IFRS 3 Executive Compensation in Acquisitions

IFRS 3 Executive Compensation in Acquisitions – The acquirer in a business combination may or must agree to assume existing compensation arrangements with employees of the acquiree or may establish new arrangements to compensate those employees for postcombination services. These arrangements may involve cash payments to the employees or the exchange (or settlement) of share-based payment awards.

These replacement share-based payment awards, in many cases, include the same terms and conditions as the original awards and are intended to keep the employees of the acquiree “whole” (i.e., preserve the value of the original awards at the acquisition date) after the acquisition. The acquirer may, in other situations, change the terms of the share-based payment awards, often to provide an incentive to key employees to remain with the combined entity.

Employee compensation arrangements should be analysed to determine whether they represent compensation for (1) precombination services, (2) postcombination services, or (3) a combination of precombination and postcombination services. Amounts attributable to precombination services are accounted for as part of the consideration transferred for the acquiree. Amounts attributable to postcombination services are accounted for separately from the business combination and are usually recognized as compensation cost in the post-acquisition period. Under IFRS 3 51, amounts attributable to a combination of precombination and postcombination services are allocated between the consideration transferred for the acquiree and the postcombination services.

Contingent payment arrangements with an acquiree may represent consideration transferred for the acquiree or compensation for postcombination services. This session discusses the analysisIFRS 3 Executive Compensation in Acquisitions that the acquirer should perform to determine if the contingent consideration is accounted for as part of the consideration transferred or as a transaction separate from the business combination (in the postcombination financial statements).

The acquiree may enter into employee related transactions during the negotiations for a business combination. These transactions might include the settlement or acceleration of vesting for share based payment awards or bonus payments to employees. The acquirer should assess these transactions to determine whether they should be accounted for in the postcombination financial statements or included as part of the consideration transferred for the acquiree.

Transactions that benefit the acquiree before the acquisition are included as part of consideration transferred. If it is determined that a transaction was arranged primarily for the economic benefit of the acquirer (or combined entity), the transaction is not deemed to be part of the consideration transferred for the acquiree and should be accounted for separately from the business combination under IFRS 3 51–52, IFRS 3 B52. Factors to consider in this analysis include:

  • The reasons for the transaction IFRS 3 Executive Compensation in Acquisitions
  • Who initiated the transaction IFRS 3 Executive Compensation in Acquisitions
  • The timing of the transaction IFRS 3 Executive Compensation in Acquisitions

The basic principle outlined in IFRS 3 51 is broadly applicable to other transactions outside of arrangements with employees. This principle and the three factors listed above are discussed in more detail in the acquisition method. IFRS 3 Executive Compensation in Acquisitions

This section also addresses the accounting for other employee compensation arrangements, such as “stay bonuses” and “golden parachute” agreements with employees of the acquiree.

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Assessing what is part of the consideration transferred for the acquiree

Employee compensation arrangements should be analysed to determine whether they represent compensation for (1) precombination services, (2) postcombination services, or (3) a combination of precombination and postcombination services. Amounts attributable to precombination services are accounted for as part of the consideration transferred for the acquiree. Amounts attributable to postcombination services are accounted for separately from the business combination and are costs in the post-acquisition period.

The cost of an arrangement that includes precombination and postcombination services is attributed between the consideration transferred for the acquiree and the postcombination services. This assessment will not always be straightforward and may require significant judgment. IFRS 3 Executive Compensation in Acquisitions

An acquirer may agree to exchange share-based payment awards held by employees of the acquiree for replacement share-based payment awards of the acquirer. The awards held by the employees of the acquiree and the replacement awards are measured using the fair-value-based measurement principles of IFRS 2 on the acquisition date and IFRS 3 B57.

Throughout this section, references to fair value of share-based payment awards mean the “fair-value based measure” that is determined in accordance with IFRS 2. The acquirer should then attribute the fair value of the awards to precombination services and postcombination services, as appropriate, based on the principles in IFRS 3.

The fair value of the awards attributed to precombination services is included as part of the consideration transferred for the acquiree. The fair value of the awards attributed to postcombination services is recorded as compensation cost in the postcombination financial statements of the combined entity in accordance with IFRS 3 B57-B59.

An acquirer may enter into a contingent consideration arrangement with the selling shareholders of the acquiree, or the acquiree may enter into a transaction for the benefit of the acquirer or the combined entity. These arrangements need to be analysed to determine if they should be included in the consideration transferred for the acquiree, accounted for as a separate transaction apart from the business combination, or a combination of both. IFRS 3 Executive Compensation in Acquisitions

A transaction arranged primarily for the economic benefit of the acquirer (or combined entity) is not deemed to be part of the consideration transferred for the acquiree and should be accounted for separately from the business combination in accordance with IFRS 3 51–52, IFRS 3 B50. Factors identified in IFRS 3 B50 to consider in this analysis include:

  • The reasons for the transaction IFRS 3 Executive Compensation in Acquisitions
  • Who initiated the transaction IFRS 3 Executive Compensation in Acquisitions
  • The timing of the transaction [IFRS 3 B50] IFRS 3 Executive Compensation in Acquisitions

The basic principle outlined in IFRS 3 and the three factors listed above are discussed in more detail in the acquisition method. Throughout this chapter, the analysis of employee compensation arrangements requires consideration of the basic principle and an assessment of the three factors. See the next caption for information on the indicators to be considered when analyzing contingent consideration arrangements. IFRS 3 Executive Compensation in Acquisitions

Contingent payments—determining whether the arrangement is compensation

Arrangements that include contingent payments are assessed to determine if the consideration is for postcombination services. In accordance with IFRS 3 B54, this assessment requires obtaining an understanding of why the contingent payments are included in the arrangement, which party (the acquiree or the acquirer) initiated the arrangement, and when the parties entered into the arrangement. IFRS 3 Executive Compensation in Acquisitions

The nature of the arrangement will dictate whether contingent payments to employees (or selling shareholders) are (1) contingent consideration in a business combination or (2) separate transactions. If it is not clear whether an arrangement is part of the exchange for the acquiree or is a separate transaction, IFRS 3 B55 provide eight indicators that should be considered.

These criteria need to be applied to all arrangements for payments to employees or selling shareholders, including both cash compensation and share-based payment awards. Additionally, arrangements between the selling shareholders and the acquiree’s employees should be evaluated to determine whether such arrangements were entered into for the benefit of the acquirer and thus represent compensation. IFRS 3 Executive Compensation in Acquisitions

All of the indicators in IFRS 3 should be considered when analysing whether consideration is for postcombination services. However, IFRS 3 require the consideration to be accounted for as postcombination compensation cost1 if the consideration is automatically forfeited upon termination of employment. Look at IFRS 3 B55 for the applicable IFRS regulation.

The following example provides an example of a contingent consideration arrangement that is forfeited upon the termination of employment and therefore is treated as postcombination compensation cost. IFRS 3 Executive Compensation in Acquisitions

EXAMPLE – Contingent consideration arrangement

Company A (the acquiree) is owned by a sole shareholder, Shareholder X, who is also the chief executive officer (CEO) of Company A. Company A is acquired by Company B (the acquirer). Shareholder X will, per the terms of the purchase agreement, receive additional consideration for the acquisition based upon specific earnings before interest, taxes, depreciation, and amortisation (EBITDA) levels of Company A over the two-year period following the acquisition. IFRS 3 Executive Compensation in Acquisitions

Company B believes that retaining the services of Shareholder X for at least two years is critical to transitioning Company A’s ongoing business. The arrangement also stipulates that Shareholder X will forfeit any rights to the additional consideration if Shareholder X is not an employee of Company B at the end of the two-year period.

