Samenvatting

Summary IFRS 2 Share based payments

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Financial Accounting

Instelling
University Of Cape Town (UCT)

A very important summary dealing with a very important standard. The summary delves into the technical aspects of the reason why and how the share based payment expense is recognized. Easy to follow examples included!

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Type Samenvatting

share based payments

Instelling
University of Cape Town (UCT)
Vak
Financial Accounting

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IFRS 2 (Share based payments)

An entity recognizes share based expenses as the services are provided. This is a
very important principle. The standard mentions that an employee may be given
share options. These options may have conditions attached such as service and
market conditions in order for the employee to be unconditionally entitled to them
(vest).

If the share options only vest after 5 years, the company will have to provide for an
expense in each of the 5 years. Various assumptions will be made at grant date as
to the best estimate of the number of share options the company ultimately expects
to deliver to employees. The expense and corresponding liability/equity entry are
made in each of the 5 years as the work is performed even though the share
options only become exercisable at the end of the 5-year period. The share options
vest evenly as the work is performed each year.

The calculation is done indirectly with reference to the fair value of the share options
granted. The standard argues that the fair value of services received would be
virtually impossible to quantify. Shares or share options are granted in addition to a
basic salary in the same way as a cash bonus. The benefits the firm is getting
include the increased likelihood that the employee will want to stay in the company’s
employ to be entitled to the options. As employees can leave at any time, it is
almost impossible to predict how long they will work at the company so providing for
additional future expenses is likely to be difficult and is against accrual principal as
you cannot provide for future expenditure. Separating what forms part of normal
wage expense and what relates to additional work put in to drive share price
upwards is also likely to be problematic.

The second additional benefit the firm receives is that issuing share options will
assist in improving the company’s performance or rewarding employees for
improving past performance. Certain parallels can be made with a machine. If
expenditure was incurred to increase the output of a machine, this would constitute
a capital improvement. Because employees can never be capitalized, the additional
benefit has to be expensed and will instead form part of internal goodwill (equity).

Share based transactions can either be cash settled or equity settled. Cash settled
is when an entity buys goods or receives service and pays by cash that is linked to
the value of the company’s own equity instruments. For example, share
appreciation rights that are issued to employees. Employees receive a cash
payment based on the increase in share price from grant date and vesting date.

Equity settled transactions are as the name suggests, instead of paying cash for
goods or services, shares or share options are issued. The calculation is done by
amortizing the fair value of the shares or share options over the vesting period
based on the expected number of options expected to vest. Whereas cash settled
transactions are remeasured, equity settled transactions are measured at grant date
and never remeasured.

Let’s take a look at a quick example: 10 employees receive 100 share options with a
fair value of R5 each at grant date. The options vest over the 2-year period

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