Advanced Financial Accounting I

Chapter Two

Share-based Compensation
Share-based Compensation
Overview of Share-based Payments
1.

Share-based Payments Settled with Equity

2.

Share-based Payments Settled with Cash

3.

Share-based Payments with Cash Alternatives

4.

Counterparty Has Choice of Settlement

5.

Issuer Has Choice of Settlement

6.

Share-based Payment Disclosures

7.
 Overview of Share-based Payments
 A major objective of the accounting for shareholders’
equity is the adequate disclosure of the sources from which
the capital was derived.
 A share-based payment is a transaction in which the
entity receives goods or services as consideration
for its equity instruments or
 Acquires goods or services by incurring liabilities for
amounts that are based on the price (or value) of the
entity’s shares (or other equity instruments of the
entity).
 Overview of Share-based Payments
• The concept of share-based payments includes not only employee
share options but also
- share appreciation rights,
- employee share ownership plans,
- employee share purchase plans,
-share option plans and other share arrangements.
 What is share-based compensation ??
• In simple words – payment based on shares or shares options.

• Share-based compensation also called Stock-based compensation or share-based

payments (SBP).
• It refers to the rewards given by the company to its employees by way of giving
them the equity ownership rights in the company with the motive of aligning the
interest of the management, shareholders, and the employees of the company.

• A ‘share-based payment’ is either a payment in equity instruments. Or

• A payment in cash or other assets.

 What is Share-based Payment (compensation) ?

An agreement between the entity and another party (including

an employee) that entitles the other party to receive :

(a) equity instruments (including shares or share options) of

the entity or another group entity, provided the specified
vesting conditions, if any, are met.

(b) cash or other assets of the entity or by incurring liabilities for

amounts that are based on the price (or value) of equity
instruments of the entity.

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 What is Share-based Payment (compensation) ?

Generally, SBP is
• a transaction in which the entity receives goods or
services as consideration for its equity instruments or

• acquires goods or services by incurring liabilities for

amounts that are based on the price (or value) of the
entity’s shares (or other equity instruments of the
entity).

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 Reasons for granting share-based payments
1. Principal-agent theory: To align the interests of principal and agent,
- helps to mitigate the conflict of interest
2. Reward for past services: SBP are also granted for past services
– e.g. to acknowledge good services of an employee by giving them a
participation in the entity (e.g. free or discounted shares).
3. Other reasons: to receive goods or services without affecting the entity’s
liquidity.
- This form of remuneration is often found in high-growth industries
e.g. the hi-tech area. It is also used to preserve cash.
 Share-based payment transactions include:

Grants to employees and others providing similar services,

e.g. non-executive directors.

Grants to non-employees, e.g. consultants, suppliers

Employee share purchase plans.

Certain share-based payments settled by an entity in, or an

external shareholder of, the same group.

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 Terminologies related to SBP

 Employees and others providing similar services-Individuals who render

personal services to the entity and meet one of the following additional
criteria:
a) The individuals are regarded as employees for legal or tax purposes;
b) The individuals work for the entity under its direction in the same way
as individuals who are regarded as employees for legal or tax purposes;
or
c) The services rendered are similar to those rendered by employees.
 Terminologies related to SBP

Grant date is the date at which the entity and the supplier agree to the SBP
arrangement.
- It is the date at which employees agree, shareholders approve,
agreement is signed or approval recorded in a company minute.
Vesting period is the period during which all the specified vesting
conditions are to be satisfied.
 It is the period during which commitment is required to enable
exercise.
 Terminologies related to SBP

Vest: means to become entitled to.

Exercise date: is the date at which option turns into cash or share.
• Vesting conditions determine whether the entity receives the services
that entitle the supplier to receive the SBP
– they are service or performance (including market) conditions.
• Vesting condition: term of employment or financial target achieved.
• Non-vesting conditions need to be satisfied for the supplier to
become entitled to the SBP.
Terminologies related to SBP
Vesting condition

Vesting condition

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 Market conditions
 The share price needs to increase by at least a specified
percentage over a specified period of time.
 The share price needs to meet a target on at least one day in a
specified period.
 The share price needs to meet a target for at least five
consecutive days in a specified period.
 The share price needs to increase by more than a share index
over a specified period.
 The total shareholder return (change in share price plus
dividends) needs to meet a specified percentage increase over a
specified period.

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 Non-Market conditions

 The entity needs to achieve a specified revenue, EBITDA, profit or EPS

target, which can be an absolute amount or a percentage increase.