How should Company B account for the contingent consideration arrangement?

Analysis IFRS 3 Executive Compensation in Acquisitions

Under IFRS 3 B55, a contingent consideration arrangement in which the payments are automatically forfeited if employment terminates is considered compensation for the postcombination services. Accordingly, any payments made to Shareholder X for achievement of the specific EBITDA levels would be accounted for as compensation cost in Company B’s postcombination financial statements. IFRS 3 Executive Compensation in Acquisitions

Golden parachute and stay bonus arrangements

Employment agreements with executives often include arrangements whereby the executive receives a bonus, in cash or shares, when his or her employment is terminated. These arrangements are often triggered by a business combination and are commonly referred to as “golden parachute” arrangements. IFRS 3 Executive Compensation in Acquisitions

These arrangements need to be assessed to determine if they represent compensation for precombination or postcombination services. Generally, if the arrangement was included in the employment agreement prior to contemplation of the business combination and there is no postcombination service required, the consideration is associated with a precombination arrangement.

The expense is typically recognized in the preacquisition financial statements of the acquiree and would typically be a liability assumed by the buyer that is therefore included in the application of the acquisition method. IFRS 3 Executive Compensation in Acquisitions

The following examples include examples of arrangements that compensate for employee services. IFRS 3 Executive Compensation in Acquisitions

EXAMPLE – Golden parachute arrangement

The employment contract for the CEO of Company B provides that if Company B is acquired by another company, the CEO will receive a CU5 million cash payment if the CEO remains employed through the acquisition date (a “golden parachute” arrangement). Several years after the employment contract is signed, Company B is acquired by Company A. The CEO is not obligated to remain employed after the acquisition date.

How should Company A account for the cash payment to the Company B CEO?

Analysis IFRS 3 Executive Compensation in Acquisitions

Company A is required to assess whether the CU5 million cash payment to the CEO is (1) an assumed obligation that should be included in the application of the acquisition method, or (2) a postcombination expense that should be accounted for separately from the business combination. IFRS 3 Executive Compensation in Acquisitions

Company A should consider the factors listed in IFRS 3 B50: IFRS 3 Executive Compensation in Acquisitions

  • The reasons for the transaction: The CU5 million payment was originally included in the CEO’s employment contract by Company B to secure employment of the CEO through the acquisition date in the event that Company B was acquired in the future. IFRS 3 Executive Compensation in Acquisitions
  • Who initiated the transaction: The payment was arranged by Company B to benefit Company B through the acquisition date, in the event of an acquisition.
  • The timing of the transaction: The employment contract was in existence prior to any discussions regarding the business combination.

The payment to the CEO is not primarily for the economic benefit of Company A. The CEO is not required to provide continuing services to Company A to receive the payment. Therefore, the payment should be recognized as compensation cost in Company B’s precombination financial statements and an assumed obligation included in the application of the acquisition method.

EXAMPLE – Stay bonus arrangements

Company Z acquires Company Y and agrees to provide each of the key officers of Company Y a cash payment of CU1 million if they remain employed with the combined company for at least one year from the acquisition date. IFRS 3 Executive Compensation in Acquisitions

The agreement stipulates that if the key officers resign prior to the first anniversary of the acquisition date, the cash payment of CU1 million will be forfeited. A similar clause was not included in Company Y’s key officers’ employment agreements prior to the discussions that lead to the business combination.

How should Company Z account for the cash payment to each of the key officers?

Analysis IFRS 3 Executive Compensation in Acquisitions

Company Z must assess whether the CU1 million cash payment to each of the key officers is (1) consideration transferred for the acquiree or (2) a postcombination expense that should be accounted for outside of the business combination. Company Z should consider the factors listed in IFRS 3 B50: IFRS 3 Executive Compensation in Acquisitions

  • The reasons for the transaction: The CU1 million payment was offered to the key officers of Company Y by Company Z to facilitate the transition process following the acquisition.
  • Who initiated the transaction: The payment was arranged by Company Z to benefit Company Z for the first year following the acquisition.
  • The timing of the transaction: The arrangement was negotiated in conjunction with the business combination and was not included in the original employment agreements of the key officers. IFRS 3 Executive Compensation in Acquisitions

The payments to the key officers of Company Y appear to be arranged primarily for the economic benefit of Company Z. The key officers will forfeit the payments if they do not provide service to the combined company for at least one year following the acquisition date. IFRS 3 Executive Compensation in Acquisitions

Therefore, the payments are not part of the consideration transferred for Company Y and should be recorded as compensation cost in the postcombination financial statements of the combined company. IFRS 3 Executive Compensation in Acquisitions

Exchange of employee share-based payment awards

The acquirer may issue its own share-based payment awards (replacement awards) in exchange for awards held by employees of the acquiree. Generally, in such a transaction, the acquirer will replace the existing awards (under which the employees would have received shares of the acquiree) with awards that will be settled in shares of the acquirer.

The purpose of this transaction may be to keep the employees “whole” after the acquisition (i.e., preserve the value of the original awards at the acquisition date) or to provide further incentive for employees to remain with the combined entity. IFRS 3 Executive Compensation in Acquisitions

Therefore, replacement awards may represent consideration for precombination services, postcombination services, or a combination of both. Replacement awards may contain the same terms as the original acquiree awards; other times, the acquirer may change the terms of the awards depending on its compensation strategy or other factors, such as to provide incentives for key employees to remain with the company. IFRS 3 Executive Compensation in Acquisitions

When the acquirer is obligated to grant replacement awards as part of a business combination, the replacement awards should be considered in the determination of the amount of consideration transferred for the acquiree. An acquirer is obligated to grant replacement awards if the acquiree or the acquiree’s employees can legally require the acquirer to replace the awards.

For purposes of applying this requirement, the acquirer is considered obligated to grant replacement awards in a business combination in accordance with IFRS 3 B56 if required by one of the following: IFRS 3 Executive Compensation in Acquisitions

  • Terms of the acquisition agreement IFRS 3 Executive Compensation in Acquisitions
  • Terms of the acquiree’s awards IFRS 3 Executive Compensation in Acquisitions
  • Applicable laws or regulations IFRS 3 Executive Compensation in Acquisitions

An exchange of share-based payment awards in a business combination is treated as a modification under IFRS 2. The replacement awards and the original acquiree awards should both be measured at fair value at the acquisition date and calculated using the fair-value-based measurement principles in IFRS 2.

Once the fair value of the awards has been determined, the replacement awards should be analysed to determine whether the awards relate to precombination or postcombination services. To the extent replacement awards are for precombination services, the value of the awards should be allocated to consideration transferred to the sellers for the acquiree.

To the extent replacement awards are for postcombination services, the value of the awards should be excluded from payments for the acquired business and recognized as compensation cost in the postcombination financial statements in accordance with IFRS 3 B57–B60. IFRS 3 Executive Compensation in Acquisitions

Acquiree awards may expire as a consequence of a business combination and the acquirer may not be obligated (as that term is defined in IFRS 3) to grant replacement awards. If the acquirer grants replacement awards for awards that would otherwise expire and the acquirer is not obligated to do so, the replacement awards are considered separate from the business combination. Under IFRS 3 B56, the entire fair value of the replacement awards should be recognized as compensation cost in the postcombination financial statements.

Below the accounting for different arrangements involving the exchange of employee awards in a business combination is summarised:

Scenarios

IFRS accounting

Acquirer’s obligation

Replacement of awards

Expiration of acquiree awards

1. The acquirer is obligated¹ to issue replacement awards.

The acquirer issues replacement awards.

