The 2 essential types of share-based payments

The 2 essential types of share-based payments – Snapshot

Share-based payments are classified based on whether the entity’s obligation is to deliver its own equity instruments (equity-settled) or cash or other assets (cash-settled).

1. Equity-settled share-based payments

For equity-settled transactions, an entity recognises a cost and a corresponding entry in equity.

Measurement is based on the grant-date fair value of the equity instruments granted.

Market and non-vesting conditions are reflected in the initial measurement of fair value, with no subsequent true-up for differences between expected and actual outcome.

The estimate of the number of equity instruments for which the service and non-market performance conditions are expected to be satisfied is revised during the vesting period such that the cumulative amount recognised is based on the number of equity instruments for which the service and non-market conditions are ultimately satisfied.

2. Cash-settled share-based paymentsCash Money Dollars

For cash-settled transactions, an entity recognises a cost and a corresponding liability.

The liability is remeasured, until settlement date, for subsequent changes in fair value.

3. Other topics in IFRS 2

Choice of settlement

Grants in which the counterparty has a choice of settlement are accounted for as compound instruments. Grants in which the entity has a choice of settlement are classified as either equity-settled share-based payments or cash-settled share-based payments, depending on the entity’s ability and intent to settle in shares.

Modifications

Modification of a share-based payment results in the recognition of any incremental fair value but not any reduction in fair value. Replacements are accounted for as modifications. Cancellation of a share-based payment results in acceleration of vesting.

Share-based payments in groups of companies

A share-based payment in which the receiving entity and the settling entity are in the same group from the perspective of the ultimate parent and which is settled either by an entity in that group or by an external shareholder of any entity in that group is a group share-based payment and is accounted for as such by both the receiving and the settling entities.

Equity-settled share-based payments with third parties

Equity-settled transactions with non-employees are generally measured based on the fair value of the goods or services received.

Cash or equity settled share-based payments

The rest of this narrative covers only share-based payments that involve the reporting entity settling in the reporting entity’s shares or a cash payment based on its shares with a counterparty in exchange for goods or services provided directly to the reporting entity.

Principles of classification as either equity-settled or cash-settled

A share-based payment transaction that is in the scope of IFRS 2 (see IFRS 2 Quick-start best share-based payments) is classified as either an equity-settled or a cash-settled share-based payment transaction. The accounting requirements for each type of transaction differ significantly; for the accounting for equity-settled share-based payments, and for the accounting for cash-settled share-based payments. If the counterparty has a choice of settlement, then the transaction is accounted for in two components.

IFRS 2 defines equity-settled and cash-settled share-based payment transactions as follows.equity settled or cash settled

An ‘equity-settled share-based payment transaction’ is a share-based payment transaction in which the entity:

  1. receives goods or services as consideration for its own equity instruments (including shares or share options); or
  2. receives goods or services but has no obligation to settle the transaction with the supplier.

A ‘cash-settled share-based payment transaction’ is a share-based payment transaction in which the entity acquires goods or services by incurring a liability to transfer cash or other assets to the supplier of those goods or services for amounts that are based on the price (or value) of equity instruments (including shares or share options) of the entity or another group entity.

From a practical point of view, users of IFRS 2 work with simplified definitions of equity-settled and cash-settled share-based payment transactions that ignore group and shareholder aspects for an initial assessment of classification. Group and shareholder aspects can then be considered separately if necessary.

One example of such a simplified definition could be as follows: A share-based payment transaction is classified as either equity-settled or cash-settled according to whether the entity is obliged to settle the transaction

  1. either in its own equity instruments, or
  2. in cash or other assets based on the value of its own equity instruments.

