ADVANCED FINANCIAL REPORTING AND ANALYSIS

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Share Based Payments - IFRS 2

The objective of IFRS 2 Share-based payment is to specify the financial reporting by an entity
when it undertakes a share-based payment transaction.

IFRS 2 requires an entity to reflect the effect of share-based payment transactions (including share
options to employees) in its profit or loss and statement of financial position.

What is a share-based payment transaction?

Share-based payment transaction is a transaction in which the entity:

 receives goods or services from the supplier (including employee) in a share-based

payment arrangement; or
 incurs an obligation to settle the transaction with the supplier in a share-based payment
arrangement when another group entity receives those goods or services.

Share-based payment arrangement is an agreement between the entity and another party
(including an employee) whereby the other party receives:

 cash or other assets of the entity for amounts that are based on the price (or value) of
equity instruments (including shares or share options) of the entity or another group
entity.
This type of arrangement is cash-settled share-based payment transaction.
Alternatively, the other party can receive
 equity instruments (including shares or share options) of the entity or another group
entity.
This type is called equity-settled share-based payment.
 There’s also the third type of share-based payment arrangements: transactions in which either the
entity or the supplier has a choice of settlement (to receive equity instruments or cash / other
assets).

If there are some specified vesting conditions, these must be met before receiving any share-
based payment.
Vesting condition
Some share-based payment transactions include vesting conditions that must be met before any
payment is made.

IFRS 2 recognizes 2 types of vesting conditions:

1. Service conditions: they require the counterparty to complete a specified period or

service;
2. Performance conditions: they require the counterparty to complete a specified period of
services AND specified performance targets to be met.

A performance condition might include a market condition that is linked to the market price of
shares in some way, for example, vesting might depend on achieving a minimum increase in the
share price of the entity.

How to recognize share-based payments

The basic recognition principle is to recognize goods or services received in a share-based
payment transaction when the goods are obtained or as the services are received.

Goods or services acquired should be recognized as expenses in profit or loss unless they qualify
for recognition as assets. That’s the debit side of an accounting entry.

The credit side depends on the type of share-based payment arrangement:

 If the goods or services were acquired in an equity-settled share-based payment

transaction, then the corresponding increase is recognized in equity.
 If the goods or services were acquired in a cash-settled share-based payment
transaction, then the corresponding increase is recognized as a liability.

Recognition of equity-settled share-based payment transactions

The key principle in IFRS 2 is to measure the amount of transaction at fair value of the goods or
services received. This is relatively easy when the transaction is with parties other than
employees.

However, sometimes (for example, when transaction is with employees), the fair value of goods
or services received cannot be measured reliably. In such a case, the entity should measure their
value by reference to fair value of the equity instruments granted.

And specifically for employees, the entity should measure the services received from employees
at the grant date (not at the date of their receipt).
Recognition of cash-settled share -based payment transactions

Typical examples of cash-settled share-based payment transactions are:

 Share appreciation rights (SARs) : employee is entitled to the cash payment in the future based
on the increase of entity’s share price over specified period of time from a specified level;
 Rights to redeemable shares: employee will receive the shares in the future that are redeemable
in cash.

Similarly as in the equity-settled share-based payment transaction, the goods or services received
are measured at the fair value of the liability.

The fair value of the liability has to be remeasured at each reporting date until this liability is
settled and any changes of fair value are recognized in profit or loss.

Vesting conditions are treated in the similar manner as in the equity-settled share-based payment
transactions.

Deferred tax implications

In some jurisdictions, a tax allowance is often available for share-based transactions. It is unlikely
that the amount of tax deducted will equal the amount charged to profit or loss under the standard.
Often, the tax deduction is based on the option’s intrinsic value, which is the difference between
the fair value and exercise price of the share. A deferred tax asset will therefore arise which
represents the difference between a tax base of the employee’s services received to date and the
carrying amount, which will effectively normally be zero. A deferred tax asset will be recognised
if the company has sufficient future taxable profits against which it can be offset.

For cash settled share-based payment transactions, the standard requires the estimated tax
deduction to be based on the current share price. As a result, all tax benefits received (or expected
to be received) are recognised in the profit or loss.

EXAMPLE
A company operates in a country where it receives a tax deduction equal to the intrinsic value of
the share options at the exercise date. The company grants share options to its employees with a
fair value of Sh. 4.8m at the grant date. The company receives a tax allowance based on the
intrinsic value of the options which is Sh. 4.2m. The tax rate applicable to the company is 30%
and the share options vest in three-years’ time.

Answer
A deferred tax asset would be recognised of:

Sh. 4.2m @ 30% tax rate x 1 year / 3 years = Sh. 420,000

The deferred tax will only be recognised if there are sufficient future taxable profits available.
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
 the effect of share-based payment transactions on the entity's profit or loss for the period
and on its financial position.