Introduction to IFRS 2
IFRS 2 Share-based Payment requires an entity to recognise the goods or services it receives in a transaction settled in its own equity instruments, or in cash amounts based on the price of those instruments. The debit goes to profit or loss, or into the carrying amount of an asset where the goods or services qualify for capitalisation. The credit goes to equity or to a liability, depending on how the award is settled.
Two distinctions drive almost every answer the standard produces. Equity-settled awards are measured once, at grant date fair value, and never remeasured; cash-settled awards are remeasured to fair value at every reporting date until settlement. And any condition attached to an award affects either the fair value of the instrument or the number of instruments expected to vest, never both.
Two definitions set the scope:
- A share-based payment arrangement entitles a counterparty to receive cash or other assets based on the price of equity instruments of the entity or another group entity, or to receive those equity instruments themselves, provided any specified vesting conditions are met. The arrangement may be with the entity, another group entity, or any shareholder of a group entity.
- A share-based payment transaction is one in which the entity receives goods or services under such an arrangement, or incurs an obligation to settle it when another group entity receives them.
That second limb is what pulls group arrangements into scope: a parent settling an award for a subsidiary's employees has an IFRS 2 transaction of its own, despite receiving nothing directly.
The question that settles most of the accounting
Is the entity obliged to hand over cash, or equity? Equity-settled fixes fair value at grant date and leaves the credit permanently in equity. Cash-settled creates a liability trued up to fair value at every reporting date, with share price movements running through profit or loss until the award is settled.
Scope and Exclusions
IFRS 2 applies to all share-based payment transactions, whether or not the entity can specifically identify the goods or services received. That last point matters: the standard presumes that where the identifiable consideration received is less than the fair value of the equity instruments granted, unidentifiable goods or services have been received, and the difference is expensed.
The standard captures three settlement patterns:
| Category | Settled by | Credit entry |
|---|---|---|
| Equity-settled | Delivering the entity's own equity instruments | Equity (share-based payment reserve) |
| Cash-settled | Cash or other assets for an amount based on the share price | Liability |
| Settlement choice | Either, at the option of the entity or the counterparty | Depends on which party holds the choice and whether an obligation to pay cash exists |
The following are outside the scope of IFRS 2:
- Transactions in which the entity acquires goods as part of the net assets acquired in a business combination to which IFRS 3 applies, in a combination of entities under common control, or in the contribution of a business on the formation of a joint venture. Replacement awards issued to the employees of the acquiree remain within IFRS 2.
- Transactions with a party acting in their capacity as a shareholder rather than as a supplier of goods or services. A rights issue offered to all holders of a class of shares is a shareholder transaction, not a share-based payment, even where employees happen to hold shares.
- Contracts to buy or sell non-financial items that are settled net in cash and therefore fall within IFRS 9, such as a commodity contract entered into for trading purposes.
Employees are defined by substance, not by contract
IFRS 2 treats directors and others who render personal services to the entity as employees where they render services similar to those rendered by employees, regardless of the legal form of the engagement. A consultant engaged on a rolling contract who works alongside staff may fall on the employee side of the line, which changes the measurement basis from the fair value of the services to the fair value of the instruments.
The Three Categories of Share-based Payment
The category drives measurement, remeasurement and presentation, so it is settled before anything else.
Equity-settled transactions are settled by delivering shares or share options. The entity has no obligation to transfer cash, so no liability arises. The credit is to equity, usually to a separate share-based payment reserve within the statement of changes in equity, and the amount is based on fair value at grant date only.
Cash-settled transactions oblige the entity to pay cash for an amount that tracks the share price. The classic example is a share appreciation right, which pays the holder the increase in the share price over a period without any share ever being issued. Phantom shares work the same way, paying out the full market value of a notional share rather than the appreciation on it. Because the entity owes cash, a liability arises and is remeasured at every reporting date.