The classification of a share-based payment transaction is not affected by how an entity obtains the equity instruments that it will use to settle its obligations. For example, to settle an obligation to transfer shares to the counterparty, an entity may expect to buy its own shares in the market, either because it is prohibited from issuing new shares or because it wishes to avoid dilution. (IFRS 2 B49)

However, this expectation is not taken into consideration when assessing the classification of the share-based payment transaction. The classification of a share-based payment as either equity-settled or cash-settled is based on the nature of the entity’s obligation to the counterparty. If the transaction is settled in equity instruments, then the transaction is classified as equity-settled. (IFRS 2 B49)

The following are practical issues that impact the classification of share-based payments, as follows:

  • Grants of equity instruments ‘to the value of’
  • Arrangements to transfer value to the employees on settlement date – e.g. when settlement is arranged in cash from the market (e.g. broker-dealer arrangements) or net of cash to be received from the counterparty
  • Grants of equity instruments that include redemption features – e.g. equity instruments that are redeemable at the employee’s option
  • Contingently cash-settled equity instruments – e.g. an event outside the control of the entity and the counterparty determines the type of settlement
  • Arrangements denominated in a currency other than the issuing entity’s functional currency

Some share-based payment transactions contain a grant of equity instruments with a cash alternative. The cash alternative may be the result of a contingent event (see ‘Contingently cash-settled equity instruments’, below) or be subject to a choice of one of the parties:

  • if the entity has the choice of settlement, then classification generally depends on the entity’s intention (see Share-based payment transactions in which entity has choice of settlement); or
  • if the counterparty has the choice of settlement, then classification as equity-settled is precluded (see Share-based payment transactions in which employee has choice of settlement). (IFRS 2 34)

In other cases, the type of settlement depends on the occurrence of an event that neither party can control (again see ‘Contingently cash-settled equity instruments’, below). (IFRS 2 34)

Grants of equity instruments ‘to the value of’

An ‘equity-settled transaction’ is defined as a transaction in which the entity receives goods or services as consideration for equity instruments of the entity. Therefore, a transaction that is settled in a variable number of shares is generally classified as an equity-settled share-based payment transaction, even though this classification may differ from the debt vs equity classification under the financial instrument standards. (IFRS 2 BC106-BC110, IAS 32 16(b)(ii))

Grant of equity instruments to the value of a fixed amount

Company B, a listed entity, grants shares with a value equal to a fixed amount of 1,000 to each of the members of the management board, subject to a one-year service condition. The number of shares to be delivered depends on the share price on vesting date.

Because services are received, the transaction in this example is in the scope of IFRS 2 and is classified as equity-settled because the only consideration is B’s own equity instruments.

In contrast, an arrangement in which no services are received but a variable number of shares is exchanged for a fixed amount of cash would be classified as a liability under the financial instruments standards, which might suggest classification as cash-settled.

It is commonly understood that the classification as equity-settled applies even if the amount of cash itself is variable.

Grant of equity instruments to the value of a variable amount

Company C, a listed entity, grants shares to its CEO, subject to a one-year service condition. The value of the grant depends on the share price level achieved at the year end and the share price on vesting date.

  • If the share price is above 100 at the end of the year, then the CEO receives 1,000 settled in shares.
  • If the share price is above 120 at the end of the year, then the CEO receives 2,000 settled in shares.

C should classify the arrangement as equity-settled because equity instruments are issued in exchange for services.

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Arrangements to transfer value to the employees on settlement date

In some share-based payment arrangements, the entity’s obligation is to deliver equity instruments, but the entity facilitates the sale of the shares on the market when employees want cash after settlement. In other arrangements, cash payments to be received from the counterparty – e.g. the exercise price of options or withholding taxes – are netted with the entity’s obligation to deliver equity instruments. (IFRS 2 41, IFRS 2 43)

In these circumstances, the question arises whether such arrangements influence the classification of the share-based payment. Generally, if the counterparty has no ability to require a cash payment from the entity for its services, then the transaction is classified as equity-settled. This assessment does not change if the entity is required to make a cash payment as an agent on behalf of the counterparty.