 The entity needs to achieve a specified non-financial performance target –

e.g. a specified market share.

 The entity needs to decrease its error rate in a certain area.

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 Non-Vesting conditions

 A condition other than a vesting condition that determines

whether a counterparty receives the share-based payment
 e.g. counterparty’s choice of participation in a share purchase
program by paying monthly contributions.

 A performance condition is a non vesting condition if the

performance assessment period extends beyond the service
period.

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17
 Terminologies related to SBP
Fair Value :
• The amount for which an asset could be
exchanged,
• a liability settled, or
• an equity instrument granted could be exchanged,
• between knowledgeable, willing parties in an
arm’s length transaction.
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 Terminologies related to SBP
Intrinsic value
• The difference between the fair value of the shares to which the
counterparty has the (conditional or unconditional) right to subscribe or
which it has the right to receive, and the price (if any) the counterparty is
(or will be) required to pay for those shares.
For example, a share option with an exercise price of Rs. 15, on a share with
a fair value of Rs. 20, has an intrinsic value of Rs. 5.

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 Terminologies related to SBP
Equity instrument
• A contract that evidences a residual interest in the assets of an
entity after deducting all of its liabilities.
Equity instrument granted
• The right (conditional/unconditional) to an equity instrument of the
entity conferred by the entity on another party, under a share-based
payment arrangement.
Share appreciation rights
• an award which provides the holder with the ability to profit from
the appreciation in value of a set number of shares of company stock
over a set period of time.
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 Measurement Date
The date at which the fair value of the equity instruments granted is
measured for the purposes of accounting.

For transactions with For transactions with

employees and others parties other than
providing similar services employees

the date, the goods or services

Is the grant Date with reference are received or acquired, with
to FV of equity instrument reference to FV of goods or
services
indirectly directly
 Three Types of Share based payment
Share-based payments
–(SBP)

Equity- Share-based
Cash-settled payments
settled
share-based
share-based payments with cash
payments alternatives

Entity receives Entity receives Either entity or the

goods/services as goods/services by counterparty has a
consideration for incurring a liability to choice to settle in equity
instruments or in cash
equity instruments. transfer cash or other
or other assets.
assets to the supplier for
Equity amounts that are based on
the price (or value) of the Equity or
entity’s shares. Liability

Liability 22
1. Equity-settled share-based payment transactions
 the entity shall measure the goods or services received, and the
corresponding increase in equity, directly, at the fair value of the
goods or services received, unless that fair value cannot be estimated
reliably.
 If the entity cannot estimate reliably the fair value of the goods or
services received, the entity shall measure their value, and the
corresponding increase in equity, indirectly, by reference to the fair
value of the equity instruments granted.
 Example 1: Provision of goods by a supplier in
exchange for equity instruments
On 1 July 2011, Supplier X provides Reporting Entity Ltd with some
inventory, which has a fair value of $140 000. In exchange for the
inventory, Reporting Entity Ltd provides Supplier X with 10,000
shares in Reporting Entity Ltd
 Example 1: Provision of goods by a supplier in
exchange for equity instruments
Solution
As it is considered that the fair value of the inventory can be determined
‘reliably’, this is deemed to be the value of the shares being issued.
The accounting entry would be:

Inventory 140, 000

Share capital 140, 000
 Example 2 Share options for goods.
A company issues share options in order to pay for the purchase of
inventory. The share options were issued on June, 1, 2010. The
inventory was eventually sold on December, 3, 2012. The value of the
inventory on June,1, 2010 was Br. 6 million and this value was
unchanged up to the date of sale. The sale proceeds were Br. 8 million.
The shares issued have a market value of Br. 6.3 million.
Requirement: How will this transaction be dealt with in the financial
statements?
 Example 2 Share options for goods.
Solution: IFRS 2 states that the FV of the goods and services received should be
used to value the share options unless the FV of the goods cannot be measured
reliably.
Thus equity would be increased by Br. 6 million and inventory increased by Br. 6
million.
Inventory 6,000,000
Share Capital 6,000,000
The inventory value will be expensed on sale.
Account Receivable 8,000,000
Cost of sales 6,000,000
Sales Revenue 8,000,000
Inventory 6,000,000
 Example 3 Share options for Services.
On 1 January Year 1, Company D enters into an agreement with Legal
firm L under which L provides 200 hours of legal services each year
over a three-year period. As compensation, L receives 8,000 shares of
D at the end of each year.