Settlement choice transactions give either the entity or the counterparty the right to decide between cash and equity at settlement. Which party holds the choice determines the accounting, and the two cases are dealt with separately below.
Where the credit is presented
An equity-settled share-based payment reserve is presented in the statement of changes in equity. Marking it as a statement of financial position item because equity ultimately appears there loses the information about where the item first arose, and the same logic would apply to every reserve and every line of profit or loss. Present the reserve and its movements in the statement of changes in equity.
Measurement: Direct and Indirect Methods
IFRS 2 measures the transaction by reference to the goods or services received wherever their fair value can be estimated reliably, and by reference to the equity instruments granted where it cannot. This produces two measurement routes.
Direct method: transactions with non-employees
For transactions with parties other than employees, there is a rebuttable presumption that the fair value of the goods or services received can be estimated reliably. The transaction is measured at that fair value, on the date the goods or services are received.
Consider an entity that settles an attorney's fee by issuing shares. The legal services have an observable value, so the expense is measured at the fair value of the services on the date they were rendered, and the credit to equity follows the debit.
| Entry | Account | Statement | Amount |
|---|---|---|---|
| Dr | Legal expenses | P/L | 45,000 |
| Cr | Share-based payment reserve | SCE | 45,000 |
Where the services are rendered evenly over a period, the fair value is measured at the date of receipt, which in practice means an average over the service period rather than a single spot value.
Indirect method: transactions with employees
The fair value of employee services cannot be measured reliably, so the transaction is measured at the fair value of the equity instruments granted, determined at grant date. That fair value is fixed for the life of the award. Subsequent movements in the share price, favourable or adverse, are irrelevant to the expense.
The cumulative expense for an equity-settled award to employees is:
Grant date fair value per instrument × number of instruments per employee × number of employees expected to satisfy all non-market vesting conditions × expired portion of the vesting period − amount already recognised
Each of those four inputs behaves differently. The fair value is frozen at grant date. The number of instruments and employees is an estimate that is trued up every reporting date for non-market conditions. The fraction of the vesting period ratchets upward with time. And the deduction of amounts already recognised means the charge in any single period is a balancing figure, which can be negative.
When identifiable consideration falls short
Where an entity receives identifiable goods or services worth less than the fair value of the instruments granted, the difference is presumed to represent unidentifiable goods or services and is expensed. The journal carries two debits:
| Entry | Account | Basis |
|---|---|---|
| Dr | Identifiable goods or services | Fair value of what was actually received |
| Dr | Expense (unidentifiable goods or services) | Balancing figure |
| Cr | Share capital or share-based payment reserve | Fair value of the equity instruments granted |
If there is no indication that unidentifiable goods or services were received, no such split arises and the transaction is recorded at the value of what was received.
Vesting and Non-vesting Conditions
A vesting condition determines whether the entity receives the services that entitle the counterparty to the award. It is either a service condition, requiring the counterparty to remain in service for a specified period, or a performance condition, requiring a service period plus the achievement of a specified target. The vesting period is the period over which all specified vesting conditions are to be satisfied.
A non-vesting condition is any other condition attached to the arrangement. It does not determine whether the entity receives services, and it falls into one of three groups:
| Type | Who controls it | Example |
|---|---|---|
| Entity-controlled | The entity can choose whether to satisfy it | Whether the entity continues to operate the plan rather than cancelling it |
| Counterparty-controlled | The counterparty can choose whether to satisfy it | A requirement that the employee contributes savings into a plan, or pays the exercise price |
| Neither party | Outside the control of both | Vesting conditional on a commodity index, interest rate or exchange rate unrelated to the entity |
The accounting consequence is that non-vesting conditions are reflected in the grant date fair value of the instrument and are then not revisited. They never adjust the number of instruments expected to vest. An award subject only to a non-vesting condition that is subsequently not met still produces a cumulative expense, because the probability of that outcome was already priced into the grant date fair value.