Cashless exercise in a variable number of shares

As illustrated in Grants of equity instruments ‘to the value of’, a transaction that is settled in a variable number of shares is generally classified as an equity-settled share-based payment transaction, even though this classification may differ from the debt vs equity classification under the financial instruments standards. Commonly, an award that is net share settled, sometimes referred to in practice as ‘cashless exercise’, would be viewed as equity-settled if the recipient has no ability to require a cash payment for the equity instruments tendered. (IFRS 2 BC106)

Cashless exercise of share options classified as equity-settled

Company B grants an employee 1,000 options at an exercise price of 100, subject to a three-year service condition. At the exercise date, the share price is 200. The exercise arrangement permits the employee to either:

  • pay an exercise price of 100,000 and receive 1,000 shares worth 200,000 (i.e. net value of 100,000); or
  • receive 500 shares worth 100,000 for no cash consideration (i.e. cashless exercise) by tendering all 1,000 options. The exercise price of 50,000 on these 500 shares is ‘paid’ by tendering unexercised options with an intrinsic value of 50,000 ((200 – 100) x 500).

The arrangement should be classified as equity-settled because the entity will not pay cash under either alternative.

Entity facilitates sale of equity instruments

An entity may facilitate the sale of shares or other equity instruments granted. For example, an entity might act as an agent for its employees. If the employer bears no risk in respect of the sale of the shares (e.g. share price fluctuations, credit risks etcetera), then classification of the transaction as an equity-settled share-based payment transaction is not precluded.

Determining whether the entity is settling the transaction in cash or acting as an agent requires an analysis of all of the terms and conditions. The following conditions are considered indicators of an agency relationship (i.e. that the equity instruments are sold on behalf of the recipient of the shares):

  • the shares are sold to the market via an independent, third party brokerage firm;
  • the entity has not agreed (explicitly or constructively) to buy the underlying shares from the brokerage firm;
  • the entity does not guarantee, or underwrite in any way, the arrangement between the owner and the brokerage firm; and
  • the entity is obliged to remit only the payments received from the broker and cannot be obliged to pay if the shares are not sold (e.g. in the event of unexpected market suspensions).
Entity facilitates the sale of equity instruments

Company C grants share options to its employees, subject to a one-year service condition.

Under the terms of the arrangement between C and the employees, employees may ask C to sell shares to the market via a third party brokerage firm. Some employees will opt for this type of settlement because it eases the realisation of the value of the shares in cash.

In addition, a slightly better price and lower costs can be achieved on the market by aggregating the transactions of multiple employees. Under this option, C settles the transaction by transferring the shares to a third party brokerage firm in accordance with all of the conditions listed above, and C is obliged to transfer the cash received from the brokerage firm to the employee.

Although C can be required to transfer cash to the employees, this transaction should be classified as an equity-settled share-based payment transaction because C is acting as the agent of the employee in transferring cash from the broker’s sale of the shares on the market.

Settling net of withheld taxes

In some countries, an employee may be subject to taxes on the receipt of a share-based payment arrangement. In some cases, the tax obligation is a liability of the employee and not the employer, although the employer may be obliged to collect or withhold the tax payable by the employee and transfer it to the tax authority. (IFRS 2 33E – 33H)

This type of transaction is classified as equity-settled in its entirety if the entire share-based payment would otherwise be classified as equity-settled without the net settlement feature. This may be referred to as ‘an exception’ to the general requirements in IFRS 2. (IFRS 2 33E – 33H)

For a discussion of when tax payments are share-based payments, see IFRS 2 Taxes and share-based payments best studies.

Grants of equity instruments that include redemption features

An entity may make a share-based payment using equity instruments that are redeemable, either mandatorily or at one party’s option. The label under which these arrangements are seen in practice varies and includes ‘buy-back arrangement’, ‘sell-back arrangement’, ‘put option’ or ‘call option’.

Although the redemption features are sometimes included in the share-based payment agreement, they may also be part of the entity’s articles of association or a separate agreement. In general, redemption features that are associated with the instrument granted as part of a share-based payment form part of the terms and conditions of the share-based payment arrangement.