The fair value for the type of legal services provided by L is available:
according to L’s list of billing rates, generally applicable to all clients,
the price for such a service is 400 per hour in Year 1 and Year 2. In
Year 3, L increases its price to 450 per hour.

Required- Make a necessary journal entries for the given events

 Example 3 Share options for Services.
Year 1
Legal Consultation Expense (200 x 400) ……80,000
Share Capital…………………80,000

• This entry Is similar in year 2

• In year 3 the amount will differ b/c of change in price per consultation
hour
Legal Consultation Expense (200 x 450) ……90,000
Share Capital…………………90,000
Transactions with employees and others providing similar services
• FV of the services received are referred to the FV of the equity
granted, as it is not possible to estimate reliably the FV of the services
received.
• FV of equity should be measured at the grant date
• Typically, share options are granted to employees as part of their
remuneration package
• Usually, it is not possible to measure directly the services received for
particular components of the employee’s remuneration package
• It might also not be possible to measure the FV of the total
remuneration package independently without measuring directly the
FV of equity instruments granted.
 Example: Share options for employee services

A company granted a total of 100 share options to 10 members of its executive

management team (10 options each) on 1 January 2012. These options vest at the
end of a three-year period. The company has determined that each option has a FV
at the date of grant equal to €15. The company expects that all 100 options will
vest and therefore records the following entry at 30 June 2012 (the end of its first
six-month interim reporting period).

Salaries ……… €250

Equity …………250

[(100 x €15) / 6 periods = €250 per period]

 Accounting for employee services received
Overview of conditions
♦ Conditions

− Vesting conditions are service related, i.e. they determine whether

the entity receives the services that entitle the counterparty to the
share-based payment.
− Service conditions; with or without …
− Performance conditions
» Market performance conditions or non-market performance conditions
» Performance conditions by definition always require a service condition

− Non-vesting conditions are not service related, i.e. they do not

determine whether the entity receives the services that entitle the
counterparty to the share-based payment
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 Accounting for employee services received (continued)
Overview of conditions
Vesting conditions

Service conditions Performance conditions

Market conditions Non-market conditions

Service condition Service condition

Requirement to complete a + +
specified period of service condition that is related condition that is a
to the market price of performance condition, but
the equity instrument not market price related
•Employee has to stay •Share price must •Revenue must increase by
employed for example , increase by 15%
10%
for 3 three years after •TSR (total shareholder
return) must increase •Percentage increase in
grant date by 10% market share
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 Accounting for employee services received (continued)
Overview of conditions

Non-vesting conditions

Conditions that the

Conditions that the entity can choose to
Conditions that neither the counterparty can
entity nor the counterparty meet
choose to meet
can choose to meet

•Inflation must not be higher • Holding participation •Continuation of the

than 5% shares over the holding plan by the entity
period.
•Price of gold must increase
by more than 3 % • Paying monthly
contributions to a share
purchase plan.

Basically Not related34to Services

 Example : Share options with vesting conditions
A company grants 2,000 share options to each of its three directors on
Jan, 1, 2012 subject to the directors being employed on Dec, 31, 2014.
The options vest on Dec,31, 2014. The FV of each option on Jan,1,
2012 is €10 and it is anticipated that all of the share options will vest on
Dec,31 2014.The options will only vest if the company’s share price
reaches €14 per share. The price at Dec,31, 2012 was €8 and it is not
anticipated that it will rise over the next two years. It is anticipated that
there will only be two directors employed on Dec,31, 2014.

Requirement How will the share options be treated in the financial

statements for the year ended Dec,31, 2012?
 Example : Share options with vesting conditions

Solution
The market based condition i.e. the increase in the share price can be
ignored for the purpose of the calculation. However, the employment
condition must be taken into account. The options will be treated as
follows:

2,000 options x 2 directors x €10 x 1/3 years = €13,333. Equity will be

increased by this amount and an expense for the year ended Dec,31,
2012.
 Equity-settled share-based payments with non-employees

 Measured directly at the fair value of goods and services

received
 If the fair value of goods and services cannot be estimated
reliably, measure the fair value of equity instrument.
 If the fair value of the equity instrument granted cannot be
estimated reliably (only in very rare cases), equity
instruments are measured at their intrinsic value.

