Share-based payments

IFRS 18 Presentation and Disclosure in Financial Statements – Best read

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IFRS 18 Presentation and Disclosure in Financial Statements

The IASB’s newly issued standard IFRS 18 mainly deals with the presentation of the income statement, balance sheet and certain footnotes. At the same time, certain aspects of the cash flow statement are modified. IFRS 18 does not change the recognition and measurement of the components of financial statements; therefore, the amounts reported as shareholders’ equity and net income are both unchanged. However, it will have a significant impact on the presentation and disaggregation of what is reported (primarily in the income statement and footnotes), including what subtotals companies must provide and how these are defined.

There are five main areas where we think the new standard will help investors as users of IFRS Financial Statements:IFRS 18 Presentation and Disclosure in Financial Statements

Operating–Investing–Financing classification

IFRS 18 aims to establishes a structured statement of profit or loss by implementing the following measures:

  • It introduces three defined categories for income and expenses: operating, investing, and financing.
    • Operating – income/expenses resulting from the company’s main business operations.
    • Investing – income/expenses from:
      • investments in associates, joint ventures and unconsolidated subsidiaries;
      • cash and cash equivalents;
      • assets that generate a return individually and largely independently (e.g. rental income from investment properties).
    • Financing – consisting of:
      • income/expenses from liabilities related to raising finance only (e.g. interest expense on borrowings); and
      • interest income/expenses and effects of changes in interest rates from other liabilities (e.g. interest expense on lease liabilities).
  • It mandates to present new defined totals and subtotals, including operating profit, thereby enhancing the clarity and consistency of financial reporting.

Entities primarily engaged in investing in assets or providing finance to customers are subject to specific categorisation requirements. This entails that additional income and expense items, which would typically be classified as investing or financing activities, are instead categorised under operating activities. Consequently, operating profit reflects the outcomes of an entity’s core business operations. Identifying the main business activity involves exercising judgment based on factual circumstances.

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Example accounting policies

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Example accounting policies

Get the requirements for properly disclosing the accounting policies to provide the users of your financial statements with useful financial data, in the common language prescribed in the world’s most widely used standards for financial reporting, the IFRS Standards. First there is a section providing guidance on what the requirements are, followed by a comprehensive example, easy to tailor to the specific needs of your company.Example accounting policies

Example accounting policies guidance

Whether to disclose an accounting policy

1. In deciding whether a particular accounting policy should be disclosed, management considers whether disclosure would assist users in understanding how transactions, other events and conditions are reflected in the reported financial performance and financial position. Disclosure of particular accounting policies is especially useful to users where those policies are selected from alternatives allowed in IFRS. [IAS 1.119]

2. Some IFRSs specifically require disclosure of particular accounting policies, including choices made by management between different policies they allow. For example, IAS 16 Property, Plant and Equipment requires disclosure of the measurement bases used for classes of property, plant and equipment and IFRS 3 Business Combinations requires disclosure of the measurement basis used for non-controlling interest acquired during the period.

3. In this guidance, policies are disclosed that are specific to the entity and relevant for an understanding of individual line items in the financial statements, together with the notes for those line items. Other, more general policies are disclosed in the note 25 in the example below. Where permitted by local requirements, entities could consider moving these non-entity-specific policies into an Appendix.

Change in accounting policy – new and revised accounting standards

4. Where an entity has changed any of its accounting policies, either as a result of a new or revised accounting standard or voluntarily, it must explain the change in its notes. Additional disclosures are required where a policy is changed retrospectively, see note 26 for further information. [IAS 8.28]

5. New or revised accounting standards and interpretations only need to be disclosed if they resulted in a change in accounting policy which had an impact in the current year or could impact on future periods. There is no need to disclose pronouncements that did not have any impact on the entity’s accounting policies and amounts recognised in the financial statements. [IAS 8.28]

6. For the purpose of this edition, it is assumed that RePort Co. PLC did not have to make any changes to its accounting policies, as it is not affected by the interest rate benchmark reforms, and the other amendments summarised in Appendix D are only clarifications that did not require any changes. However, this assumption will not necessarily apply to all entities. Where there has been a change in policy, this will need to be explained, see note 26 for further information.