Redemption features are generally observed in share-based payments of unlisted entities. Often, those grants are under the condition that the equity instruments are redeemable when the employee ceases employment with the entity. This is because the shareholders of unlisted entities often do not want to allow external parties other than employees to participate in their decisions or to receive the benefit of subsequent increases in the value of the entity. Such a feature, however, does not always preclude the classification of the transaction as equity-settled, as discussed below.

Mandatorily redeemable equity instruments

Sometimes, share-based payments include both a grant of an equity instrument and an obligation to pay cash at a later date. Although such a share-based payment includes the grant of an equity instrument, classification as equity-settled is precluded if the instruments issued are redeemable mandatorily. This is because the entity is required to pay cash at some point in time – i.e. to settle the share-based payment in cash. (IFRS 2 31)

Grant of equity instruments that are redeemable mandatorily

Company B, an unlisted entity, grants share options to its employees, subject to a three-year service condition. On exercise of the options, B is obliged to deliver own shares. When the employee ceases employment with B, the shares are redeemable mandatorily at the then-current fair value.

In this example, the share-based payment is classified as cash-settled, because B will be required to pay cash at some point in time.

Equity instruments redeemable at the employee’s option

Classification as equity-settled is also precluded if the share-based payment results in the issuance of equity instruments that are redeemable at the option of the employee. The probability of the entity being required to pay cash is not considered. (IFRS 2 31, IFRS 2 34)

Grant of equity instruments that are redeemable at employee’s option (put option)

Company C, an unlisted entity, grants share options to its employees, subject to a three-year service condition. On exercise of the options, C is obliged to deliver its own shares. The employee may require C to redeem the shares at any time within five years after exercise.

In this example, the share-based payment is classified as cash-settled, because C can be required to pay cash at some point within five years after vesting.

The requirement to classify transactions involving puttable or redeemable shares as cash-settled share-based payment transactions is not limited to instruments with put or redemption terms that are exercisable immediately. Therefore, in in general this means instruments that require a minimum holding period before put rights are exercisable should be classified as cash-settled, regardless of the length of the minimum holding period. (IFRS 2 31, IFRS 2 34)

The fair value of a cash-settled share-based payment is remeasured at each reporting date and ultimately on settlement date. Commonly, for a grant of options to acquire redeemable shares, the settlement of the share-based payment occurs only on redemption of the shares and not on exercise of the options. (IFRS 2 33)

Therefore, an entity should recognise compensation cost and a corresponding cash-settled liability equal to the grant-date fair value of the options; this liability should be remeasured at each reporting date. On exercise of the options, the entity should continue to remeasure the cash-settled liability to fair value. The entity should remeasure the cash-settled liability through profit or loss until the shares are redeemed.

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The requirement to classify a grant of equity instruments that are redeemable at the employee’s option as cash-settled in its entirety is consistent with the requirements for a share-based payment in which the employee has a choice of settlement. For an instrument that is redeemable at the holder’s option, the entity first determines the value of the debt component. (IFRS 2 31, IFRS 2 35, IFRS 2 37, IFRS 2 BC259)

If the equity-settled alternative is for the same award (e.g. 100 shares or their cash value), then there is nothing left to assign to the equity component. For example, the equity element will be measured at zero if the price at which the employee can redeem the share is structured so that the fair value of the payment is always the same as the fair value of the equity instrument.

Equity instruments redeemable at the entity’s option

If the entity rather than the employee has the option to redeem the shares granted in a share-based payment, then the entity determines whether it has a present obligation to settle in cash and accounts for the share-based payment transaction accordingly. (IFRS 2 41)

Even if the equity instruments are not puttable or redeemable, the entity should consider whether the overall effect of the arrangements is that, in substance, the employer has a substantive choice of cash or equity settlement. A question may arise if, for example, the employee is required to offer shares back on ceasing employment and, although it is not required, the employer has a stated policy or past practice of accepting the offer and buying them back. (IFRS 2 BC265)

Entity’s option to buy back shares

Company D, an unlisted entity, grants shares to its employees at a discount.