Market versus Non-market Conditions
This is the distinction that determines where a condition is reflected in the calculation, and it applies to performance conditions.
| Treatment | Market condition | Non-market condition |
|---|---|---|
| Reflected in grant date fair value | Yes | No |
| Reflected in the number of instruments expected to vest | No | Yes, trued up each reporting date |
| Affects the estimated vesting period | No | Yes, where the period depends on when the target is met |
| Expense reversed if never achieved | No | Yes, cumulatively to nil |
A market condition is one that depends on the market price of the entity's equity instruments: a share price target, a total shareholder return hurdle, or a condition tied to an index of the entity's own shares. Because the valuation model already assigns a probability to that outcome, the expense is recognised regardless of whether the target is achieved. The award is accounted for as if the market condition were satisfied, provided all non-market conditions are met.
A non-market condition is anything else: continued employment, a profit target, an earnings per share target, a units-sold target. It is excluded from fair value and instead reduces the number of instruments expected to vest, with the estimate revised at each reporting date. Non-vesting conditions follow the same route as market conditions, into fair value rather than into the count.
A non-market performance condition applied over three years
An entity grants 200 options to each of 500 employees. The employees must remain in service for three years and each must sell 100 cars. Both are non-market conditions. Grant date fair value is 10 per option.
At the end of year one, 480 employees remain, 450 are expected to remain until vesting date, but only 380 are expected to both remain and have sold 100 cars. The estimate that matters is the one that reflects all non-market conditions:
- 10 × 1/3 × 200 options × 380 employees = 253,333
At the end of year two, the equivalent expectation has fallen to 370 employees:
- Cumulative: 10 × 2/3 × 200 × 370 = 493,333
- Less recognised to date: 253,333
- Charge for year two: 240,000
The charge rose because two-thirds of the period has now expired rather than one-third, but it rose by less than a full year's worth because the one-third already recognised in respect of ten departed employees has been reversed through profit or loss.
A non-market condition that fails, then recovers
Where the performance target affects every employee identically, such as a profit target, the estimate swings between everything and nothing. An entity grants 200 options to each of 500 employees, vesting after four years subject to service and a 10% increase in profit. Grant date fair value is 10 per option ignoring the profit target, and 8 taking it into account. Because the target is a non-market condition, 10 is the correct input and the probability of achieving it is dealt with through the employee count.
| Year end | Expected to meet all conditions | Cumulative | Charge for the year |
|---|---|---|---|
| 1 — target expected to be met | 450 | 225,000 | 225,000 |
| 2 — target no longer expected to be met | 0 | 0 | (225,000) |
| 3 — target expected to be met again | 435 | 652,500 | 652,500 |
| 4 — target actually met, actual employees | 432 | 864,000 | 211,500 |
In year two nobody can satisfy both conditions on the expectations then held, so the cumulative expense is nil and the entire prior charge reverses through profit or loss. At vesting date, expectation is replaced by actual outcome.
The same award with a market condition
Change the performance target to a 10% increase in the share price and the mechanics invert. Grant date fair value is 10 before considering the target and 7 after. Because a share price target is a market condition, 7 is the correct input, and the expectation of achieving it never enters the calculation again.
At the end of year one, with 450 employees expected to remain in service:
- 7 × 1/3 × 200 × 450 = 210,000
This is recognised whether or not the share price target is expected to be met. At vesting date the entity uses the actual number of employees who satisfied the service condition, and the actual share price outcome remains irrelevant to the expense.
When the reserve can never become share capital
If a market condition is not actually achieved, the options do not vest and can never be exercised, yet the cumulative expense stands and a balance remains in the share-based payment reserve. Vesting for legal purposes and recognition for accounting purposes are separate questions. Entities commonly adopt a policy of transferring such a reserve to retained earnings within the statement of changes in equity, since it can no longer become share capital.