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 Equity-settled share-based payments with non-employees
Measured at the date the goods or services are obtained
As opposed to grant date – in case of employees
 Means “daily” if services are rendered
 Simplification method: “regular intervals”
 Expense immediately (means no vesting conditions) unless
 Goods or services qualify for capitalisation as asset (e.g.
inventory); or
 Vesting conditions exist
 Expense when services are rendered over the vesting
period
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 2. Cash-settled share-based payment transactions
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 the entity’s shares or other equity instruments of the
entity.
 2. Cash-settled share-based payment transactions
The expense is the cash paid by the company.
• Goods and services acquired and liability incurred should be
measured at the FV of the liability.
• Until the liability is settled, the entity should re-measure the
fair value of the liability at each reporting date and at the date
of settlement, with any changes in fair value recognised.
• The services received, and the liability incurred, should be
recognised as the services are rendered.
 Example 1
Red plc. granted 300 share appreciation rights to each of its 500 employees on
Aug,1, 2012. Management believe that as at July, 31, 2013, Red plc’s year end,
80% of the awards will vest on July, 31 2014. The fair value of each share
appreciation right on July, 31, 2013 is €15.

Requirement.
What is the fair value of the liability to be recorded in the financial statements for
the year ended July, 31, 2013?

Solution
300 rights x 500 employees x 80% x €15 x 1year/2year = €900,000.
 Example 2:
• On 1 July 2012 Coogee Ltd provides its managing director with a share-based
incentive according to which she is offered a bonus that is calculated as 200,
000 times the increase in the fair value of the entity’s share price above $2.50.
When the bonus was offered the share price was $2.25.
• If the managing director does not leave the organisation the accrued
entitlement will be paid after three years. However, if she leaves the
organisation the accrued entitlement will be paid out upon departure—that is,
the benefit will not be forfeited.
 Example 2:continued
Other information
• The share price at 30 June 2013 is $3.00, at 30 June 2014 is $2.90, at 30 June
2015 is $4.10 and the managing director stays for three years and is paid the
bonus on 1 July 2015.
REQUIRED
Prepare the journal entries that would appear in the accounting records of
Coogee Ltd to account for the issue of the share appreciation rights.
 Solution
Year end Calculation Remuneration expense for period
30 June 2013 200, 000 × ($3.00 – $2.50) $100 000
30 June 2014 200, 000 × ($2.90 – $2.50) – $100 000 ($20 000)
30 June 2015 200, 000 × ($4.10 – $2.50) – $80 000 $240 000

30 June 2013 30 June 2015

Employee benefits expense …….100 000 Employee benefits expense ……….240 000
Accrued salaries payable ……….100 000 Accrued salaries payable …….240 000

30 June 2014 1 July 2016

Accrued salaries payable …………….20 000 Accrued salaries payable …….320 000
Employee benefits expense recouped (revenue) Cash …. …………….320 000
……….20 000
3. Share-based payment transactions with cash
alternatives.
• Where the terms of the arrangement provide either the entity
or the counterparty with the choice of whether the entity
settles the transaction in cash (or other assets) or by issuing
equity instruments.
 Cont’d…

• The entity should account for that transaction, or the components of

that transaction, as a cash-settled share-based payment transaction if,
and to the extent that, the entity has incurred a liability to settle in cash
or other assets, or as an equity-settled share-based payment transaction
if, and to the extent that, no such liability has been incurred.
 The counterparty has a choice of settlement

• Paragraphs IFRS 2.35-40 cover share-based payment transactions with cash

alternatives in which the terms of the arrangement provide the counterparty with a
choice of settlement.

• Such transactions are quite common in share-based payment arrangements with

employees.

• Entities need to recognize separate debt and equity components in such

transactions in accordance with requirements for cash settled and equity
settled share-based payment transactions, respectively.
 Transaction with non-employee

• In transactions with parties other than employees, where fair

value of goods or services is measured directly, the entity
measures the equity component as the difference between the
fair value of the goods or services received and the fair value
of the debt component (i.e. cash alternative), at the date when
the goods or services are received.
 Transaction With employees
• For transactions where fair value of goods or services is measured with
reference to instruments issued (most often to employees) entities need to
measure fair value of two components.

• Such measurement starts with debt component (i.e. cash alternative), then
the fair value of the equity component is measured taking into account that
the counterparty will not receive cash in order to receive the equity
instrument.
• On settlement, the liability needs to be remeasured so that it equals the
payment amount.

• If the entity issues equity instruments on settlement rather than paying

cash, the remeasured liability is transferred directly to equity.