When an employee leaves, they are required to offer to sell the shares back to D at the then-current fair value. D is not required to buy back the shares.

Classification will depend on D’s stated policy and/or its past practice of buying back shares under similar transactions. If D has a past practice of buying back the shares, then the share-based payment arrangement should be classified as cash-settled.

However, a past practice of buying back shares issued in an equity-settled share-based payment transaction does not automatically require future similar transactions to be classified as cash-settled because the significance of past practices can depend on the nature of the repurchase arrangements of each transaction.

If there is no mandatory redemption feature and a repurchase arrangement is available to all shareholders, including non-employees, and is substantive, then in rare circumstances it may be appropriate to ‘de-link’ the repurchase arrangement from the share-based payment, because it is considered more a shareholder-related term and condition. If the repurchase arrangement is de-linked in this manner, then it is not considered in the classification of the share-based payment, which is classified as equity-settled from grant date.

Buy-back arrangement de-linked from share-based payment

Company B, an unlisted entity, has established a discretionary share buy-back arrangement. The following facts are relevant for this example.

  • Each year a share-dealing window operates around the annual general meeting date. A letter is distributed to all shareholders that advises them of the procedures for buying and selling B’s shares and the fixed price at which the shares will be bought back as determined by an independent third party.

  • These buy-back arrangements are available to all shareholders. Employees can leave B’s employment and keep the shares that they have obtained through the share-based payment arrangements. Shareholders include employees, former employees, descendants of former employees and a pool of individual shareholders – i.e. not related to employees.

  • Notwithstanding the existence of the buy-back arrangement, B is not obliged to repurchase the shares.

In this example, B should classify the equity instruments issued to its employees under a share-based payment arrangement as equity-settled because the buy-back arrangement available to all other shareholders is substantive and B is not obliged to repurchase the shares from the employee -i.e. there is no mandatory redemption feature.

B should also consider the terms of the buy-back arrangement to determine whether the offer to buy back shares is a written put in the scope of the financial instruments standards.

Buy-back arrangement not de-linked from share-based payment

Company C, an unlisted entity, plans to issue shares to its employees. The following facts are relevant for this example.

  • These equity instruments will be subject to discretionary share buy-back arrangements; C plans to make this buy-back available to all shareholders, but has not yet done so.

  • Notwithstanding the proposal to establish a broad-based buy-back arrangement, C is not obliged to repurchase the shares. However, unlike in the Buy-back arrangement de-linked from share-based payment-example, C is owned currently by a single shareholder. Following the share issue, a small percentage of C’s shares will be held by other shareholders – i.e. employees. If they leave C’s employment, then employees must offer their shares for sale to other employees or C, but C is still not obliged to repurchase the shares. Therefore, a body of ex-employee shareholders may in due course develop.

In this example, there is not sufficient evidence to support a conclusion that it is appropriate to de-link the buy-back arrangement from the terms of the share-based payment arrangement. Therefore, considering the proposed buy-back arrangement as a shareholder arrangement (rather than a term of the employee share-based payment) is not appropriate because there is no body of existing shareholders outside the employee pool to demonstrate that the buy-back arrangement relates other than to employees who receive shares in their role as employees.

Commonly, the possible future development of a substantial external shareholding body should not be anticipated and the share-based payment should be classified following the requirements for share-based payment transactions in which the entity has the choice of settlement.

Equity instruments redeemable at the option of both parties

If the equity instruments are redeemable at the option of either party, then a question arises about whether layering an entity’s call option on top of an employee’s put option changes the conclusion reached for the employee’s put option (see Equity instruments redeemable at the employee’s option). Because the entity can still be required to pay cash based on the employee’s choice, such a transaction would be classified as cash-settled. (IFRS 2 31)

Return of up-front payments on forfeiture of a share-based payment

The scenarios in Mandatorily redeemable equity instruments, Equity instruments redeemable at the employee’s option , Equity instruments redeemable at the entity’s option and Equity instruments redeemable at the option of both parties cover equity instruments that are subject to redemption features once the equity instruments are vested. These redemption features affect the classification assessment and may result in classification as cash-settled.

