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CHAPTER TWO
SHARE-BASED COMPENSATION
2.1. Overview of Share-based Payments
In February 2004 the International Accounting Standards Board (Board) issued IFRS 2 Share-
based Payment. The Board amended IFRS 2 to clarify its scope in January 2008 and to incorporate
the guidance contained in two related Interpretations (IFRIC 8 Scope of IFRS 2 and IFRIC 11 IFRS
2—Group and Treasury Share Transactions) in June 2009.

International Financial Reporting Standard (IFRS®) 2, Share-based Payment, applies when a

company acquires or receives goods and services for equity-based payment. These goods can
include inventories, property, plant and equipment, intangible assets, and other non-financial
assets.

The objective of this IFRS is to specify the financial reporting by an entity when it undertakes
a share-based payment transaction. In particular, it requires an entity to reflect in its profit or
loss and financial position the effects of share-based payment transactions, including expenses
associated with transactions in which share options are granted to employees.

There are two notable exceptions: shares issued in a business combination, which are dealt with
under IFRS 3, Business Combinations; and contracts for the purchase of goods that are within the
scope of International Accounting Standard (IAS®) 32 and IAS 39. In addition, a purchase of
treasury shares would not fall within the scope of IFRS 2, nor would a rights issue where some of
the employees are shareholders.

Examples of some of the arrangements that would be accounted for under IFRS 2 include call
options, share appreciation rights, share ownership schemes, and payments for services made to
external consultants based on the company’s equity capital.

Stock Based Compensation (also called Share-Based Compensation or Equity Compensation) is a

way of paying employees, executives, and directors of a company with equity in the business. It is
typically used to motivate employees beyond their regular cash-based compensation (salary and
bonus) and to align their interests with those of the company’s shareholders.

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2.1.1 Recognition of share-based payment

IFRS 2 requires an asset or expense to be recognized for the goods or services received by a
company. The corresponding entry in the accounting records will either be a liability or an
increase in the equity of the company, depending on whether the transaction is to be settled
in cash or in equity shares.

2.1.2 Advantages of Stock Based Compensation

There are many advantages to this type of remuneration, including:

 Creates an incentive for employees to stay with the company (they have to wait for shares to
vest)
 Aligns the interests of employees and shareholders – both want to see the company prosper
and the share price rise
 Doesn’t require cash

2.1.3 Disadvantages of Share Based Compensation

 Dilutes the ownership of existing shareholders (by increasing the number of shares
outstanding)
 May not be useful for recruiting or retaining employees if the share price is decreasing

2.2. Share-based Payments Settled with Equity

Equity-settled Share-based Payments is where the entity receives goods/services that are
settled by issuing equity instruments (that is, shares or share options).
For 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.

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To apply the requirements of the transactions with employees and others providing similar services,
the entity shall measure the fair value of the services received by reference to the fair value of the
equity instruments granted, because typically it is not possible to estimate reliably the fair value of
the services received, as explained above.

The fair value of those equity instruments shall be measured at grant date. Typically, shares,
share options or other equity instruments are granted to employees as part of their remuneration
package, in addition to a cash salary and other employment benefits. 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 fair value of the total remuneration package
independently, without measuring directly the fair value of the equity instruments granted.
Furthermore, shares or share options are sometimes granted as part of a bonus arrangement,
rather than as a part of basic remuneration, eg as an incentive to the employees to remain in the
entity’s employ or to reward them for their efforts in improving the entity’s performance. By
granting shares or share options, in addition to other remuneration, the entity is paying additional
remuneration to obtain additional benefits. Estimating the fair value of those additional benefits is
likely to be difficult. Because of the difficulty of measuring directly the fair value of the services
received, the entity shall measure the fair value of the employee services received by reference to
the fair value of the equity instruments granted.

Transactions in which goods are received

EXAMPLE 1

Assume ABC Company issued share options on 1 June 2006 to pay for the purchase of
inventory. The inventory is eventually sold on 31 December 2008. The value of the inventory
on 1 June 2006 was $6m and this value was unchanged up to the date of sale. The sale
proceeds were $8m. The shares issued have a market value of $6 m.

How will this transaction be dealt with in the financial statements?