On exercise
Where options do vest and are exercised, the exercise price is received and the reserve is transferred to share capital. For 10,000 options exercised at 10 each with 240,000 standing in the reserve:
| Entry | Account | Statement | Amount |
|---|---|---|---|
| Dr | Bank | SFP | 100,000 |
| Dr | Share-based payment reserve | SCE | 240,000 |
| Cr | Share capital | SCE | 340,000 |
Where only a portion of the options is exercised, the reserve is apportioned between the amount transferred to share capital and the amount transferred to retained earnings in respect of the lapsed portion.
Equity-settled Share-based Payments
Bringing the measurement rules together, the recognition pattern for an equity-settled award to employees is:
- Determine grant date fair value per instrument, incorporating market and non-vesting conditions.
- Estimate the number of instruments expected to vest based on non-market conditions.
- Spread the product over the vesting period on a straight-line basis.
- Recognise the movement from the cumulative amount previously recognised.
| Entry | Account | Statement |
|---|---|---|
| Dr | Employee benefits expense | P/L |
| Cr | Share-based payment reserve | SCE |
Where the services received qualify for recognition as an asset, for instance where employee time is directly attributable to constructing an item of property, plant and equipment, the debit is capitalised instead of expensed. The credit to equity is unchanged.
Where an award vests immediately, with no service period required, the services are presumed already to have been received and the entire expense is recognised on grant date.
Repurchasing shares from employees
A repurchase of vested equity instruments from employees is accounted for as a deduction from equity, in the same way as any other share buy-back. Where the price paid exceeds the fair value of the instruments repurchased at the repurchase date, the excess is recognised as an expense under IFRS 2 rather than as a further deduction from equity.
Cash-settled Share-based Payments
A cash-settled award creates a liability, measured at the fair value of that liability, and remeasured at every reporting date and at settlement date with all changes recognised in profit or loss. The grant date fair value has no continuing role once the award has been granted.
Share appreciation rights are the standard case: the holder receives a cash payment equal to the increase in the share price over a defined period. Non-market conditions still adjust the number of rights expected to vest, and market and non-vesting conditions are still reflected within the fair value of the right. What changes is that the fair value is refreshed continuously rather than frozen.
Recognition sequence
Two steps, in order:
Step 1 — recognise any cash actually paid to holders who exercise during the period. This is measured at intrinsic value, being the actual increase in the share price between grant and exercise, and it reduces the liability.
| Entry | Account | Statement |
|---|---|---|
| Dr | Share appreciation rights liability | SFP |
| Cr | Bank | SFP |
Step 2 — remeasure the remaining liability to the amount expected to be paid, being the number of rights still expected to be exercised multiplied by the fair value of a right at the reporting date, apportioned over the expired vesting period. The movement is the balancing figure between the carrying amount after the payment and the required closing balance.
| Entry | Account | Statement |
|---|---|---|
| Dr | Employee benefits expense | P/L |
| Cr | Share appreciation rights liability | SFP |
This is a net approach. The rights of those exercising are not separately remeasured before payment, but the outcome is identical because the closing liability is recalculated from first principles each period.
Five-year illustration
Rights over 100 units each, granted to a population that changes as employees leave and exercise, with a three-year vesting period:
| Year | Opening balance | Paid | Carrying amount after payment | Closing balance required | Charge to P/L |
|---|---|---|---|---|---|
| 1 | — | — | — | 194,400 | 194,400 |
| 2 | 194,400 | — | 194,400 | 413,333 | 218,933 |
| 3 | 413,333 | 225,000 | 188,333 | 460,460 | 272,127 |
| 4 | 460,460 | 280,000 | 180,460 | 241,820 | 61,360 |
| 5 | 241,820 | 282,500 | (40,680) | — | 40,680 |
Two features are worth drawing out. In year one the closing balance is apportioned at one-third because only one year of the three-year vesting period has expired, and the vesting fraction is applied to the liability balance, not merely to a notional expense. From year three onward the fraction is 3/3, so the balance is the full amount expected to be paid on the rights still outstanding. In year five the cash paid exceeds the opening liability, producing a debit carrying amount that is cleared by a final charge to profit or loss.
