## Option valuation models

Option valuation models use mathematical techniques to identify a range of possible future share prices at the exercise date. From these possible future share prices, the pay-off of an option can be calculated. These intrinsic values at exercise are then probability-weighted and discounted to their present value to estimate the fair value of the option at the grant date.

This narrative is part of the IFRS 2 series, look here.

### Model selection

There are three main models used to value options:

• closed-form models: e.g. the BSM model;
• lattice models; and
• simulation models: e.g. Monte Carlo models.

These models generally result in very similar values if the same assumptions are used. However, certain models may be more restrictive than others – e.g. in terms of the different pay-offs that can be considered or assumptions that can be incorporated.

For example, a BSM model incorporates early exercise behaviour by using an expected term assumption that is shorter than the contractual life, whereas a lattice model or Monte Carlo model can incorporate more complex early exercise behaviour.

### Simple model explanation

The approach followed in, for example, a lattice model illustrates the principles used in an option valuation model in a simplified manner.

## IFRS 2 Fair value of equity instruments granted

IFRS 2 Fair value of equity instruments granted – Share-based payment transactions with employees are measured with reference to the fair value of the equity instruments granted (IFRS 2.11).

The fair value of a equity instrument granted is determined as follows (IFRS 2.16-17):

• If market prices are available for the actual equity instruments granted – i.e. shares or share options with the same terms and conditions – then the estimate of fair value is based on these market prices. IFRS 2 Fair value of equity instruments granted
• If market prices are not available for the equity instruments granted, then the fair value of equity instruments granted is estimated using a valuation technique.

## Fair value measurement

Fair Value Measurement can present significant challenges for preparers of financial statements, particularly because it involves using judgment and estimation. Further, it is the market participant view that shapes fair value, so preparers need to monitor whether the valuation models and assumptions they use for financial reporting appropriately reflect those of market participants.

Fair Value Measurement under IFRS 13:

1. defines fair value;
2. sets out in a single IFRS a framework for measuring fair value; and
3. requires disclosures about fair value measurements.

The definition of fair value focuses on assets and liabilities because they are a primary subject of accounting measurement. In addition, IFRS 13 is applied to an entity’s own equity instruments measured at fair value.… Read more

## Valuation techniques Income approach

Valuation techniques Income approach converts future amounts (cash flows or income and expenses) to a single current (i.e. discounted) exit price amount.

## Share-based payment

In share-based payment transactions, an entity receives goods or services from a counterparty and grants equity instruments (equity-settled share-based payment transactions) or incurs a liability to deliver cash or other assets for amounts that are based on the price (or value) of equity instruments (cash-settled share-based payment transactions) as consideration.

The following transactions are not in the scope of IFRS 2:

• transactions with counterparties acting as shareholders rather than as suppliers of goods or services;
• transactions in which a share-based payment is made in exchange for control of a business; and
• transactions in which contracts to acquire non-financial items in exchange for a share-based payment are in the scope of the financial instruments standards.

A ‘counterparty’ can be … Read more

## IFRS 13 Fair value measurement

IFRS 13 Fair Value Measurement is a single source of fair value measurement guidance that:

• clarifies the definition of fair value, IFRS 13 Fair value measurement
• provides a clear framework for measuring fair value, and IFRS 13 Fair value measurement
• enhances the disclosures about fair value measurements. IFRS 13 Fair value measurement

### Basis for use in other IFRS

IFRS 13 Fair Value Measurement applies to IFRSs that require or permit fair value measurements or disclosures. It does not introduce new fair value measurements, nor does it eliminate practicability exceptions to fair value measurements. In other words, IFRS 13 specifies how an entity should measure fair value and disclose information about fair value measurements. It does not specify when an entity … Read more