Chapter 6 HKFRS 2 Share-Based Payment

Chapter 4 IFRS 2 Share-Based Payment

LEARNING OBJECTIVES
1. Apply and discuss the recognition and measurement criteria for share-based payment transactions.
2. Account for modifications, cancellations and settlements of share-based payment transactions.


1. Introduction

1.1 Share-based payment has become increasingly common. Share-based payment occurs when an entity buys goods or services from other parties (such as employees or suppliers), and settles the amounts payable by issuing shares or share options to them.

1.2 If a company pays for goods or services in cash, an expense is recognized in profit or loss. If a company pays for goods or services in share options, there is no cash outflow and under traditional accounting, no expense would be recognized.

1.3 This leads to an anomaly if a company pays its employees in cash, an expense is recognized in the income statement, but if the payment is in share options, no expense is recognized.

1.4 IFRS 2 Share-based payment was issued to deal with this accounting anomaly. IFRS 2 requires that all share-based payment transactions must be recognized in the financial statements.

2. Types of Transaction

2.1 IFRS 2 specifies the financial reporting by an entity when it undertakes a share-based payment transaction (SBPT). A SBPT is a transaction in which the entity:

(a) receives goods or services as consideration for equity instruments of the entity (including shares or share options); or

(b) acquires goods or services by incurring liabilities to the supplier of those goods or services for amounts that are based on the price of the entity’s shares or other equity instruments of the entity.

2.2 Goods include inventories, consumables, property, plant and equipment, intangible assets and other non-financial assets.

2.3 /

Types of SBPT

(a) Equity-settled share-based payment transactions (equity-settled SBPT) – in which the entity receives goods or services as consideration for equity instruments of the entity (including shares or share options).
(b) Cash-settled share-based payment transactions (cash-settled SBPT) – in which the entity acquires goods or services by incurring liabilities to the supplier of those goods or services for amounts that are based on the price (or value) of the entity’s shares or other equity instruments of the entity.
(c) SBPT with cash alternatives – in which the entity receives or acquires goods or services and the terms of the arrangement provide either the entity or the supplier of those goods or services with a choice of whether the entity settles the transaction in cash (or other assets) or by issuing equity instruments.

3. General Recognition of SBPT

3.1 /

General recognition of SBPT

IFRS 2 requires that an entity should:
(a) recognize the goods or services received or acquired in a SBPT when it obtains the goods or as the services are received. When the goods or services received or acquired do not qualify for recognition as assets, they should be recognized as expense.
(b) recognize a corresponding increase in equity if the goods or services were received in an equity-settled SBPT, or a liability if the goods or services were acquired in a cash-settled SBPT.

3.2 /

Example 1 – Equity settled SBPT

AC Ltd enters into a contract to buy 1,000 units of commodity at a price equal to 1,000 shares of its ordinary shares. AC Ltd’s ordinary share is $1 par value and worth $2 at the date of delivery. The entity settled the contract by issuing 1,000 ordinary shares at $2.
The following entry should be made at the date of delivery:
Dr. ($) / Cr. ($)
Inventory / 2,000
Equity / 2,000
3.3 /

Example 2 – Goods or services received or acquired do not qualify for recognition as assets

On 5 May 2012, ABC Ltd acquires some sundry laboratory equipment with a market value of $120,000 from its associates for its ongoing research project by issuing 100,000 of its ordinary shares (par value of $1 each).
In this case, IFRS 2 requires ABC Ltd to record the transaction on 5 May 2012 as follows:
Dr. ($) / Cr. ($)
Research expense / 120,000
Share capital / 100,000
Share premium / 20,000

4. Equity-Settled SBPT

4.1 Measurement of equity-settled SBPT with employees

4.1.1 Typically, shares, share option or other equity instruments are granted to employees as part of their remuneration package, in addition to a cash salary and other employment benefits. By granting shares or share options, in addition to other remuneration, the entity is paying additional remuneration to obtain additional benefits. However, estimating the fair value of those additional benefits is likely to be difficult.

4.1.2 /

Measurement of equity-settled SBPT with employees

(a) IFRS 2 takes the position that it is usually not possible to measure directly the services received for particular components of the employee’s remuneration package. Because of the difficulty of measuring directly the fair value of the services received, the entity should measure the fair value of the employee services received by reference to the fair value of the equity instruments granted measured at grant date.
(b) IFRS 2 provides that the fair value of the equity instrument shall be based on the market price, if available, taking into account the terms and conditions upon which the equity instruments are granted.
(c) If market prices are not available, IFRS 2 provides that the entity shall estimate the fair value of the equity instrument granted using a valuation technique to determine what the price of those equity instrument would have been on the grant date in an arm’s length transaction between knowledgeable, willing parties. (Note that this definition is different from that in IFRS 13 Fair Value Measurement, but the IFRS 2 definition applies.)
4.1.3 /