Not relevant.

The awards are considered in the determination of the amount of consideration transferred for the acquiree or for postcombination services.

2. The acquirer is not obligated¹ to issue replacement awards to the acquiree.

The acquirer issues replacement awards.

The acquiree awards would otherwise expire.

The entire fair value of the replacement awards is recognized as postcombination compensation cost in the postcombination period.

3. The acquirer is not obligated¹ to issue replacement awards to the acquiree.

The acquirer does not issue replacement awards. The acquiree awards remain outstanding postcombination as a non-controlling interest.

The acquiree awards would not otherwise expire.

The acquirer accounts for the continuation of the awards as if the acquirer was obligated to issue replacement awards (see Acquirer’s obligation #1 above).

4. The acquirer is not obligated¹ to issue replacement awards to the acquiree.

The acquirer issues replacement awards.

The acquiree awards would not otherwise expire.

The acquirer accounts for the continuation of the awards as if the acquirer was obligated to issue replacement awards (see Acquirer’s obligation #1 above).

Something else -   Contingent consideration

1 An acquirer is obligated to issue replacement awards if required by the terms of the acquisition agreement, the terms of the acquiree’s awards, or applicable laws or regulations.

Determining the fair value attributable to precombination and postcombination services

IFRS 2 uses a vesting-period concept. For purposes of these standards, the vesting period includes only periods of employee service that directly contribute to meeting the specified vesting conditions of the award. In accordance with IFRS 3 B58, the portion of the replacement award attributable to precombination service is the fair value of the acquiree awards multiplied by the ratio of the precombination vesting period completed prior to the exchange to the greater of the total vesting period of the replacement awards or the original vesting period of the acquiree awards.

The fair value of the awards to be attributed to postcombination services would then be calculated by subtracting the portion attributable to precombination services from the total fair value of the acquirer replacement awards under IFRS 3 B59. Excess fair value which is the incremental amount by which the fair value of the replacement awards exceeds the fair value of the acquiree awards on the acquisition date, should be attributed to postcombination services. IFRS 3 Executive Compensation in Acquisitions

Here is an illustration of how to calculate the amount of fair value attributed to precombination and postcombination services.

IFRS 3 Executive Compensation in Acquisitions

Here is an illustration of some of these terms to assist in obtaining an understanding of this attribution:

Allocation between pre and post combination servoces share based payment

When determining the fair value attributable to precombination and postcombination services, the total vesting period includes both the vesting period of the acquiree’s awards completed before the acquisition date and the postcombination vesting period of the replacement awards in accordance with IFRS 3 B58.

The amount attributable to precombination services should be included in the consideration transferred for the acquiree. The amount attributable to postcombination services, however, is not part of the consideration transferred for the acquired business. IFRS 3 Executive Compensation in Acquisitions

The amount attributable to postcombination services should instead be recognized as compensation cost in the postcombination financial statements over the postcombination requisite vesting period in accordance with IFRS 3 B58–B59. IFRS 3 Executive Compensation in Acquisitions

The method of attributing the fair value of replacement awards between periods of precombination services and postcombination services is the same for equity- and liability-classified awards. All changes in the fair-value-based measure of the awards classified as liabilities after the acquisition date and the related income tax effects are recognized as an expense in the acquirer’s postcombination financial statements in the periods in which the changes occur in accordance with IFRS 3 B61. IFRS 3 Executive Compensation in Acquisitions

Fair value attribution to postcombination services for share options that are deep out of the money at the acquisition date

The awards would be attributed over the one-year service period. IFRS 3 Executive Compensation in Acquisitions

Fair value of the acquirer’s unvested replacement awards inclusion in the consideration transferred for the acquiree reflect an estimate of forfeitures

IFRS 3 provide that replacement share-based payment awards should be measured using the fair-value-based measurement method of IFRS 2. Under IFRS 2 19, no compensation cost is recognized for an award that is not expected to vest. Accordingly, the amount included in consideration transferred for the acquiree related to unvested awards should be reduced to reflect an estimate of future forfeitures. IFRS 3 Executive Compensation in Acquisitions

The estimate of future forfeitures should be based on the acquirer’s estimate of pre-vesting forfeitures. When determining this estimate, the acquirer may need to consider the acquiree’s historical employee data as well as the potential impact of the business combination on the employees’ future behavior in accordance with IFRS 3 B60. Any postcombination changes in assumptions should be recognized directly in net income. IFRS 3 Executive Compensation in Acquisitions

 Adjustment of compensation cost recognized in the acquirer’s postcombination financial statements to reflect estimated forfeitures of unvested awards

IFRS 2 require companies to recognize compensation cost based on the number of awards expected to vest. Therefore, companies are required to estimate future forfeitures of unvested awards. For awards that are unvested at the acquisition date, the amount of compensation cost recognized in the postcombination financial statements should be reduced to reflect estimated forfeitures.

Under IFRS 3 B60, postcombination forfeitures, or changes in the estimated forfeiture rate, should be accounted for as adjustments to compensation cost in the period in which the forfeiture or change in estimate occurred. When determining this estimate, the acquirer may need to consider the acquiree’s historical employee data as well as the potential impact of the business combination on the employees’ future behavior in accordance with IFRS 2 20. IFRS 3 Executive Compensation in Acquisitions

Awards with graded-vesting features

Awards with graded-vesting features vest in stages (tranches) over an award’s contractual term, as opposed to vesting on a specific date. An example of an award with graded-vesting features is an award that vests 25% each year over a four-year period. The portion of the award that vests each year is often referred to as a “vesting tranche.”

IFRS 2 does not provide companies with the option to use the straight-line attribution method for awards with graded-vesting features. Thus, a graded-vesting attribution approach should be used. IFRS 3 Executive Compensation in Acquisitions

Graded vesting is defined as an award that vests in stages (or tranches). This is in contrast to cliff vesting, in which an award vests in its entirety on a specific date. In concept, an award that vests in tranches can be thought of as a series of individual awards with different cliff-vesting dates. IFRS 3 Executive Compensation in Acquisitions

The graded vesting method: A company recognizes compensation cost over the requisite service period for each separately-vesting tranche as though each tranche of the award is, in substance, a separate award. IFRS 3 Executive Compensation in Acquisitions

When acquiree share-based awards with graded-vesting features are granted prior to a business combination, some of the original awards may have vested and been exercised prior to the acquisition. Share-based payment awards of the acquiree that have already been exercised will be included in the consideration transferred for the acquiree’s outstanding shares.

For replacement awards related to awards still outstanding at the time of the business combination, the acquirer must determine the portion of the awards’ fair value attributable to precombination services that will be recorded as part of the consideration transferred. The remainder of the fair value of the replacement awards will be attributable to postcombination services.

The following example illustrates the attribution of the fair value of replacement awards to the precombination and postcombination services when a portion of the original awards has been exercised prior to the acquisition date. IFRS 3 Executive Compensation in Acquisitions

EXAMPLE – Attribution of the fair value of replacement awards with graded-vesting features to precombination and postcombination services as part of a business combination when a portion of the original awards has been exercised

Company A acquires Company B on 1 July 20X9. Company A issues replacement awards with identical terms for Company B’s outstanding awards held by employees. The original awards were issued to employees by Company B on 1 January 20X7 and provided employees with the right to purchase 100 shares of Company B. IFRS 3 Executive Compensation in Acquisitions

The original awards vest annually over 5 years (i.e., the original awards vest at a rate of 20% per year on the anniversary of the date of grant). The first two tranches of the original awards were exercised prior to the acquisition and only the unvested tranches remain outstanding at the acquisition date. IFRS 3 Executive Compensation in Acquisitions

The fair value of an award to purchase one common share at the acquisition date is CU10. There is no excess fair value of the replacement awards over the fair value of the acquiree awards as of the acquisition date. IFRS 3 Executive Compensation in Acquisitions

How should the fair value of the replacement awards be attributed to the precombination and postcombination services?