Answer
IFRS 2 states that the fair value of the goods and services received should be used to value the

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share options unless the fair value of the goods cannot be measured reliably. Thus equity would be
increased by $6m and inventory increased by $6m. The inventory value will be expensed on sale.

Inventory …………………………………….. 6,000,000

Equity …………………………………….. 6,000,000

Transactions in which services are received

If the equity instruments granted vest immediately, the counterparty 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 shall presume that services rendered by the
counterparty as consideration for the equity instruments have been received. In this case, on grant
date the entity shall recognise the services received in full, with a corresponding increase in
equity.

If the equity instruments granted do not vest until the counterparty completes a specified period
of service, the entity shall presume that the services to be rendered by the counterparty as
consideration for those equity instruments will be received in the future, during the vesting period.
The entity shall account for those services as they are rendered by the counterparty during the
vesting period, with a corresponding increase in equity. For example: if an employee is granted
share options conditional upon completing three years’ service, then the entity shall presume that
the services to be rendered by the employee as consideration for the share options will be
received in the future, over that three-year vesting period.

 Grant Date means the date on which an Option is granted under the Plan. Date of Grant
means the date on which the granting of an Award is authorized by the Committee
 Vesting date is the date that employees entitled to the share based payment
 Exercise date is the date in which employees receive the share based payments.
 Vesting Conditions means any term, condition or restriction, including without limitation any
performance-based condition or criteria, described in the award documents applicable to an
Award that a Participant must satisfy in order to receive a payment, distribution or otherwise
realize monetary value from an Award.

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 A vesting period is the time an employee must work for an employer in order to own outright
employee stock options, shares of company stock or employer contributions to a tax-
advantaged retirement plan. Vesting periods come in a variety of durations
 Share vesting is the process by which an employee, investor, or co-founder is rewarded with
shares or stock options but receives the full rights to them over a set period of time or, in some
cases, after a specific milestone is hit – usually one that's established in an employment
contract or a shareholders' agreement.
EXAMPLE 2
ABC Company grants 2,000 share options to each of its three directors on 1 January 2006, subject to
the directors being employed on 31 December 2008. The options vest on 31 December 2008. The fair
value of each option on 1 January 2006 is $10, and it is anticipated that on 1 January 2006 all of the
share options will vest on 30 December 2008. The share price at 31 December 2006 is $8 and it is
anticipated that it will rise over the next two years. It is anticipated that on 31 December 2006 only
two directors will be employed on 31 December 2008.
How will the share options be treated in the financial statements for the year ended 31 December
2006?
Answer
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 year / 3 years = $13,333

Expense …………………………………….. $13,333
Equity …………………………………….. $13,333
*** Equity will be increased by this amount and an expense shown in profit or loss for the year
ended 31 December 2006.
During 31 December 2007 assume the share price went to 13 and no director left his work. The
options will be treated as follows: the movement will be recorded the profit or loss and financial
position statements.
=2,000 options x 2 directors x $10 x 2 year / 3 years = $26,667
Expense …………………………………….. $13,333

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Equity …………………………………….. $13,333

*** Assume during 31 December 2008 no assumptions have been changed. The options will be treated
as follows:
=2,000 options x 2 directors x $10 x 3year / 3 years = $40,000
Expense …………………………………….. $13,333
Equity …………………………………….. $13,333
2.3. Share-based Payments Settled with Cash

Cash settled share-based payment transactions occur where goods or services are paid for at
amounts that are based on the price of the company’s equity instruments. The expense for
cash settled transactions is the cash paid by the company.

For cash-settled share-based payment transactions, the entity shall measure the goods or services
acquired and the liability incurred at the fair value of the liability, Until the liability is settled, the
entity shall re measure the fair value of the liability at the end of each reporting period and at the
date of settlement, with any changes in fair value recognized in profit or loss for the period.

For example, an entity might grant share appreciation rights to employees as part of their
remuneration package, whereby the employees will become entitled to a future cash payment
(rather than an equity instrument), based on the increase in the entity’s share price from a
specified level over a specified period of time.

