PwC Sees Stock-option Impact from IFRS Shift

The investment community benefits when it has clear and consistent information and analyses. In the absence of market prices, fair value is estimated using a valuation technique to estimate what the price of those equity instruments would have been on the measurement date in an arm's length transaction between knowledgeable, willing parties. Technically, under pro forma diluted ESP item iv on the above financial report , the share base is further increased by the number of shares that could be purchased with the "un-amortized compensation expense" that is, in addition to exercise proceeds and the tax benefit. IFRS 2 makes a distinction between the handling of market based performance conditions from non-market performance conditions. The Statement requires that a nonpublic entity account for its options and similar equity instruments based on their fair value unless it is not practicable to estimate the expected volatility of the entity's share price.

IFRS 2 Share-based Payment requires an entity to recognise share-based payment trans­ac­tions (such as granted shares, share options, or share ap­pre­ci­a­tion rights) in its financial state­ments, including trans­ac­tions with employees or other parties to be settled in .

History of IFRS 2

The staff believes that application of the guidance provided by IFRS 2 regarding the measurement of employee share options would generally result in a fair value measurement that is consistent with the fair value objective stated in Statement R. Accordingly, the staff believes that application of Statement R's measurement guidance would not generally result in a reconciling item required to be reported under Item 17 or 18 of Form F for a foreign private issuer that has complied with the provisions of IFRS 2 for share-based payment transactions with employees.

However, the staff reminds foreign private issuers that there are certain differences between the guidance in IFRS 2 and Statement R that may result in reconciling items. The purpose of the study is to help investors gauge the impact that expensing employee stock options will have on the earnings of US public companies.

Exhibits to the study present the results by company, by sector, and by industry. The report emphasises that:. It includes all of its electronic products The investment community benefits when it has clear and consistent information and analyses. A consistent earnings methodology that builds on accepted accounting standards and procedures is a vital component of investing.

The current debate as to the presentation by companies of earnings that exclude option expense, generally being referred to as non-GAAP earnings, speaks to the heart of corporate governance. Additionally, many equity analysts are being encouraged to base their estimates on non-GAAP earnings. While we do not expect a repeat of the EBBS Earnings Before Bad Stuff pro-forma earnings of , the ability to compare issues and sectors depends on an accepted set of accounting rules observed by all.

In order to make informed investment decisions, the investing community requires data that conform to accepted accounting procedures. Of even more concern is the impact that such alternative presentation and calculations could have on the reduced level of faith and trust investors put into company reporting.

The corporate governance events of the last two-years have eroded the trust of many investors, trust that will take years to earn back. In an era of instant access and carefully scripted investor releases, trust is now a major issue. The Board had proposed the amendment in an exposure draft on 2 February The amendment is effective for annual periods beginning on or after 1 January , with earlier application permitted.

The amendments clarify how an individual subsidiary in a group should account for some share-based payment arrangements in its own financial statements.

In these arrangements, the subsidiary receives goods or services from employees or suppliers but its parent or another entity in the group must pay those suppliers.

The amendments make clear that:. The amendments are effective for annual periods beginning on or after 1 January and must be applied retrospectively. Earlier application is permitted. Accounting for cash-settled share-based payment transactions that include a performance condition. Until now, IFRS 2 contained no guidance on how vesting conditions affect the fair value of liabilities for cash-settled share-based payments.

IASB has now added guidance that introduces accounting requirements for cash-settled share-based payments that follows the same approach as used for equity-settled share-based payments. IASB has introduced an exception into IFRS 2 so that a share-based payment where the entity settles the share-based payment arrangement net is classified as equity-settled in its entirety provided the share-based payment would have been classified as equity-settled had it not included the net settlement feature.

Accounting for modifications of share-based payment transactions from cash-settled to equity-settled. Until now, IFRS 2 did not specifically address situations where a cash-settled share-based payment changes to an equity-settled share-based payment because of modifications of the terms and conditions. The IASB has intoduced the following clarifications:. See Legal for additional copyright and other legal information.

DTTL and each of its member firms are legally separate and independent entities. These words serve as exceptions. Once entered, they are only hyphenated at the specified hyphenation points. Each word should be on a separate line. The full functionality of our site is not supported on your browser version, or you may have 'compatibility mode' selected.