Analysis IFRS 3 Executive Compensation in Acquisitions

The first two tranches of the original awards (40 awards with a hypothetical acquisition date fair value of CU400) were exercised and are no longer outstanding. Therefore, the shares issued upon exercise of those awards would have already been included in the consideration transferred for Company B’s outstanding shares. IFRS 3 Executive Compensation in Acquisitions

Company A will issue replacement awards for the 60 share-based awards outstanding at the acquisition date. The fair value of the 60 replacement awards is CU600 and Company A must determine the total amount attributable to precombination services that will be recorded as part of the consideration transferred for Company B. The remainder will be attributable to postcombination services. IFRS 3 Executive Compensation in Acquisitions

If Company A’s accounting policy for recognizing share-based award compensation cost were to utilize a graded-vesting allocation approach (as required under IFRS and as permitted under US GAAP), the allocation would be calculated differently. Under a graded-vesting allocation approach CU392 of the CU600 fair value of the replacement awards would be attributable to precombination services and be recorded as part of the consideration transferred for Company B. This is calculated as follows:

Replacement awards

Total fair value

(CU)

% Vesting at acquisition date

Graded-vesting attributed to precombination services (CU)

Tranche 3

200

83.3¹

167

Tranche 4

200

62.5²

125

Tranche 5

200

50.0³

100

Total

600

392

1 Calculated as 30 months out of 36 months total service period.
2 Calculated as 30 out of 48 months total service period.
3 Calculated as 30 out of 60 months total service period.

The remaining value of the 60 replacement awards is attributable to postcombination services. That is, CU600 fair value of the 60 replacement awards less the CU392 attributable to precombination services results in CU208 attributable to postcombination services. IFRS 3 Executive Compensation in Acquisitions

Service required after the acquisition date is equal to or greater than the original service requirement

An employee may hold an award that is fully vested under its original terms, but the terms of the replacement award require additional service from the employee. Although the holder of the award performed all of the service as required by the original award granted by the acquiree, the acquirer added an additional vesting period to the replacement awards. Therefore, a portion of the fair value of the replacement award will be attributable to postcombination services. IFRS 3 Executive Compensation in Acquisitions

Consider a scenario in which the original terms of an award require four years of service which were completed as of the acquisition date. However, an additional year of service was added to the terms of the replacement award by the acquirer, resulting in a total vesting period of five years. IFRS 3 Executive Compensation in Acquisitions

The acquirer will use the ratio of the four years of service completed compared to the total vesting period of five years, resulting in 80% of the fair value of the acquiree award being attributed to precombination services and accounted for as consideration transferred for the acquiree. The remaining fair value of the replacement award, including any excess fair value, would be accounted for over the remaining vesting period of one year in the postcombination financial statements. IFRS 3 Executive Compensation in Acquisitions

Service required after the acquisition date is less than the original service requirement

A replacement award that requires less service after the acquisition than would have been required under the original award effectively accelerates the vesting of the original award, eliminating all or a portion of the postcombination service requirement. See Acquiree awards with an automatic change in control provision below for information on awards with an automatic change in control clause. IFRS 3 Executive Compensation in Acquisitions

The amount of fair value attributable to the accelerated vesting of the award should be recognized as additional compensation cost separate from the business combination. The amount included in the consideration transferred for the acquiree is limited to the amount of the acquiree’s award attributable to precombination service. The portion of the vesting period completed to the greater of the total vesting period or the original vesting period of the acquiree award should be used when calculating the amount of the replacement award attributable to precombination services.

The following example further illustrates this guidance. IFRS 3 Executive Compensation in Acquisitions

EXAMPLE – Attribution of fair value when service required after the acquisition date is less than the original service requirement

Company X (the acquirer) exchanges replacement awards with a fair value of CU100 for Company Y’s (the acquiree) awards with a fair value of CU100. When originally granted, Company Y’s awards provided for cliff vesting after a vesting period of four years from the grant date. IFRS 3 Executive Compensation in Acquisitions

As of the acquisition date, three of the four years of service required by the original terms of Company Y’s awards have been rendered. The replacement awards issued by Company X are fully vested. Company X was obligated to issue replacement awards under the terms of the acquisition agreement.

How should the fair value of the replacement awards be attributed to the precombination services?

Analysis IFRS 3 Executive Compensation in Acquisitions

Company X accelerated the vesting of the awards by eliminating the one year of postcombination service that would have been required under the awards’ original terms. The amount of Company X’s replacement awards’ value attributable to precombination services is equal to the fair value of Company Y’s awards at the acquisition date, multiplied by the portion of the vesting period completed to the greater of the total vesting period or the original vesting period of Company Y’s awards. IFRS 3 Executive Compensation in Acquisitions

  • The total vesting period is three years (i.e., the years of service rendered as of the acquisition date). IFRS 3 Executive Compensation in Acquisitions
  • The original vesting period of Company Y’s awards was four years. IFRS 3 Executive Compensation in Acquisitions
  • The original vesting period of four years is greater than the total vesting period of three years; therefore, the original vesting period of four years should be used to determine the amount attributable to precombination services; the amount attributable to precombination services is CU75 (the value of Company Y’s awards of CU100 × 3 years precombination service / 4 years original service). IFRS 3 Executive Compensation in Acquisitions
  • The fair value of Company Y’s replacement awards of CU100, less the amount attributed to precombination services of CU75, or CU25 (the portion for which vesting was accelerated), should be recognized in the postcombination financial statements. Because the replacement awards are vested, the entire CU25 should be recognized immediately in the postcombination financial statements. IFRS 3 Executive Compensation in Acquisitions

Acquiree awards with an automatic change in control provision

The fair value of acquiree awards that include a pre-existing, automatic change in control clause (whereby awards vest immediately upon a change in control) should be included in the consideration transferred for the acquiree. The excess fair value of any replacement awards over the fair value of the acquiree awards should be reflected in the postcombination period in accordance with IFRS 3 B56–B59, IFRS 3 IE70. IFRS 3 Executive Compensation in Acquisitions

However, a pre-existing change in control clause should be assessed carefully to determine if the change in control clause is a transaction separate from the business combination (e.g., considering when the change in control clause was added to the terms of the agreement). IFRS 3 Executive Compensation in Acquisitions

The following example illustrates the accounting for an award with an automatic change in control provision. IFRS 3 Executive Compensation in Acquisitions

EXAMPLE – Allocation of fair value when an automatic change in control provision accelerates vesting upon closing of an acquisition

Company X (the acquirer) exchanges vested shares with a fair value of CU100 for Company Y’s (the acquiree) awards with a fair value of CU100. Company Y’s awards contain a change in control clause, whereby they automatically vest upon closing of an acquisition. IFRS 3 Executive Compensation in Acquisitions

When originally granted, Company Y’s awards provide for cliff vesting after a vesting period of four years. As of the acquisition date, three of the four years of service required by the original terms of Company Y’s awards have been rendered. IFRS 3 Executive Compensation in Acquisitions

How should the fair value of the replacements awards be attributed to the precombination services?

Analysis IFRS 3 Executive Compensation in Acquisitions

The change in control clause in Company Y’s awards requires that all awards automatically vest upon closing of an acquisition. Due to the fact that the change in control clause was in the original terms of Company Y’s awards prior to the acquisition and required automatic vesting of the awards, there is no need to compare the total vesting period to the original vesting period.