The vesting fraction applies to the liability, not only to the expense
Because the closing liability is measured as expected payment × expired portion of the vesting period, the apportionment is embedded in the balance sheet amount. Calculating a full expected payment and then spreading it as though it were an expense allocation produces a liability that is overstated in the early years.
Transactions with a Settlement Choice
Where either party may choose between cash and equity settlement, the accounting depends on who holds the choice.
Counterparty holds the choice
The entity has granted a compound instrument: a debt component representing the counterparty's right to demand cash, and an equity component representing the right to demand equity instruments. For transactions with non-employees, the equity component is the residual after measuring the debt component at fair value. The debt component is accounted for as a cash-settled award and remeasured; the equity component is accounted for as an equity-settled award and is not.
Entity holds the choice
The entity determines whether it has a present obligation to settle in cash. Such an obligation exists where the choice of equity settlement has no commercial substance, where the entity has a past practice or stated policy of settling in cash, or where it generally settles in cash whenever the counterparty asks.
- If a present obligation to settle in cash exists, account for the award as cash-settled throughout, and settle the liability with the cash payment. No further steps arise at settlement.
- If no such obligation exists, account for the award as equity-settled over the vesting period.
Where the award has been treated as equity-settled, an additional test applies at settlement date:
- Compare the fair value of the two alternatives at the date the choice was exercised. The fair value of the equity alternative is the number of shares or options multiplied by their fair value at settlement date; the fair value of the cash alternative is the cash amount payable.
- If the entity chose the more expensive alternative, recognise an additional expense for the difference.
- If it chose the cheaper alternative, no additional expense arises and the settlement is recorded directly against equity.
The comparison in practice
An award vests over two years, with one employee and a grant date fair value of 20. On settlement date the fair value per share is 23.
Scenario A — the entity may give cash equal to the value of 800 shares, or 900 shares. The equity-settled expense is based on 900 shares, being the number that would be issued: 20 × 900 × 1/2 = 9,000 in each of the two years, leaving a reserve of 18,000.
At settlement, cash is worth 800 × 23 = 18,400 and shares are worth 900 × 23 = 20,700, a difference of 2,300.
| Choice made | Entries |
|---|---|
| Cash (the cheaper alternative) | Dr Reserve 18,400 / Cr Bank 18,400. No additional expense. The resulting debit balance of 400 in the reserve may be transferred from retained earnings. |
| Shares (the more expensive alternative) | Dr Expense 2,300 / Cr Reserve 2,300, then Dr Reserve 20,300 / Cr Share capital 20,300. |
Scenario B — the alternatives are reversed, so cash is worth 900 shares and the share alternative is 800 shares. The expense is now based on 800 shares, giving a reserve of 16,000. Cash is worth 20,700 and shares 18,400, so cash is now the more expensive route and choosing it triggers the additional 2,300 expense.
Cash is not automatically the more expensive alternative
The additional expense arises from choosing the higher-value alternative, whichever it happens to be. The comparison is made using fair values on the date the choice was exercised, not grant date values, and it must be performed in both directions before concluding that no additional expense arises.
Modifications, Cancellations and Settlements
Modifications
The entity recognises, as a minimum, the services received measured at the grant date fair value of the original award, whether or not the modification is beneficial. Where a modification increases the total fair value of the arrangement or is otherwise beneficial to the employee, the incremental fair value is also recognised. That increment is the difference between the fair value of the modified instrument and the fair value of the original instrument, both measured at the date of the modification, and it is spread over the remainder of the vesting period.
Modifications that reduce the fair value of the arrangement are ignored: the entity continues to recognise the original grant date fair value as though nothing had changed.
Cancellation of an equity-settled award during the vesting period
A cancellation or early settlement is treated as an acceleration of vesting. Three steps follow:
- Recognise immediately the amount that would otherwise have been recognised over the remainder of the vesting period, using the expected number of employees.