• All previously recognized equity components remain within equity

(transfers within equity are allowed).
 Example: Share-based payment transaction
with cash alternative
• On 1 January 20X1, Entity A grants 100 shares to each of its 200 employees
provided they will remain employed until 31 December 20X3. These shares
will then be locked-in for another two years (i.e. employees would not be
able to sell them until 31 Dec 20X5).

• Employees have also a right to receive cash instead of shares (so called
‘phantom shares’), the payment will be based on the market price of these
shares as at 31 Dec 20X3 and payment will be made immediately. However,
the cash alternative will be based on 80 shares only.
 Example …..cont’d
Moreover, at the grant date:
 it is estimated that 90% out of 200 employees will meet the service condition
 fair value of phantom shares granted is $30 (cash alternative)
 fair value of shares granted is $28 (share alternative)

• The measurement of such a share-based payment arrangement starts with debt component (i.e. cash
alternative), then the fair value of the equity component is measured taking into account that the
counterparty will not receive cash in order to receive the equity instrument.

• The liability component as of the grant date amounts to $432,000 (200*80*30*90%), whereas the
equity component amounts to $72,000 ((200*100*28*90%) - 432,000).
Solution……….. Year 20X1
Entity A starts recognizing the expense relating to both components over
the vesting period. Entries for year 20X1 are as follows:

Employee benefits expense…168,000

Equity…………..24,000
Liability…………. 144,000

Where, 24,000=72,000/3 yrs.

144,000=432,000/3 yrs.
 Year 20X2
Market price of Entity A shares increases. This is reflected only in liability
component which increases to $32. Fair value of equity instruments is not
subsequently remeasured. Entries recognized for year 20X2 are as follows:

Employee benefits expense…187,200

Equity…………..24,000
Liability…………. 163,200

24,000 = 72,000/3yrs
163,200 = 200*80*32*90%*2/3yrs - 144,000
 Year 20X3
• 85% of employees (170) remained in the workforce as at 31 December 20X3. 120
employees chose the share alternative and 50 employees chose the cash
alternative. The market price of shares increased further so that the fair value of
the cash alternative is now $35.
• First, Entity A recognizes expense for year 3 taking into account the actual number
of employees that fulfilled service conditions and the final market price of shares
(the latter impacts liability component only). This is recognized for year 20X3 as
follows:
Employee benefits expense…188,800
Equity…………..20,000
Liability…………. 168,800

20,000 = (72,000*85%/90%) - 24,000 - 24,000

168,800 = (200*80*35*85%) - 163,200 -144,000
• Payment to 50 employees who choose cash alternative is booked as follows:

Liability…..175,000
Cash………175,000

(Liability=175,000 = 50*35*100)

• Issuance of shares to 120 employees who chose share alternative transfers the
remaining liability balance to equity:

Liability …..301,000
Equity …………301,000

Liability = 301,000= (144,0001st yr. +163,2002nd yr+168,8003rd yr.) - 175,000

3.2.The entity has a choice of settlement
• Paragraphs IFRS 2.41-43 cover share-based payment transactions with cash
alternatives in which the terms of the arrangement provide the reporting entity
with a choice of settlement. For this type of transactions, the entity needs to
determine whether to use general equity settled or cash settled basis of IFRS 2.
Such a transaction is accounted for as cash-settled if, for example:

 Settlement in equity instruments has no commercial or economic substance,

 Settlement in equity instruments is impracticable due to legal or other constraints,
 Entity has a past practice or a stated policy of settling in cash whenever it can,
 Entity has created a constructive obligation to settle in cash.
 ………Cont’d
• When actual equity instruments are issued, no changes in equity is
recognized other than a transfer within equity if needed.

• If entity, despite the original choice of approach, settles in cash, the

payment is treated as a deduction of equity.

• But if the entity, on settlement, chooses the alternative that has a higher fair
value at the settlement date, the difference between settlement date fair
values is recognized as an additional expense.
 Share-based Payment Disclosures
IFRS 2 requires extensive disclosure requirements under three main headings:

1. Information that enables users of financial statements to understand the nature and
extent of the share based payment transactions that existed during the period.

2. Information that allows users to understand how the FV of the goods or services
received or the FV of the equity instruments which have been granted during the period
was determined.

3. Information that allows users of financial statements to understand the affect of

expenses which have arisen from share based payment transactions on the entities
income statement in the period.
End of chapter two

Thank you !!