If the redemption feature applies to unvested equity instruments on forfeiture only, then the assessment of classification may be different if the buy-back is only a mechanism for repaying an initial purchase price.

Buy-back arrangement for non-vested shares

The employees of Company G are eligible to buy shares from G at a discount from the market price and the employees become unconditionally entitled to the shares if they satisfy a service vesting condition. If an award is forfeited because employment terminates before the award is vested, then the employee is required to sell the shares back to G for an amount equal to the original purchase price.

The discount from the grant-date fair value of the shares with protection from a decline in value is a share-based payment that is recognised over the service period.

The requirement for the employee to sell the shares back to G at the original purchase price if the vesting condition is not satisfied does not result in the share-based payment being classified as cash-settled. In this case, the redemption feature is considered, in general, as a mechanism to claw back unvested share-based payments.

Because the employee is not unconditionally entitled to the shares during the vesting period, the entity should recognise the purchase price received as a deposit liability until the share-based payment vests – i.e. the entity should initially recognise a liability to refund the purchase price rather than reflecting this in equity as an issuance of shares.

Contingently cash-settled equity instruments

IFRS 2 provides guidance on the classification of share-based payments that contain a cash alternative that can be chosen by the entity or by the employee. However, it does not provide guidance on the classification of a share-based payment in which equity instruments are cash-settled only on the occurrence or non-occurrence of a contingent event.

If an entity issues a share-based payment that is contingently cash-settled and the contingency is not within the control of the issuer or the counterparty, then it should determine whether to classify the share-based payment as cash-settled or equity-settled based on the liability recognition criteria of IAS 37 Provisions, Contingent Liabilities and Contingent Assets.

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This is because IFRS 2 does not base classification solely on the legal right to avoid cash payment; for example, the standard also considers the intended manner of settlement. Therefore, in respect of contingently cash-settled share-based payment transactions, in general it is considered that an entity is not required to analogise to the guidance in IAS 32 Financial Instruments: Presentation on the classification of instruments as debt or equity.

Examples of contingent events outside the control of the issuer and the counterparty include IPOs and changes in control of the entity.

Based on the classification guidance in IAS 37, determining whether a liability to the employee exists, the contingent feature would affect the classification only if the contingent event is probable – i.e. more likely than not. If the event’s likelihood of occurrence is less than probable and the share-based payment would otherwise be classified as equity-settled, then it should be classified as equity-settled.

In general, after initial classification the entity should reassess at each reporting date the probability of cash outflow to determine whether the share-based payment is equity-settled or cash-settled. This is because IAS 37 requires reassessment of probabilities and estimates of expected cash flows at each reporting date.

Cash settlement contingent on an event outside the control of the entity or the employee

On 1 January Year 1 Company B, a listed company, grants 10 share options each to its 100 employees, subject to a two-year service condition. B is obliged to settle the transaction in its own shares, unless an employee gets a long-term illness.

In this case, the employee is entitled to receive cash equal to the intrinsic value of the options at vesting date for a pro rata amount of options and the remainder of the options lapses.

B should estimate the probability of the employees getting a long-term illness during the vesting period. If B concludes that this is unlikely, then the grant is initially classified as equity-settled for all options granted.

At the end of Year 1, one employee contracts a long-term illness. B should change the classification of the share-based payment from equity-settled to cash-settled for five of the share options granted to this employee because a cash outflow on a pro rata basis is now probable.

The employee is entitled to a payment based on five out of 10 of the options because he falls ill halfway through the two years. Under the agreement, the other five share options lapse and are accounted for as a forfeiture.

If a change in the probability of cash outflows is such that the classification of the arrangement as either equity-settled or cash-settled changes, then a switching approach should be followed to account for the change in classification, because there is one single grant with two possible outcomes from inception.

This approach is the same as that for an award with multiple alternative performance conditions (see Multiple alternative performance conditions (‘or’ conditions)). In general, it is considered not appropriate to account for the change in classification using the approach for changes in classification arising from modifications.