Example 3

On1 October 2011, ABC Ltd (with 31 December accounting year-ends) approves a plan that grants the company’s top five executives options to purchase 200,000 shares each (a total of 1,000,000) of the company’s ordinary shares (par value $1.00) at $5.00 per share. The options are granted on 1 January 2012, and will vest on 1 January 2015 if the executives remain in the employment of the company until then. The options are exercisable from 1 January 2015 to 31 December 2018.
Assume that, using the Black-Scholes model, the fair value of each option on 1 January 2012 is $1.50.
In this case, the journal entries to record the share options are as follows:
1 October 2011 – No entry
31 December 2012 / Dr. ($) / Cr. ($)
Staff cost ($1.5 × 1,000,000 ÷ 3) / 500,000
Capital reserve (equity) / 500,000
31 December 2013
Staff cost ($1.5 × 1,000,000 ÷ 3) / 500,000
Capital reserve (equity) / 500,000
31 December 2014
Staff cost ($1.5 × 1,000,000 ÷ 3) / 500,000
Capital reserve (equity) / 500,000
If, on 10 January 2015, all the share options are exercised, the journal entry will be as follows:
10 January 2015 / Dr. ($) / Cr. ($)
Cash / 5,000,000
Capital reserve / 1,500,000
Share capital / 1,000,000
Share premium / 5,500,000
If none of the share options are exercised and are eventually forfeited on 31 December 2018, the journal entry will be as follows:
31 December 2018 / Dr. ($) / Cr. ($)
Capital reserve – share option / 1,500,000
Capital reserve – general / 1,500,000

4.2 Measurement of equity-settled SBPT with parties other than employees

4.2.1 For equity-settled SBPT transactions with parties other than employees, there is a rebuttable presumption that the fair value (measured at the date the entity obtains the goods or the counter-party renders service) of the goods or services received can be estimated reliably.

4.2.2 In rare cases, if the entity rebuts this presumption because it cannot estimate reliably the fair value of the goods or services received, the entity should measure the goods or services received, and the corresponding increase in equity, indirectly, by reference to the fair value of the equity instruments granted measured at the date the entity obtains the goods or the counter-party renders service.

4.2.3 Summary of measurement of share-based payments

Counterparty / Measurement basis / Measurement date / Recognition date
Employee / Fair value of equity instruments awarded / Grant date / Date goods or services received
Non-employee / Fair value of goods or services received / Date goods or services received / Date goods or services received
4.2.4 /

Example 4

Scenario A
On 6 June 2012, A Ltd acquires a piece of land, which has been valued by professional valuer at $50,000,000, by issuing 10,000,000 of its ordinary shares (par value of $1 each).
In this case, IFRS 2 requires A Ltd to measure the transaction based on the fair value of the land, and record the transaction on 6 June 2012 as follows:
6 June 2012 / Dr. ($) / Cr. ($)
Land / 50,000,000
Share capital / 10,000,000
Share premium / 40,000,000
Scenario B
On 6 June 2012, B Ltd acquires a building of historical significance which has been valued by various professional valuers ranging from $10,000,000 and $50,000,000, by issuing 1,000,000 of its ordinary shares (par value of $1 each).
B Ltd’s 1,000,000 ordinary shares are traded in the HKSE and are quoted at $22 per share on 6 June 2012.
In this case, IFRS 2 requires B Ltd to measure the transaction by reference to the fair value of shares issued, and record the transaction on 6 June 2012 as follows:
6 June 2012 / Dr. ($) / Cr. ($)
Land / 22,000,000
Share capital / 1,000,000
Share premium / 21,000,000

4.3 Effects of vesting conditions on recognition and measurement

4.3.1 If the equity instruments granted vest immediately, the employee or other party is not required to complete a specified period of service before becoming unconditionally entitled to those equity instruments. In the absence of evidence to the contrary, the entity should presume that services rendered by the counter-party as consideration for the equity instruments have been received. In this case, on grant date the entity should recognize the services received in full, with a corresponding increase in equity.

4.3.2 However, a grant of equity instruments under an equity-settled SBPT might be conditional upon satisfying specified vesting conditions, which must be satisfied for the employees or other parties to become entitled to equity instruments of the entity.

4.3.3 /

Example 5

IK Ltd grants share options to each of its 100 employees working in the sales department. The share options will vest at the end of year 3, provided that the employees remain in the entity’s employment and that the volume of sales of a particular product increases by at least an average of 5% per year. If the volume of sales of the product increases by an average of between 5% and 10% per year, each employee will receive 100 share options. If the volume of sales increases by an average of between 10% and 15% each year, each employee will receive 200 share options. If the volume of sales increases by an average of 15% or more, each employee will receive 300 share options.
On grant date, IK Ltd estimates that the share options have a fair value of $21 per option. It also estimates that the volume of sales of the product will increase by an average of between 10% and 15% per year, and therefore expects that, for each employee who remains in service until the end of year 3, 200 share options will vest. No employees will be expected to leave before the end of year 3.
The relevant accounting entries are as follows:
Year 1 / Dr. ($) / Cr. ($)
Share option expense / 140,000
Capital reserve [(100 × ($200 × 21) ÷ 3)] / 140,000
Year 2
Product sales increased to 18% and the entity expects each sales employee will receive 300 share options
Share option expense / 280,000
Capital reserve (equity) [(100 × ($300 × 21) × 2/3 – $140,000)] / 280,000
Year 3
Two employees left during the year.
Dr. ($) / Cr. ($)
Share option expense / 197,400
Capital reserve [(98 × ($300 × 21) – $140,000 – $280,000) / 197,400
Generally, vesting conditions are not taken into account when estimating the fair value of the shares or options at grant date. Vesting conditions are taken into account by adjusting the number of equity instruments included in the measurement of the transaction amount so that, ultimately, the amount recognized for goods or services received as consideration for the equity instruments granted is based on the number of equity instruments that eventually vest [e.g. 98 x (300 x $21) = $617,400] and this amount has been expensed over 3 years.

4.4 Performance condition

4.4.1 In many countries, share-based payments may be conditional not only when a future period of employment but also on the achievement of one or more performance conditions.

4.4.2 Under IFRS 2, the treatment of a performance condition depends on whether or not it is a market condition. A market condition is a condition which the exercise price, vesting or exercisability of an entity instrument depends on the market price of the entity’s equity instruments.