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Employee benefits accounting policies

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Employee benefits accounting policies

This is a separated part of the example accounting policies, it is separated because of the size of this note and the specific nature of employee benefits.

Example accounting policies – Introduction

Get the requirements for properly disclosing the accounting policies to provide the users of your financial statements with useful financial data, in the common language prescribed in the world’s most widely used standards for financial reporting, the IFRS Standards. Here is a section providing guidance on what the requirements are, below a comprehensive example is provided, easy to tailor to the specific needs of your company.

Employee benefits Guidance

Presentation and measurement of annual leave obligations

RePort Plc has presented its obligation for accrued annual leave within current employee benefit obligations. However, it may be equally appropriate to present these amounts either as provisions (if the timing and/or amount of the future payments is uncertain, such that they satisfy the definition of ‘provision’ in IAS 37) or as other payables.

For measurement purposes, we have assumed that RePort Plc has both annual leave obligations that are classified as Employee benefits accounting policiesshort-term benefits and those that are classified as other long-term benefits under the principles in IAS 19. The appropriate treatment will depend on the individual facts and circumstances and the employment regulations in the respective countries.(IAS19(8),(BC16)-(BC21))

To be classified and measured as short-term benefits, the obligations must be expected to be settled wholly within 12 months after the end of the annual reporting period in which the employee has rendered the related services. The IASB has clarified that this must be assessed for the annual leave obligation as a whole and not on an employee-by-employee basis.

Share-based payments – expense recognition and grant date

Share-based payment expenses should be recognised over the period during which the employees provide the relevant services. This period may commence prior to the grant date. In this situation, the entity estimates the grant date fair value of the equity instruments for the purposes of recognising the services received during the period between service commencement date and grant date.(IFRS2(IG4))

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Fair value employee share options in IFRS 2

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Fair value employee share options

Share options give the holder the right to buy the underlying shares at a set price, called the ‘exercise price’, over or at the end of an agreed period. If the share price exceeds the option’s exercise price when the option is exercised, then the holder of the option profits by the amount of the excess of the share price over the exercise price. Benefit is derived from the right under the option to buy a share for less than its value.

The holder’s cost is the exercise price, whereas the value is the share price. It is not necessary for the holder to sell the share for this profit to exist. Sale only results in realisation of the profit. Because an option holder’s profit increases as the underlying share price increases, share options are used to incentivise employees to contribute to an increase in the price of the underlying shares.

Employee options are typically call options, which give holders the right but not the obligation to buy shares. However, other types of options are also traded in markets. For example, put options give holders the right to sell the underlying shares at an agreed price for a set period.

Given that holders of put options profit when share prices fall below the exercise price, such options are not viewed as aligning the interests of employees and shareholders. All references in this section to ‘share options’ are to employee call options.

Share options granted by entities often cannot be valued with reference to market prices. Many entities, even those whose shares are quoted publicly, do not have options traded on their shares. Options that trade on recognised exchanges such as the Chicago Board Options Exchange are created by market participants and are not issued by entities directly.

Even when there are exchange-traded options on an entity’s shares for which prices are available, the terms and conditions of these options are generally different from the terms and conditions of options issued by entities in share-based payments and, as a result, the prices of such traded options cannot be used directly to value share options issued in a share-based payment.

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Option valuation models

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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.

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Replacements of employee share-based payments

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Replacements of employee share-based payments

Sometimes a share-based payment is granted as a replacement for another share-based payment that is cancelled. In this case, the principles of modification accounting are applied. The basis for conclusions to IFRS 2 explains that the reason for permitting a cancellation and a new grant to be accounted for as a modification is that the Board could not see a difference between those two transactions and a re-pricing, being a change in the exercise price.