Therefore, the amount attributable to precombination services is the entire CU100 fair value of the replacement awards. If the replacement awards issued by Company X had a fair value greater than CU100, any excess would have been recognized in the postcombination financial statements of the combined company. IFRS 3 Executive Compensation in Acquisitions

Acquiree awards with a discretionary change in control provision

Acquiree awards for which vesting is accelerated based on a discretionary change in control clause need to be analysed to determine if the acceleration of the vesting of the awards by the acquiree was arranged primarily for the economic benefit of the acquirer (or combined entity), or if it was for the benefit of the acquiree (as illustrated in EXAMPLE – Attribution of fair value when service required after the acquisition date is less than the original service requirement above). IFRS 3 Executive Compensation in Acquisitions

The portion of the fair value of the acquiree’s award related to the acceleration of vesting under a discretionary change in control clause would be recognized in the postcombination financial statements of the combined company if it is for the benefit of the acquirer. Refer to Assessing what is part of the consideration transferred for the acquiree above for the factors to consider in this analysis. IFRS 3 Executive Compensation in Acquisitions

Excess fair value of the acquirer’s replacement award

Any excess fair value of the replacement awards over the fair value of the acquiree awards at the acquisition date is considered an expense incurred by the acquirer (i.e., additional compensation) outside of the business combination. The excess fair value at the acquisition date, typically, is not significant if the replacement awards have the same terms and conditions as the acquiree awards.

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The assumptions used to calculate fair value immediately before the business combination may converge with the assumptions used to calculate the fair value of the replacement awards immediately after the modification because the value of the equity of the acquirer and the acquiree will usually reflect the pending acquisition as the closing date approaches.

However, if the acquirer changes the terms and conditions of the awards or the employee’s awards are exchanged using a different ratio than that offered to other equity holders (as this would usually be a change to make the awards more valuable to the employees), it is likely that there will be excess fair value. IFRS 3 Executive Compensation in Acquisitions

The acquirer should recognize the excess fair value over the remaining vesting period in the postcombination financial statements in accordance with IFRS 3 B59. Refer to IFRS 3 IE63-IE64 for an example of replacement awards with excess fair value. IFRS 3 Executive Compensation in Acquisitions

Acquiree awards that continue after the business combination

There may be circumstances when acquiree employee awards are not exchanged and do not expire but continue after the business combination. This may occur when the acquirer purchases a target company and the target company continues as a separate subsidiary of the acquirer. IFRS 3 Executive Compensation in Acquisitions

When the employee awards of the target are not exchanged but continue under the original terms after the business combination, the acquirer could account for the continuation of the awards as if the acquirer was obligated to issue replacement awards. This is similar to an exchange of awards in a business combination under IFRS 3 B56. IFRS 3 Executive Compensation in Acquisitions

Awards with performance or market conditions

For awards with performance conditions (as defined by IFRS 2), the acquirer should follow the same principle outlined in IFRS 3 for awards with service conditions. Consistent with the guidance in IFRS 3, the amount by which the fair value of the replacement awards exceeds the fair value of the original awards should be recognized in the postcombination financial statements in accordance with IFRS 3 B59. IFRS 3 Executive Compensation in Acquisitions

The determination of the fair value attributable to precombination and postcombination services would also be consistent with the analysis performed for awards with service conditions. The amount attributable to precombination services is determined by multiplying the fair value of the acquiree award by the ratio of the precombination vesting period completed prior to the exchange to the greater of the total vesting period or the original vesting period of the acquiree award. IFRS 3 Executive Compensation in Acquisitions

The amount attributable to postcombination services would then be calculated by subtracting the portion attributable to precombination services from the total fair value of the acquirer’s replacement award. The determination of the postcombination vesting period for the replacement awards should include consideration of the performance condition and the period in which it is probable that the performance condition will be achieved. The acquirer will need to make a probability assessment at the acquisition date. IFRS 3 Executive Compensation in Acquisitions

The following example illustrates this guidance. IFRS 3 Executive Compensation in Acquisitions

EXAMPLE – Allocation of fair value for awards with a performance condition

Company Z (the acquirer) exchanges replacement awards with a fair value of CU300 for Company A’s (the acquiree) awards with a fair value of CU300. Company Z was obligated to issue replacement awards under the terms of the acquisition agreement. When granted, Company A’s awards cliff vest following the completion of the development of a new product.

Because the awards contain a performance condition, at the acquisition date Company A had to assess the probability of whether the performance condition would be achieved. Prior to the acquisition, it was considered probable that the product would be finished three years from the grant date. As of the acquisition date, one year has passed since the grant date; therefore, two years remain in the original vesting condition. IFRS 3 Executive Compensation in Acquisitions

Company Z assessed the performance condition on the acquisition date and determined that it is still likely that the new product will be completed two years from the acquisition date. This probability assessment should be consistent with the assumptions included in the valuation of Company A’s in-process research and development (IPR&D).

How much of the fair value of the replacement awards should be attributed to precombination services?

Analysis IFRS 3 Executive Compensation in Acquisitions

The amount of Company Z’s replacement awards attributable to precombination services is equal to the fair value of Company A’s awards at the acquisition date, multiplied by the portion of the vesting period completed to the greater of the total vesting period or the original vesting period of Company A’s awards. IFRS 3 Executive Compensation in Acquisitions

The original vesting period of Company A’s awards was three years. Company Z, at the acquisition date, determined that it is still probable that the development of the new product will be completed in two more years; therefore, the awards will have a total vesting period of three years. That is, the original vesting period and the total vesting period are both three years.

The amount attributable to precombination services is CU100 (CU300 × 1 year precombination service / 3 years original service). The remaining fair value of the awards of CU200 should be recognized in the postcombination financial statements over the remaining vesting period of two years because the awards have not yet vested. IFRS 3 Executive Compensation in Acquisitions

Had the acquirer determined on the acquisition date that it was probable that the product would be completed one year from the acquisition date, then the amount attributable to precombination services (CU100) would remain the same. This would be the case since the original vesting period of three years is greater than the total vesting period of two years. The remaining fair value of CU200, however, would be recognized over the remaining vesting period of one year. IFRS 3 Executive Compensation in Acquisitions

Acquirer accounting for the exchange of an equity settled award with a performance (non-market) condition (as defined by IFRS 2), assuming it is not probable both before and after the exchange that the condition will be achieved IFRS 3 Executive Compensation in Acquisitions

Under IFRS 2, the probability that an award with a service or performance condition will vest is not incorporated into the fair value of the award; instead, compensation cost is recognized only for awards expected to vest. In other words, compensation cost is recognized if and when it is probable that the performance condition will be achieved in accordance with IFRS 2 20.

IFRS 3 provide that replacement share-based payment awards should be measured using the fair-value-based measurement method of IFRS 2 in accordance with IFRS 3 B57. Under IFRS 2 20, no compensation cost is recognized for an award with a performance condition that is not expected to vest. IFRS 3 Executive Compensation in Acquisitions

Accordingly, if it is not probable both before and after the exchange that the performance condition will be achieved, then no amount should be recorded for that replacement award in connection with the business combination. The acquirer should not record any compensation cost in the postcombination financial statements unless and until achievement of the performance condition becomes probable. IFRS 3 Executive Compensation in Acquisitions

Once achievement of the performance condition becomes probable, the company should begin recognizing cumulative compensation cost from the date it becomes probable based on the fair value of the replacement award as of the acquisition date. No adjustment should be made to the amounts recorded in connection with the business combination (e.g., goodwill) in accordance with IFRS 3 B60. IFRS 3 Executive Compensation in Acquisitions IFRS 3 Executive Compensation in Acquisitions

For awards with a market condition, the acquirer should follow the same principle outlined in IFRS 3 for awards with service conditions. Because a market condition is reflected in the fair value of an award, the market condition should be taken into consideration when calculating the fair value of the acquirer’s replacement awards. Consistent with the guidance in IFRS 3, any excess fair value should be recognized as compensation cost in the postcombination financial statements. IFRS 3 Executive Compensation in Acquisitions

The determination of the fair value attributable to precombination and postcombination services is consistent with the analysis performed for awards with service conditions. The determination of the precombination and postcombination vesting periods for the replacement awards should include consideration of the market condition.