- Treat any payment made as a repurchase of the equity interest, debited to equity, measured at the fair value of the instruments repurchased at that date using the actual number of employees paid.
- Recognise any excess of the payment over that fair value as an expense.
| Entry | Account | Statement | Measured at |
|---|---|---|---|
| Dr | Share-based payment reserve | SCE | Current fair value × actual number of employees |
| Dr | Employee benefits expense | P/L | Balancing figure (excess paid over fair value) |
| Cr | Bank | SFP | Amount actually paid |
Any residual balance left in the reserve is transferred to or from retained earnings. That residual arises from two sources: the accelerated expense was built on grant date fair value while the repurchase is measured at settlement date fair value, and the expense used the expected number of employees while the repurchase used the actual number.
Cancellation of a cash-settled award
The pattern is simpler. Recognise the expense for the period as normal, then derecognise the liability by debiting it against the expense. Where the cancelled award is replaced by an equity-settled award, that replacement is accounted for as an equity-settled arrangement in the ordinary way.
Share-based Payments Among Group Entities
Group arrangements are where IFRS 2 becomes demanding, because the same award can be equity-settled in one set of books, cash-settled in another, and equity-settled again in the consolidated financial statements. The governing paragraphs are IFRS 2.3A and .43A to .43D.
Classification in each entity's own books
| Entity | Equity-settled when | Otherwise |
|---|---|---|
| The entity receiving the goods or services | The awards granted are its own equity instruments, or it has no obligation to settle | Cash-settled |
| The entity settling the transaction | It settles in its own equity instruments | Cash-settled |
Repayment arrangements, under which the receiving entity reimburses the settling entity, are ignored for classification purposes. They are accounted for separately under IAS 37 or IFRS 9.
Classification in the consolidated financial statements
The group is a single reporting entity, so the equity instruments of any group company are the group's own equity. An award settled in the shares of any group entity is therefore equity-settled at group level, regardless of how the individual entities classified it.
| Arrangement | Subsidiary | Parent | Group |
|---|---|---|---|
| Parent grants its own shares to subsidiary's employees | Equity-settled (no obligation to settle) | Equity-settled (settles in own shares) | Equity-settled |
| Subsidiary grants parent's shares to its own employees | Cash-settled (obliged to settle, not in own shares) | No share-based payment transaction | Equity-settled |
| Parent grants subsidiary's shares to subsidiary's employees | Equity-settled (no obligation to settle) | Cash-settled (obliged to settle, not in own shares) | Equity-settled |
| Parent obliged to pay cash to subsidiary's employees, linked to any group share price | Equity-settled (no obligation to settle) | Cash-settled | Cash-settled |
Where an entity grants its own equity instruments but buys the shares in from a third party in order to deliver them, the award remains equity-settled in that entity's books. It received services in exchange for its own equity instruments, and how it sourced the shares does not change that.
Employees who transfer between subsidiaries
Where rights to the parent's equity are granted to employees across several subsidiaries and an employee moves between them without forfeiting the award, each subsidiary recognises the services relating to the portion of the vesting period spent in its employ, based on the fair value of the equity at the original grant date. Where a subsidiary has an obligation to settle, so that the award is cash-settled in its books, it additionally recognises the change in fair value for the period the employee was in its employ. If an employee fails a non-market vesting condition, no amount is recognised cumulatively in either the individual or the group accounts, so each entity reverses what it previously recognised.
Consolidation mechanics
On consolidation, the parent's and subsidiary's books are aggregated before consolidation journals are processed, so the same award may appear twice, or under the wrong classification. Three steps resolve this:
- Determine what is already recorded in the aggregated books, based on what each entity recognised.
- Determine what the group requires, applying the group classification test.
- Process consolidation journals to bridge from the first to the second, reversing and recreating as necessary, and taking care to allocate prior-period effects to retained earnings rather than to current year profit or loss.