Alternatively, an entity might grant to its employees a right to receive a future cash payment by
granting to them a right to shares (including shares to be issued upon the exercise of share
options) that are redeemable, either mandatorily (for example, upon cessation of employment) or
at the employee’s option. These arrangements are examples of cash-settled sharebased payment
transactions. This creates a liability, and the recognized cost is based on the fair value of the
instrument at the reporting date. The fair value of the liability is re-measured at each reporting
date until settlement.

EXAMPLE 3
JOY a public limited company, has granted 300 share appreciation rights to each of its 500 employees
on 1 July 2005. The management feel that 80% of employees will stay and the awards will vest on 31

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July 2007. The fair value of each share appreciation right on 31 July 2006 is $15. What is the fair
value of the liability to be recorded in the financial statements for the year ended 31 July 2006?
Answer
= 300 rights x 500 employees x 80% x $15 x 1 year / 2 years = $900,000
Expense ……………………………………. 900,000
Liability ……………………………………. 900,000
*** Assume fair value at the end of July 2007 is $16. What is the fair value of the liability to be
recorded in the financial statements for the year ended 31 July 2007?
= 300 rights x 500 employees x 80% x $16 x 2 year / 2 years = $1,920,000
Expense ……………………………………. 1,020,000
Liability ……………………………………. 1,020,000
*** At the exercise date the company will record the cash payment as
Liability ……………………………………. 1,920,000
Cash ……………………………………. 1,920,000
2.4. Share-based Payments with Cash Alternatives

For share-based payment transactions in which 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, the entity shall 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.

2.5. Counterparty Has Choice of Settlement

If an entity has granted the counterparty the right to choose whether a share-based payment
transaction is settled in cash or by issuing equity instruments, the entity has granted a compound
financial instrument, which includes a debt component (i.e. the counterparty’s right to demand
payment in cash) and an equity component (i.e. the counterparty’s right to demand settlement in
equity instruments rather than in cash).

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For transactions with parties other than employees, in which the fair value of the goods or
services received is measured directly, the entity shall measure the equity component of the
compound financial instrument as the difference between the fair value of the goods or services
received and the fair value of the debt component, at the date when the goods or services are
received.

For other transactions, including transactions with employees, the entity shall measure the
fair value of the compound financial instrument at the measurement date, taking into account
the terms and conditions on which the rights to cash or equity instruments were granted.
the entity shall first measure the fair value of the debt component, and then measure the fair value
of the equity component—taking into account that the counterparty must forfeit the right to
receive cash in order to receive the equity instrument.

The entity shall account separately for the goods or services received or acquired in respect of
each component of the compound financial instrument. For the debt component, the entity shall
recognize the goods or services acquired, and a liability to pay for those goods or services, as the
counterparty supplies goods or renders service, in accordance with the requirements
applying to cash-settled share-based payment transactions

For the equity component (if any), the entity shall recognize the goods or services received, and an
increase in equity, as the counterparty supplies goods or renders service, in accordance with the
requirements applying to equity-settled share-based payment transactions.

2.6. Issuer Has Choice of Settlement

For a share-based payment transaction in which the terms of the arrangement provide an entity
with the choice of whether to settle in cash or by issuing equity instruments, the entity shall
determine whether it has a present obligation to settle in cash and account for the share-based
payment transaction accordingly.

The entity has a present obligation to settle in cash if the choice of settlement in equity
instruments has no commercial substance (eg because the entity is legally prohibited from issuing
shares), or the entity has a past practice or a stated policy of settling in cash, or generally settles in
cash whenever the counterparty asks for cash settlement. If the entity has a present obligation to
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settle in cash, it shall account for the transaction in accordance with the requirements applying to
cash-settled share-based payment transactions. If no such obligation exists, the entity shall
account for the transaction in accordance with the requirements applying to equity-settled share-
based payment transactions.

2.7. Share-based Payment Disclosures

IFRS 2 requires extensive disclosures under three main headings:

 Information that enables users of financial statements to understand the nature and extent
of the share-based payment transactions that existed during the period.
 Information that allows users of financial statements to understand how the fair value of
the goods or services received, or the fair value of the equity instruments which have been
granted during the period, was determined.
 Information that allows users of financial statements to understand the effect of expenses,
which have arisen from share-based payment transactions, on the entity’s profit or loss in
the period.

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