As noted in Excess fair value of the acquirer’s replacement award above, the assumptions used to calculate fair value immediately before the business combination may converge with the assumptions used to calculate the fair value of the replacement awards immediately after the exchange. IFRS 3 Executive Compensation in Acquisitions

Illustrative summary of attributing fair value to precombination and postcombination services

The examples presented in the next table are based on the following assumptions: IFRS 3 Executive Compensation in Acquisitions

  1. the original terms of the acquiree’s awards cliff vest following four years of service, IFRS 3 Executive Compensation in Acquisitions
  2. the acquirer is obligated to issue replacement awards under the terms of the acquisition agreement (except as specified in Example 6 in the table below), and
  3. the fair value of the replacement awards is equal to the fair value of the acquiree awards on the acquisition date (except as specified in Example 3 in the table below).

See Awards with graded-vesting features above for information on awards with graded-vesting features. IFRS 3 Executive Compensation in Acquisitions

Table – Attribution of fair value to precombination and postcombination services

Acquiree’s awards

Acquirer’s replacement awards

Greater of total vesting period or original vesting period

Fair value attributable to precombination services

Fair value attributable to postcombination services

Example 1:

4 years of service required under original terms. All required services rendered prior to acquisition.

.

No service required after the acquisition date.

.

4 years. The original vesting period and the total vesting period are the same

.

100% (4 years precombination service/4 years total service).

.

.0.00%

IFRS 3 Executive Compensation in Acquisitions

Example 2:

4 years of service required under original terms. 3 years of service rendered prior to acquisition

.

1 year of service required after the acquisition date

IFRS 3 Executive Compensation in Acquisitions

.

4 years (3 years prior to acquisition plus 1 year after acquisition). The original vesting period and the total vesting period are the same.

..

.75% (3 years precombination service/4 years total service).

IFRS 3 Executive Compensation in Acquisitions

.

25% (total fair value of the replacement award less the 75% for precombination services). This amount is recognized in the postcombination financial statements over the remaining vesting period of 1 year.

Example 3:

4 years of service required under original terms. 4 years of service rendered prior to acquisition.

.

1 year of service required after the acquisition date. The employee has agreed to the additional year of service because the fair value of the replacement awards is greater than the fair value of the acquiree awards.

.

5 years (4 years completed prior to acquisition plus 1 year required after acquisition). The total vesting period of 5 years is greater than the original vesting period of 4 years.

.

80% of the acquiree award (4 years precombination service/5 years total service).

IFRS 3 Executive Compensation in Acquisitions

.

20% of the acquiree award and the excess fair value of the replacement award (total fair value of the replacement award less the 80% for precombination services). This amount is recognized in the postcombination financial statements over the remaining vesting period of 1 year.

Example 4:

4 years of service required under original terms. 1 year of service rendered prior to acquisition.

.

2 years of service required after the acquisition date. Therefore, the replacement awards require one less year of service

IFRS 3 Executive Compensation in Acquisitions

.

4 years (since only 2 years of service are required postcombination, the total vesting period for the replacement awards is 3 years, which is less than the original vesting period of 4 years). Therefore, the original vesting period is greater than the total vesting period.

.

25% (1 year precombination service/4 years original vesting period).

IFRS 3 Executive Compensation in Acquisitions

.

75% (total fair value of the replacement award less the 25% for precombination services). This amount is recognized in the postcombination financial statements over the remaining vesting period of 2 years.

Example 5:

4 years of service required under original terms. 3 years of service rendered prior to acquisition. There was no change in control clause in the terms of the acquiree awards.

.

No service required after the acquisition date.

IFRS 3 Executive Compensation in Acquisitions

IFRS 3 Executive Compensation in Acquisitions

.

4 years (since no additional service is required, the total vesting period for the replacement awards is 3 years, which is less than the original vesting period of 4 years). Therefore, the original vesting period is greater than the total vesting period.

.

75% (3 years precombination service / 4 years original vesting period).

IFRS 3 Executive Compensation in Acquisitions

.

25% (total fair value of the replacement award less the 75% for precombination services). This amount is recognized in the postcombination financial statements immediately because no future service is required.

Example 6:

4 years of service required under original terms. 3 years of service rendered prior to acquisition. There was a change in control clause in the original terms of the acquiree awards when granted that accelerated vesting upon a change in control.

.

No service required after the acquisition date.

IFRS 3 Executive Compensation in Acquisitions

IFRS 3 Executive Compensation in Acquisitions

.

Not applicable.

Because the awards contain a preexisting change in control clause, the total fair value of the acquiree awards is attributable to precombination services.

.

100%. For acquiree awards with a change in control clause that accelerates vesting, the total fair value of the acquiree awards is attributable to precombination services.

.

0%. For acquiree awards with a preexisting change in control clause, no amount is attributable to postcombination services because there is no future service required.

Cash settlement of employee share-based payment awards

An acquirer may elect to pay cash to settle outstanding awards held by employees of the acquiree instead of granting replacement awards. The accounting for the cash settlement of share-based payment awards outside of a business combination is addressed by IFRS 2 28. The accounting for the cash settlement of share-based payment awards within a business combination is not explicitly addressed by IFRS 3. However, many of the same principles that apply to the exchange of share-based payment awards should be applied to these transactions.

That is, determine the portion of the cash settlement to be attributed to precombination services or postcombination services using the guidance for the exchange of share-based payment awards and the allocation formula described in Calculation of the amount of fair value attributed to precombination services or postcombination services above.

The following sections discuss cash settlements initiated by the acquirer as well as cash settlements initiated by the acquiree. Determining who initiated the cash settlement may require analysis of the factors listed above in Assessing what is part of the consideration transferred for the acquiree and Contingent payments—determining whether the arrangement is compensation.

Initiated by the acquirer

Cash payments made by the acquirer to settle vested awards should be included in the consideration transferred for the acquiree up to an amount equal to the fair value of the acquiree’s awards measured at the acquisition date. To the extent the cash payment is greater than the fair value of the acquiree’s awards, the excess fair value amount is considered an expense incurred by the acquirer outside of the business combination rather than as consideration transferred for the acquiree. IFRS 3 Executive Compensation in Acquisitions

Accordingly, the excess amount of cash paid over the fair value of the acquiree’s awards should be immediately recognized as compensation cost in the postcombination financial statements in accordance with IFRS 3 B59. IFRS 3 Executive Compensation in Acquisitions

If cash payments are made by the acquirer to settle unvested awards (assuming no future service is required to receive the cash payment), the acquirer has effectively accelerated the vesting of the awards by eliminating the postcombination service requirement and settled the awards for cash. The portion attributable to precombination service provided to the acquiree should be included in the consideration transferred for the acquiree. IFRS 3 Executive Compensation in Acquisitions

The remaining portion of the cash payment to the acquiree’s employees, attributable to the postcombination service, should be immediately recognized as compensation cost in the postcombination financial statements. This analysis is similar to the illustration in Attribution of fair value when service required after the acquisition date is less than the original service requirement above, in which vested replacement share-based payment awards are transferred for unvested acquiree awards in accordance with IFRS 3 IE70–IE71.