Where a subsidiary recorded a cash-settled award that is equity-settled at group level, the consolidation journals eliminate the liability and its associated expense, splitting the reversal between the current year and retained earnings, and then recognise the group's equity-settled expense on the same basis:
| Entry | Account | Statement |
|---|---|---|
| Dr | Share-based payment liability | SFP |
| Cr | Employee benefits expense (current year portion) | P/L |
| Cr | Retained earnings (prior year portion) | SCE |
| Then recognise the group's equity-settled charge | ||
| Dr | Retained earnings (prior year portion) | SCE |
| Dr | Employee benefits expense (current year portion) | P/L |
| Cr | Share-based payment reserve | SCE |
Because the two classifications produce different measurement bases, the amounts reversed and recognised will not agree, and the net difference is the correction to the group charge.
Separate financial statements of the parent
Where a parent grants its own equity instruments to the employees of a subsidiary, the parent has not received those services itself. In its separate financial statements the debit is capitalised as an increase in the cost of the investment in the subsidiary, not recognised as an expense. The subsidiary recognises the expense with a credit to equity, representing a capital contribution from the parent.
Effect on the equity analysis
Where a subsidiary grants its own shares to its own employees, the resulting reserve is a post-acquisition equity movement of the subsidiary and is allocated between the group and the non-controlling interest. For a subsidiary that is 80% held with a reserve of 100,000, only 80,000 appears within the group's share of the statement of changes in equity, and 20,000 is allocated to the non-controlling interest.
The reserve does not enter the equity analysis in two cases: where the award is cash-settled, because a liability rather than a reserve arises; and where the parent granted the award to the subsidiary's employees, because the reserve in the subsidiary's books is eliminated on consolidation against the parent's investment. In both cases only the reduced profit for the year flows through the analysis.
Watch the direction of the equity analysis entry
The non-controlling interest's share of a subsidiary's own share-based payment reserve is transferred out of the group reserve on consolidation. Omitting this leaves the full reserve in the group column while the non-controlling interest balance is understated by the same amount, even though group profit is correct.
Tax and Deferred Tax Consequences
The tax treatment set out here reflects the South African Income Tax Act, and the position differs in other jurisdictions.
Equity-settled awards
Equity-settled share-based payments are generally not deductible, since the transaction is regarded as an issue of shares rather than the incurral of expenditure, aside from the limited relief available under section 8B read with section 11(lA). The accounting expense is therefore a permanent difference. It gives rise to no current tax and no deferred tax, and it must be disclosed as a non-deductible expense in the tax rate reconciliation.
Cash-settled awards
Amounts paid under cash-settled awards are usually deductible under section 11(a) once actually incurred, which happens on payment rather than as the liability accrues. The liability recognised over the vesting period therefore has a tax base of nil, creating a deductible temporary difference and a deferred tax asset, subject to the usual assessment of whether sufficient future taxable profit is probable.
| Equity-settled | Cash-settled | |
|---|---|---|
| Deductible | Generally no | Yes, when paid |
| Difference type | Permanent | Temporary |
| Deferred tax | None | Deferred tax asset on the liability |
| Tax rate reconciliation | Reconciling item | No reconciling item |
Disclosure Requirements
IFRS 2 disclosure is built on three objectives: enabling users to understand the nature and extent of the arrangements, how their fair value was determined, and their effect on profit or loss and financial position.