To apply modification accounting, the entity identifies the new equity instruments granted as a replacement for cancelled equity instruments on the date on which the new equity instruments are granted. (IFRS 2.28(c))

If the entity does not identify a new equity-settled plan as a replacement for a cancelled equity-settled plan, then the two plans are accounted for separately. For example, if a new equity-settled share-based payment is offered and an old equity-settled share-based payment is cancelled, but the new plan is not identified as a replacement plan for the cancelled plan, then the new grant is recognised at its grant-date fair value and the original grant is accounted for as a cancellation. (IFRS 2.28(c))

IFRS 2 specifies that identification of a new grant as a replacement award is required on the date of the new grant. However, the standard is silent on the question of whether the cancellation should also be on the same date as the new grant. Judgement is required to determine whether the facts and circumstances demonstrate that the arrangement is a modification if time has passed between the cancellation and the identification of a new grant.

When modification accounting is applied, the entity accounts for any incremental fair value in addition to the grant-date fair value of the original award. In the case of a replacement, the incremental fair value is the difference between the fair value of the replacement award and the net fair value of the cancelled award, both measured at the date on which the replacement award is issued.

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Cancellation of employee share-based payments

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Cancellation of employee share-based payments

Cancellations or settlements of equity instruments during the vesting period by the entity or by the counterparty are accounted for as accelerated vesting, and therefore the amount that would otherwise have been recognised for services received is recognised immediately. (IFRS 2.28(a), IG15A.Ex9)

Cancellation by employee

Cancellations by the employee can occur because the employee waives the share-based payment for their own reasons. In our experience, this does not occur often in practice (see case – Voluntary cancellation by employee below). Cancellations will occur more often as a consequence of the employee choosing not to meet a non-vesting condition that is part of the share-based payment arrangement (see case – Cancellation by employee due to failure to meet non-vesting condition below). Failure to meet such a non-vesting condition is treated as a cancellation. (IFRS 2.28A, BC237B)

Case – Voluntary cancellation by employee

On 1 January Year 1, Company B grants 1,000 share options to its CEO, subject to a three-year service condition. A share option has a grant-date fair value of 10. B expects the CEO to satisfy the service condition, which they do.

In Year 2, the CEO waives the entitlement to share options in difficult economic times.

B accounts for the transaction as follows.

Cancellation of employee share-based payments

The example illustrates that the principle of accelerated vesting applies even if the employee voluntarily cancels an unvested share-based payment.

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Employee share purchase plans

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Employee share purchase plans

In an ESPP, the employees are usually entitled to buy shares at a discounted price. The terms and conditions can vary significantly and some ESPPs include option features. (IFRS 2.IG17)

In my view, the predominant feature of the share-based payment arrangement determines the accounting for the entire fair value of the grant. That is, depending on the predominant features, a share purchase plan is either a true ESPP or an option plan.

All of the terms and conditions of the arrangement should be considered when determining the type of equity instruments granted and judgement is required. The determination is important because the measurement and some aspects of the accounting for each are different (see below).

Options are characterised by the right, but not the obligation, to buy a share at a fixed price. An option has a value (i.e. the option premium), because the option holder has the benefit of any future gains and has none of the risks of loss beyond any option premium paid. The value of an option is determined in part by its duration and by the expected volatility of the share price during the term of the option.

In my view, the principal characteristic of an ESPP is the right to buy shares at a discount to current market prices. ESPPs that grant short-term fixed purchase prices do not have significant option characteristics because they do not allow the grant holder to benefit from volatility. I believe that ESPPs that provide a longer-term option to buy shares at a specified price are, in substance, option plans, and should be accounted for as such. (IFRS 2.B4-B41)

Examples of other option features that may be found in ESPPs are: (IFRS 2.IG17)

  • ESPPs with look-back features, whereby the employees are able to buy shares at a discount, and choose whether the discount is applied to the entity’s share price at the date of the grant or its share price at the date of purchase;
  • ESPPs in which the employees are allowed to decide after a significant period of time whether to participate in the plan; and
  • ESPPs in which employees are permitted to cancel their participation before or at the end of a specified period and obtain a refund of any amounts paid into the plan.