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An acquirer may pay cash in exchange for unvested awards of the acquiree and additional postcombination service, with the cash payment made at the completion of the additional vesting period. In this case, the acquirer will need to determine the portion of the payment attributable to precombination services and postcombination services.

The amount attributable to precombination services is determined by multiplying the fair value of the acquiree award by the ratio of the precombination vesting period completed prior to the payment, to the greater of the total vesting period or the original vesting period of the acquiree award. The amount attributable to postcombination services would be recognized in the postcombination financial statements over the remaining vesting period. IFRS 3 Executive Compensation in Acquisitions

Initiated by the acquiree

The acquiree (as opposed to the acquirer) may cash-settle outstanding awards prior to the acquisition. However, these transactions, including their timing, should be carefully assessed to determine whether the cash settlement, or a portion thereof, was arranged primarily for the economic benefit of the acquirer (or the combined entity).

Even though the form of the transaction may indicate that the acquiree initiated the cash settlement, it may be determined that, in substance, the acquirer reimbursed the acquiree for the cash settlement (either directly or as part of the consideration transferred for the acquiree). This assessment should include an analysis of the factors listed in Assessing what is part of the consideration transferred for the acquiree above. IFRS 3 Executive Compensation in Acquisitions

If the acquiree cash-settles its awards and it is determined that the transaction was for the economic benefit of the acquiree, the settlement should be recorded in the acquiree’s financial statements prior to the business combination in accordance with IFRS 2 28.

If it is determined that the acquirer reimbursed the acquiree for the cash settlement (either directly or as part of the transaction price paid for the acquiree), the accounting by the acquirer should generally be the same as if the acquirer had settled the awards directly. The following example illustrates this guidance.

EXAMPLE – Example of cash settlement of awards by the acquiree

Company D (the acquiree) cash-settles the outstanding unvested awards held by its employees immediately prior to being acquired by Company C (the acquirer). The amount of cash paid by Company D is CU100 million, which is equal to the current fair value of the awards. At the time of settlement, the employees had completed 75% of the service required to vest in the awards (and 25% of the service period remained). IFRS 3 Executive Compensation in Acquisitions

How should Companies C and Company D account for the cash settlement of the outstanding unvested awards by Company D?

Analysis IFRS 3 Executive Compensation in Acquisitions

Company C should determine whether a portion of the consideration transferred for Company D is attributable to the settlement of unvested awards held by Company D’s employees. The settlement of the portion of the unvested awards not attributable to precombination services may be a transaction arranged primarily for the economic benefit of Company C. Factors to consider in this analysis (as discussed in IFRS 3 B50) include: IFRS 3 Executive Compensation in Acquisitions

  • The reasons for the transaction: Why did Company D elect to cash-settle the outstanding awards? IFRS 3 Executive Compensation in Acquisitions
  • Who initiated the transaction: Did Company C direct Company D to settle the awards? Was the settlement a condition of the acquisition?
  • The timing of the transaction: Was the settlement in contemplation of the business combination? IFRS 3 Executive Compensation in Acquisitions

If Company D was requested by Company C to cash-settle the awards, the settlement of the unvested awards would be deemed a transaction arranged primarily for the economic benefit of Company C. Therefore, a portion of the total consideration transferred should be attributed to the cash settlement of the awards and excluded from the consideration transferred to acquire Company D. IFRS 3 Executive Compensation in Acquisitions

In this example, the fair value of the unvested awards that is not attributable to precombination services, or CU25 million (the fair value of the awards of CU100 million remaining vesting period of 25%), is the amount that would be excluded from consideration transferred and recognized as expense in Company C’s postcombination financial statements. The CU25 million should be recognized immediately because no postcombination service is required. IFRS 3 Executive Compensation in Acquisitions

Other arrangements

Other forms of compensation arrangements may be provided to the employees of the acquiree in conjunction with a business combination. Two common arrangements are “last-man-standing” arrangements and “dual trigger” arrangements. IFRS 3 Executive Compensation in Acquisitions

Last-man-standing” arrangements

Awards granted to a group of employees and reallocated equally among the remaining employees if any of the employees terminate employment prior to completion of the vesting period are often described as ‘last-man-standing’ arrangements. The estimated number of awards that are expected to vest does not change; therefore, a reallocation of awards would generally not have an accounting impact. IFRS 3 Executive Compensation in Acquisitions

The first example below illustrates “last-man-standing” arrangements that are provided as share-based payment awards; the second example illustrates those that are payable in cash.

EXAMPLE – “Last-man-standing” arrangement involving share-based payment awards

On 1 January 2X10, Company M (the acquirer) acquires Company G (the acquiree) and, as part of the acquisition agreement, grants 100 awards to each of five former executives of Company G. Each set of awards has a fair value of CU300 on the acquisition date. The awards cliff vest upon two years of continued employment with the combined company. However, if the employment of any one of the executives is terminated prior to 1 January 2X12, any awards forfeited by that executive are reallocated equally among the remaining executives who continue employment. The reallocated awards will continue to cliff vest on 1 January 2X12. IFRS 3 Executive Compensation in Acquisitions

On 1 January 2X11, one of the five executives terminates employment with the combined company. The 100 unvested awards (100 awards × 1 executive) are forfeited and redistributed equally to the other four executives. At the time of the forfeiture, the fair value of each set of awards is CU360. IFRS 3 Executive Compensation in Acquisitions

How should Company M account for the “last-man-standing” arrangement?

Analysis IFRS 3 Executive Compensation in Acquisitions

Under IFRS, the estimated number of total awards that will ultimately vest is not expected to change; therefore, there is no accounting consequence arising from the reallocation

EXAMPLE “Last-man-standing” arrangement involving cash consideration

Company B (the acquirer) acquires Company A (the acquiree) for cash consideration of CU250. The selling shareholders of Company A were all key employees of Company A prior to the acquisition date and will continue as employees of the combined business following the acquisition by Company B. Company B will pay the selling shareholders additional consideration in the event Company A achieves pre-determined sales targets for the 3 years following the acquisition. This additional consideration will be paid to the previous shareholders in proportion to their relative previous ownership interests. IFRS 3 Executive Compensation in Acquisitions

Any shareholders who resign their employment with Company A during the 3-year period forfeit their portion of the additional payments. Amounts forfeited are redistributed among the previous shareholders who remain as employees for the 3-year period. If none of the previous shareholders remain employed at the end of the 3-year period, but the relevant sales targets are still achieved, all of the previous shareholders will receive the additional payment in proportion to their previous ownership interests. The selling shareholders will have the ability to influence sales volumes if they continue as employees. IFRS 3 Executive Compensation in Acquisitions

Analysis IFRS 3 Executive Compensation in Acquisitions

The contingent payments are not automatically forfeited if all the selling shareholders cease employment. However, each of the selling shareholders controls their ability to earn their portion of the additional payment by continuing employment. The selling shareholders have the ability to influence sales volumes if they continue as employees. The commercial substance of the agreement incentivises the selling shareholders to continue as employees. IFRS 3 Executive Compensation in Acquisitions

Further, the scenario where all selling shareholders cease employment is unlikely because the last selling shareholder remaining in employment would not likely voluntarily leave employment and forfeit the entire amount of additional payment. The entire additional payment, given this combination of factors, would be accounted for as compensation expense in the postcombination period.

