Poor's published a report of the impact of expensing stock options on the S&P 500 companies. FAS 123(R) requires expensing of stock options (mandatory for most SEC registrants in 2006). IFRS 2 is nearly identical to FAS 123(R). S&P found:

S&P takes issue with those companies that try to emphasise earnings before deducting stock option expense and with those analysts who ignore option expensing. The report emphasises that:

Click to download The Impact of Option Expensing on S&P 500 Earnings (PDF 399k). Please note that the report remains copyright Standard & Poor's, all rights reserved, and is posted here with the kind permission of S&P.

February 2006: Proposed Amendments for Vesting Conditions and Cancellations

On 2 February 2006, the IASB issued an Exposure Draft that proposes to amend two aspects of IFRS 2 Share-based Payment – what are 'vesting conditions' and what is a 'cancellation':

The proposed amendments would apply for annual periods beginning on or after 1 January 2007, with earlier application encouraged. Click for IASB Press Release (PDF 52k).

Comment deadline is 2 June 2006.

Discussion at the July 2006 IASB Meeting

Vesting conditions

The Board agreed that vesting conditions include performance conditions and service conditions only. As to whether a definition of vesting condition (and, by extension, 'performance condition' and 'service condition') was required, different opinions were expressed.

The Board agreed to develop further guidance, to be incorporated as an addition to the Implementation Guidance for IFRS 2, on the various conditions that may determine whether a counterparty obtains the equity instruments granted. This might take the form of a simple organisation chart or table.

Cancellations

More time was spent discussing the topic of cancellations and whether it should make a difference whether the cancellation comes about through the actions of the counterparty or the entity.

The Board agreed that cancellations are cancellations, which ever party brings them about and that no amendment to IFRS 2 should be made with respect to this principle.

However, the Board agreed to investigate further whether some of the schemes that were seen as causing the problem, such as Save As You Earn schemes, were truly share-based payment schemes. Board members noted that such schemes often required contributions and/or salary deductions from plan participants; these contributions were held in a segregated account by the plan sponsor until such time as the depositor purchased the shares using the amounts in the SAYE account. As such, the arrangement operates in a manner similar to a savings account with interest. It was not entirely obvious that there was a share-based element. The staff will investigate this further and revert to the Board.