Contingently cash-settled equity instruments on non-occurrence of an IPO

On 1 January Year 1, Company P grants its employees an award with the following characteristics:

  • if there is an IPO before 31 December Year 5 and the employees are still in service, then P will settle the award in equity; andThe 2 essential types of share-based payments
  • if there is no IPO before 31 December Year 5 and the employees are still in service, then P will settle the award in cash.

On 1 January Year 1, it is not considered probable that an IPO will occur before 31 December Year 5. Therefore, the award is initially classified as cash-settled. On 1 January Year 2, it becomes probable that an IPO will occur before 31 December Year 5.

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Therefore, on 1 January Year 2, the award should be reclassified as an equity-settled award; the cash-settled liability is reversed through profit or loss, and an expense for services provided to date for the equity-settled award is recognised using the grant-date fair value with a credit to equity.

Change-in-control clauses

A further issue arises when the contingent event is a change in the control of the entity. Often, a change in control requires approval of the entity’s board and/or the shareholders. Generally, IFRS 2 regards shareholders as part of the entity – e.g. when it requires attribution to the entity of equity-settled grants made directly by the shareholders.

Therefore, the shareholders of an entity are generally regarded as part of the entity for the purposes of the standard, unless it is clear that they are acting as an investor and not on behalf of the entity. In general, in respect of a change in control, shareholders should be regarded as separate from the entity because they generally make decisions about whether to sell or retain their shares as investors based on the terms offered.

Therefore, a change in control would not be regarded as an event within the control of the entity and should be considered a contingent event. This is consistent with the view on the impact of a change-in-control clause on the classification of a financial instrument as debt or equity under the financial instruments standards.

Contingently cash-settled equity instruments on change in control

On 1 On 1 January Year 1, Company K issues to employees share options that vest after three years of service; the options are exercisable until 31 December Year 5. If there is a change in control of K before 31 December Year 5, then K is required to settle the share options in cash at their fair value at that date.

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Based on the approach described above, this share option is not cash-settled at the option of the entity but is a contingently cash-settled option that would be recognised as an equity-settled share-based payment unless it becomes probable that there will be a change in control of K before 31 December Year 5.

Arrangements denominated in a currency other than the issuing entity’s functional currency

There is no specific guidance on the classification of share-based payment arrangements that are denominated in a currency other than the issuing entity’s functional currency.

Under IAS 32, contracts that will be settled by an entity by delivering a fixed number of its own equity instruments for a variable amount of cash are classified as financial liabilities. Delivering a fixed number of shares for a fixed amount of foreign currency is not equity-classified because the amount of cash in the entity’s functional currency is variable. (IFRS 2 BC106-BC110)

In the absence of specific guidance in IFRS 2, the question arises whether the classification of the share-based payment should be consistent with that which would be required under the financial instruments standards.

Classification under IFRS 2 should be based on what form of consideration the entity is providing to its employees. Because there are a number of identified differences between the share-based payments standard and the financial instruments standards, it does not seem logical that an analogy to the financial instruments standards is required for these arrangements.

Exercise price in foreign currency

Company C’s shares are traded and quoted in euro, which is also C’s functional currency. C issues options on its shares to employees of its US subsidiary with a fixed exercise price that is denominated in US dollars.

Because the functional currency of C is the euro but the exercise price is denominated in US dollars, C will receive a variable amount of cash on exercise of the options for a fixed number of shares.

The reasoning is that the arrangement should be classified as equity-settled, because C is providing equity instruments to employees in exchange for services. Because there are a number of identified differences between IFRS 2 and the financial instruments standards, it does not seem logical that an analogy to the financial instruments standards is required in respect of these arrangements.

In determining the grant-date fair value of the foreign currency-denominated option, the exercise price should be translated into the entity’s functional currency at the exchange rate on that date. As a result, in general one would expect the grant-date fair value not to be remeasured for subsequent changes in exchange rates.

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