Nature and extent
For each type of arrangement existing during the period, the entity discloses a description covering the general terms and conditions: grant date, method of settlement, number granted, contractual life, and the vesting conditions attached.
| Type of arrangement | Senior management share option plan | General employee share option plan | Senior management share appreciation rights |
|---|---|---|---|
| Date of grant | 1 January 2004 | 1 January 2005 | 1 July 2005 |
| Method of settlement | Equity | Equity | Cash |
| Number granted | 50,000 | 75,000 | 25,000 |
| Contractual life | 10 years | 10 years | 10 years |
| Vesting conditions | 1.5 years' service and a share price target, which was achieved | Three years' service | Three years' service and a target increase in market share |
A reconciliation of the number of options is also required, showing options outstanding at the beginning of the period, granted, forfeited, exercised, expired, outstanding at the end of the period and exercisable at the end of the period, each with its weighted average exercise price. The weighted average share price at the date of exercise, and the range of exercise prices and weighted average remaining contractual life of outstanding options, complete the picture.
How fair value was determined
For options, the entity discloses the option pricing model used and the inputs to it: share price at grant date, exercise price, expected volatility, option life, expected dividends, the risk-free interest rate, and how any market or non-vesting conditions were incorporated. A typical disclosure states that the fair value of 23 per option was calculated using a binomial model with a grant date share price of 50, an exercise price of 50, expected volatility of 30%, no dividends, a contractual life of 10 years and a risk-free rate of 5%.
For shares granted rather than options, the fair value is normally the share price at grant date, and where goods or services are measured directly, the entity states how that fair value was determined.
Effect on profit or loss and financial position
The entity discloses the total expense recognised for the period, separately identifying the portion arising from equity-settled transactions, together with the total carrying amount of liabilities arising from share-based payment transactions and the total intrinsic value of liabilities for rights that had vested by the end of the period.
Key Judgement Areas
| Area | Where difficulty arises | Resolution |
|---|---|---|
| Classification | Treating an award as cash-settled because cash may ultimately be paid | Test whether a present obligation to settle in cash exists, considering past practice and stated policy |
| Market conditions | Reducing the number of instruments expected to vest when a share price target looks unlikely | Market conditions sit in fair value only; the expense stands whether or not the target is met |
| Non-market conditions | Using a fair value that has already been discounted for the probability of achieving the target | Use the undiscounted fair value and reflect the probability in the number expected to vest |
| Employee population | Using the number currently in service rather than the number expected at vesting date | Use the expectation at vesting date, replaced by actual numbers once the vesting date arrives |
| Cash-settled measurement | Applying grant date fair value to a liability | Remeasure to fair value at each reporting date, apportioned over the expired vesting period |
| Cancellations | Recognising only the payment and stopping the expense | Accelerate the remaining expense first, then treat the payment as a repurchase of equity |
| Settlement choice | Assuming no additional expense because cash was chosen | Compare both alternatives at settlement date fair values in both directions |
| Group arrangements | Applying the group classification in the separate financial statements | Classify separately for each entity, then bridge to the group position through consolidation journals |
| Prior period consolidation effects | Posting the whole reclassification against current year profit or loss | Split the adjustment between current year profit or loss and opening retained earnings |
| Deferred tax | Recognising deferred tax on an equity-settled expense | Equity-settled awards create a permanent difference disclosed in the tax rate reconciliation |
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Conclusion
IFRS 2 rests on a small number of decisions applied consistently. Establish whether the arrangement is equity-settled, cash-settled or subject to a settlement choice, because that determines whether fair value is fixed at grant date or refreshed at every reporting date. Sort each condition into market, non-market or non-vesting, because that determines whether it belongs in the fair value of the instrument or in the number of instruments expected to vest. Everything else, including cancellations, modifications and group arrangements, is an application of those two decisions.
Group arrangements repay careful sequencing: classify the award separately in each entity's books, establish what the group requires on the basis that any group entity's shares are the group's own equity, and bridge the two with consolidation journals that allocate prior period effects to retained earnings. The same discipline of separating measurement from presentation appears elsewhere in consolidated reporting, including our guides to consolidated group cash flows and leases acquired in a business combination. For how the resulting expense is presented and disaggregated on the face of the financial statements, see our analysis of operating expenses under IFRS 18.
For clarification, guidance, or feedback on our article, please reach out to us at insight@leash.co.za.