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Determination of the vesting period in IFRS 2

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Determination of the vesting period

Service commencement date and grant date – The ‘vesting period’ is the period during which all of the specified vesting conditions are to be satisfied in order for the employees to be entitled unconditionally to the equity instrument. Normally, this is the period between grant date and the vesting date. (IFRS 2.A)

However, services are recognised when they are received and grant date may occur after the employees have begun rendering services. Grant date is a measurement date only. If grant date occurs after the service commencement date, then the entity estimates the grant-date fair value of the equity instruments for the purpose of recognising the services from the service commencement date until grant date.

A possible method of estimating the fair value of the equity instruments is by assuming that grant date is at the reporting date. Once grant date has been established, the entity revises the earlier estimates so that the amounts recognised for services received are based on the grant-date fair value of the equity instruments. In our view, this revision should be treated as a change in estimate. (IFRS 2.IG4, IGEx1A, IGEx2)

Case – Service commencement date before grant date

Determination of the vesting period

On 1 January Year 1, Company B sets up an arrangement in which the employees receive share options, subject to a four-year service condition. The total number of equity instruments granted will be determined objectively based on B’s profit in Year 1. The total number of options will be allocated to employees who started service on or before 1 January Year 1.

Significant subjective factors are involved in determining the number of instruments allocated to each individual employee and B concludes that grant date should be postponed until the outcome of the subjective evaluations is known in April Year 2 – i.e. subsequent to the approval of the financial statements for the reporting period ending 31 December Year 1.

Because the subjective factors are determined only in April Year 2, grant date cannot be before this date. However, in this case there is a clearly defined performance period, commencing on 1 January Year 1, which indicates that the employees have begun rendering their services before grant date. Accordingly, B recognises the cost of the services received from the date on which service commences – i.e. 1 January Year 1.

The estimate used in the Year 1 financial statements is based on an estimate of the fair value, assuming that grant date is 31 December Year 1. This estimate will be revised in April Year 2 when the fair value at grant date is determined.

Assume that B estimates on 31 December Year 1 that the grant-date fair value of an equity instrument granted will be 10 and the actual fair value on grant date of April Year 2 is 9. Based on preliminary profit figures, B further estimates at 31 December Year 1 that the total number of equity instruments granted will be 100, which is confirmed by the final profit figure. If all instruments are expected to and actually do vest, then the accounting is as follows.

Determination of the vesting period

Notes

1. 100 x 10.
2. 100 x 9.
3. 1,000 x 1/4.
4. 900 x 2/4.
5. 900 x 3/4.
6. 900 x 4/4.

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Employee cash-settled share-based payments in IFRS 2

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Employee cash-settled share-based payments

In short – For employee cash-settled share-based payments, an entity recognises a cost and a corresponding liability. The liability is remeasured, until settlement date, for subsequent changes in fair value.

Overview

  • Employee services received in a cash-settled share-based payment are measured indirectly at the fair value of the liability at grant date.
  • Market and non-vesting conditions are taken into account in determining the fair value of the liability.
  • Service and non-market performance conditions are taken into account in estimating the number of awards that are expected to vest, with a true-up to the number ultimately satisfied.Example Disclosure financial instruments
  • The grant-date fair value of the liability is recognised over the vesting period.
  • The grant-date fair value of the liability is capitalised if the services received qualify for asset recognition.
  • The liability is remeasured at each reporting date and at settlement date so that the ultimate liability equals the cash payment on settlement date.
  • Remeasurements during the vesting period are recognised immediately to the extent that they relate to past services, and recognised over the remaining vesting period to the extent that they relate to future services. Remeasurements after the vesting period are recognised immediately.
  • Remeasurements of the liability are recognised in profit or loss.

Basic principles of accounting for cash-settled share-based payment transactions with employees

Initial measurement

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