Dual trigger” arrangements

Preexisting employment agreements often include clauses that accelerate vesting upon a change of control and termination of employment within a defined period of time from the acquisition date, often referred to as dual trigger arrangements. Employment agreements of the acquiree should be carefully assessed to determine whether acceleration of vesting is primarily for the economic benefit of the acquirer by considering the following factors: IFMeasurement of remaining coverageRS 3 Executive Compensation in Acquisitions

  • The reasons for the transaction IFRS 3 Executive Compensation in Acquisitions
  • Who initiated the transaction IFRS 3 Executive Compensation in Acquisitions
  • The timing of the transaction [IFRS 3 B50] IFRS 3 Executive Compensation in Acquisitions

If it is determined the clause or transaction that accelerates vesting is primarily for the economic benefit of the acquirer, the acceleration of vesting of unvested awards should be accounted for separately from the business combination and will be recognized as compensation cost to the acquirer in accordance with IFRS 3 51–52, IFRS 3 B50.

The dual trigger clause effectively places the decision to retain the acquiree’s employees in the control of the acquirer, and thus the decision would be made primarily for the acquirer’s economic benefit (e.g., reduce cost). Therefore, since the acquirer makes the decision to terminate the employees, the acquirer should recognize cost in the postcombination period for the acceleration of the unvested portion of the awards (measured as of the acquisition date using the methodology described in IFRS 3 B58–B59). IFRS 3 Executive Compensation in Acquisitions

An acquiree may put in place a new, or alter an existing, compensation arrangement at the direction of the acquirer. In these instances, it may be necessary to record compensation cost in both the acquirer’s post-acquisition financial statements and the acquiree’s pre-acquisition financial statements. These scenarios typically arise when the acquiree legally incurred the related obligation, and other accounting standards require the acquiree to recognize the related cost even though the cost was incurred for the benefit of the acquirer.

The following example illustrates the accounting for a dual trigger arrangement. IFRS 3 Executive Compensation in Acquisitions

EXAMPLE – Accelerated vesting conditioned upon a dual trigger consisting of change in control and termination

Company A acquires Company B in a business combination, and Company A is obligated to grant replacement awards as part of the business combination [IFRS 3R B56].

Company B has an existing employment agreement in place with one of its key employees that states that all of the key employee’s unvested awards will fully vest upon a change in control and termination of employment within 12 months following the acquisition date. The employment agreement was in place before Company A and Company B began negotiations for the acquisition of Company B. IFRS 3 Executive Compensation in Acquisitions

The awards vest only if the employee is subsequently terminated without cause or leaves for good reason as defined in the employment contract. Prior to the acquisition date, Company A had determined it would not offer employment to the key employee of Company B, effectively terminating employment on the acquisition date. This resulted in the acceleration of all the key employee’s unvested awards upon closing of the acquisition. IFRS 3 Executive Compensation in Acquisitions

How should Company A account for the accelerated vesting of the awards?

Analysis IFRS 3 Executive Compensation in Acquisitions

Company A should immediately recognize compensation cost related to the accelerated vesting of the awards (measured as of the closing of the acquisition using the methodology described in IFRS 3 B58–B59) in its postcombination period. The accelerated vesting is conditioned upon both a change in control of the acquiree and the termination of employment of the key employee. At the acquisition date, both conditions were triggered. IFRS 3 Executive Compensation in Acquisitions

The decision not to employ the key employee was in the control of Company A and effectively made for its primary economic benefit (e.g., reduce cost) and, therefore, should be recorded separately from the business combination [IFRS 3 51–52]. IFRS 3 Executive Compensation in Acquisitions

Postcombination accounting for share-based payment awards

Compensation cost associated with share-based payment awards that is recorded in the acquirer’s postcombination financial statements should be accounted for in accordance with IFRS 2 26-29. For example, the determination of whether the acquirer’s replacement awards should be classified as equity or as a liability and the period over which compensation cost is recognized should be based on the guidance in IFRS 2. IFRS 3 Executive Compensation in Acquisitions

Modifications of awards after the acquisition date should be accounted for based on the modification guidance in IFRS 2. No adjustments are made to the accounting for the business combination as a result of changes in forfeiture estimates (refer to Fair value of the acquirer’s unvested replacement… and Adjustment of compensation cost recognized….) or modifications of replacement awards after the acquisition date in accordance with IFRS 3 B60. This includes fair value adjustments for the remeasurement of liability-classified awards at each balance sheet date until the settlement date under IFRS 3 B61.

New share-based payment awards (as opposed to replacement awards) granted by the acquirer to the former employees of the acquiree will be subject to the guidance in IFRS 2, and will not affect the accounting for the business combination. IFRS 3 Executive Compensation in Acquisitions

Acquirer accounting for the acceleration of unvested share-based payment awards that is triggered when the acquirer does not issue equivalent replacement awards as part of a business combination IFRS 3 Executive Compensation in Acquisitions

If the provision that accelerates vesting is primarily for the benefit of the acquirer, the acceleration of vesting of unvested awards should be accounted for separate from the business combination and be recognized as compensation cost in the acquirer’s postcombination financial statements in accordance IFRS 3 51–52. IFRS 3 Executive Compensation in Acquisitions

The aquirer’s decision not to issue replacement awards is in the control of the acquirer. Therefore, the acquirer should immediately recognize compensation cost in the postcombination period for the acceleration of the unvested portion of the awards. The accounting would be the same if the acquirer issued fully vested replacement awards.

Acquirer accounting for a modification to an arrangement with contingent payments in a business combination when the modification occurs during the measurement period

A subsequent change to a compensation arrangement does not lead the acquirer to reassess its original conclusion under IFRS 3 B55 regarding whether the arrangement is treated as consideration transferred or is accounted for outside of the business combination. Assuming the original conclusion reached as of the acquisition date was not an error, the original treatment should be respected even if the subsequent change was made during the measurement period. IFRS 3 Executive Compensation in Acquisitions

The following example illustrates an arrangement that includes contingent payments that is modified during the measurement period.

EXAMPLE – Accounting for modifications during the measurement period to compensation arrangements

Company A acquired Company B in a business combination. Company A wanted to retain the services of the former Company B shareholders to help transition the business.

Therefore, Company A agreed to pay a portion of the consideration to the former shareholders of Company B over the length of their new employment contracts (3 years) with the combined entity. The former shareholders would forfeit any unearned portion of the contingent payment if employment were voluntarily terminated. IFRS 3 Executive Compensation in Acquisitions

After considering the guidance in IFRS 3 B55, Company A appropriately determined that it should account for the contingent payment as compensation cost and not as an element of consideration transferred. The contingent payment to the former shareholders was linked to their continued employment. IFRS 3 Executive Compensation in Acquisitions

Six months after the business combination, Company A decided it no longer needed the former shareholders for transition purposes and terminated their employment. As part of the termination, Company A agreed to settle the contingent payment arrangement with an additional payment to the former shareholders.

How should Company A account for the modification?

Analysis IFRS 3 Executive Compensation in Acquisitions

Company A appropriately concluded at the acquisition date that the arrangement should be treated as compensation cost. A subsequent change to that arrangement does not cause Company A to reassess its original conclusion under IFRS 3 B55. IFRS 3 Executive Compensation in Acquisitions

This would also apply even if the subsequent change was made while Company A was in the process of finalizing any measurement period adjustments. Company A should consider the payment to the former shareholders of Company B as being made to settle their employment contracts with Company A (i.e., Company A accelerated the service period) and not as consideration transferred to acquire Company B. IFRS 3 Executive Compensation in Acquisitions

IFRS 3 Executive Compensation in Acquisitions

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