Please turn off compatibility mode, upgrade your browser to at least Internet Explorer 9, or try using another browser such as Google Chrome or Mozilla Firefox. Login or Register Deloitte User? Welcome My account Logout. Navigation International Financial Reporting Standards. Overview IFRS 2 Share-based Payment requires an entity to recognise share-based payment transactions such as granted shares, share options, or share appreciation rights in its financial statements, including transactions with employees or other parties to be settled in cash, other assets, or equity instruments of the entity.

Definition of share-based payment A share-based payment is a transaction in which the entity receives goods or services either as consideration for its equity instruments or by incurring liabilities for amounts based on the price of the entity's shares or other equity instruments of the entity. Scope The concept of share-based payments is broader than employee share options.

There are two exemptions to the general scope principle: Therefore, IAS 32 and IAS 39 should be applied for commodity-based derivative contracts that may be settled in shares or rights to shares. Recognition and measurement The issuance of shares or rights to shares requires an increase in a component of equity. Illustration — Recognition of employee share option grant Company grants a total of share options to 10 members of its executive management team 10 options each on 1 January 20X5.

Share option expense Cr. However, if one member of the executive management team leaves during the second half of 20X6, therefore forfeiting the entire amount of 10 options, the following entry at 31 December 20X6 would be made: General fair value measurement principle.

In principle, transactions in which goods or services are received as consideration for equity instruments of the entity should be measured at the fair value of the goods or services received. Only if the fair value of the goods or services cannot be measured reliably would the fair value of the equity instruments granted be used. Measuring employee share options. For transactions with employees and others providing similar services, the entity is required to measure the fair value of the equity instruments granted, because it is typically not possible to estimate reliably the fair value of employee services received.

When to measure fair value - options. For transactions measured at the fair value of the equity instruments granted such as transactions with employees , fair value should be estimated at grant date. When to measure fair value - goods and services. For transactions measured at the fair value of the goods or services received, fair value should be estimated at the date of receipt of those goods or services. For goods or services measured by reference to the fair value of the equity instruments granted, IFRS 2 specifies that, in general, vesting conditions are not taken into account when estimating the fair value of the shares or options at the relevant measurement date as specified above.

Instead, 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 recognised for goods or services received as consideration for the equity instruments granted is based on the number of equity instruments that eventually vest.

IFRS 2 requires the fair value of equity instruments granted to be based on market prices, if available, and to take into account the terms and conditions upon which those equity instruments were granted. In the absence of market prices, fair value is estimated using a valuation technique to estimate what the price of those equity instruments would have been on the measurement date in an arm's length transaction between knowledgeable, willing parties.

The standard does not specify which particular model should be used. If fair value cannot be reliably measured. IFRS 2 requires the share-based payment transaction to be measured at fair value for both listed and unlisted entities. IFRS 2 permits the use of intrinsic value that is, fair value of the shares less exercise price in those "rare cases" in which the fair value of the equity instruments cannot be reliably measured. However this is not simply measured at the date of grant.

An entity would have to remeasure intrinsic value at each reporting date until final settlement. IFRS 2 makes a distinction between the handling of market based performance conditions from non-market performance conditions. Market conditions are those related to the market price of an entity's equity, such as achieving a specified share price or a specified target based on a comparison of the entity's share price with an index of share prices of other entities. Market based performance conditions are included in the grant-date fair value measurement similarly, non-vesting conditions are taken into account in the measurement.

However, the fair value of the equity instruments is not adjusted to take into consideration non-market based performance features - these are instead taken into account by adjusting the number of equity instruments included in the measurement of the share-based payment transaction, and are adjusted each period until such time as the equity instruments vest.

Modifications, cancellations, and settlements The determination of whether a change in terms and conditions has an effect on the amount recognised depends on whether the fair value of the new instruments is greater than the fair value of the original instruments both determined at the modification date. Any payment in excess of the fair value of the equity instruments granted is recognised as an expense New equity instruments granted may be identified as a replacement of cancelled equity instruments.

Disclosure Required disclosures include: Transition All equity-settled share-based payments granted after 7 November , that are not yet vested at the effective date of IFRS 2 shall be accounted for using the provisions of IFRS 2.

IFRS 2 requires the use of the modified grant-date method for share-based payment arrangements with nonemployees. In contrast, Issue requires that grants of share options and other equity instruments to nonemployees be measured at the earlier of 1 the date at which a commitment for performance by the counterparty to earn the equity instruments is reached or 2 the date at which the counterparty's performance is complete.

IFRS 2 contains more stringent criteria for determining whether an employee share purchase plan is compensatory or not. As a result, some employee share purchase plans for which IFRS 2 requires recognition of compensation cost will not be considered to give rise to compensation cost under the Statement.

IFRS 2 applies the same measurement requirements to employee share options regardless of whether the issuer is a public or a nonpublic entity. The Statement requires that a nonpublic entity account for its options and similar equity instruments based on their fair value unless it is not practicable to estimate the expected volatility of the entity's share price. In that situation, the entity is required to measure its equity share options and similar instruments at a value using the historical volatility of an appropriate industry sector index.

Financial statements exhibit the standard of relevance when they include all material costs incurred by the company - and nobody seriously denies that options are a cost.

Reported costs in financial statements achieve the standard of reliability when they are measured in an unbiased and accurate manner. These two qualities of relevance and reliability often clash in the accounting framework.

For example, real estate is carried at historical cost because historical cost is more reliable but less relevant than market value - that is, we can measure with reliability how much was spent to acquire the property. Opponents of expensing prioritize reliability, insisting that option costs cannot be measured with consistent accuracy.

This means that options cost estimates must be disclosed as a footnote, but they do not have to be recognized as an expense on the income statement, where they would reduce reported profit earnings or net income.

This means that most companies actually report four earnings per share EPS numbers - unless they voluntarily elect to recognize options as hundreds have already done: On the Income Statement: Specifically, what do we do with outstanding but un-exercised options, "old" options granted in previous years that can easily be converted into common shares at any time?

This applies to not only stock options, but also convertible debt and some derivatives. Diluted EPS tries to capture this potential dilution by use of the treasury-stock method illustrated below.

Our hypothetical company has , common shares outstanding, but also has 10, outstanding options that are all in the money. Diluted EPS uses the treasury-stock method to answer the following question: In the example discussed above, the exercise alone would add 10, common shares to the base. However, the simulated exercise would provide the company with extra cash: Because the IRS is going to collect taxes from the options holders who will pay ordinary income tax on the same gain.

Please note the tax benefit refers to non-qualified stock options. Let's see how , common shares become , diluted shares under the treasury-stock method, which, remember, is based on a simulated exercise. We assume the exercise of 10, in-the-money options; this itself adds 10, common shares to the base. To complete the simulation, we assume all of the extra money is used to buy back shares. In summary, the conversion of 10, options creates only 3, net additional shares 10, options converted minus 6, buyback shares.

But what do we do with options granted in the current fiscal year that have zero intrinsic value that is, assuming the exercise price equals the stock price , but are costly nonetheless because they have time value?

The answer is that we use an options-pricing model to estimate a cost to create a non-cash expense that reduces reported net income. Whereas the treasury-stock method increases the denominator of the EPS ratio by adding shares, pro forma expensing reduces the numerator of EPS. You can see how expensing does not double count as some have suggested: While the proposed accounting rule requiring expensing is very detailed, the headline is "fair value on the grant date".

This means that FASB wants to require companies to estimate the option's fair value at the time of grant and record "recognize" that expense on the income statement. Consider the illustration below with the same hypothetical company we looked at above: However, under pro forma, the diluted share base can be different. See our technical note below for further details.

3 April Accounting for share-based payments under IFRS 2: the essential guide 1. Overview and background Share-based payment awards (such as share options and shares) are common. Definition of employee The definition of an employee is based on the common-law definition of the term. Awards to employees are treated differently than awards and IFRS when accounting for stock-based compensation. Refer to ASC and and IFRS 2 for all of the specific requirements applicable to accounting for stock-based. By David Harper Relevance above ReliabilityWe will not revisit the heated debate over whether companies should "expense" employee stock options. However, we .