During the vesting period, we believe that the entity should make an assessment at each reporting date of the
basis on which the award is expected to vest. It should assess whether, as at that date, the award is expected
to vest by virtue of the earnings condition, but not the TSR condition, being satisfied. Assume (for example)
that the entity assesses at the end of year 1 that the award is likely to vest by virtue of the TSR condition, and
at the end of year 2 that it is likely to vest by virtue of the earnings condition, and that the award actually does
not vest, but the employee remains in service. This would give rise to annual expense as follows:
Cumulative
Expense for
Year Calculation of cumulative expense
expense (£)
period (£)
1 210,000 × 1/3
70,000
70,000
2 300,000 × 2/3
200,000
130,000
3 210,000 × 3/3
210,000
10,000
We believe that ongoing reassessment during the vesting period is most consistent with the general approach
of IFRS 2 to awards with a number of possible outcomes (see 10 below).
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Of course, as for other awards, the accounting treatment would also require an assessment of whether or not
the employee was actually going to remain in service.
A further question that arises is how the award should be accounted for if both conditions are satisfied. It
would clearly be inappropriate to recognise an expense of £510,000 (the sum of the separate fair values of
the award) – this would be double-counting, because the employee receives only one package of 100 options.
However, should the total expense be taken as £210,000 or £300,000? In our view, it is appropriate to
recognise a cost of £300,000 since the non-market vesting condition has been satisfied.
Ultimately, this is an issue which only the IASB can solve, since it arises from the
inconsistent treatment by IFRS 2 of awards with market conditions and those with non-
market conditions. As noted at 3.4 above, the IASB agreed in September 2011 to
consider the interaction of multiple vesting conditions as a future agenda item but had
not done so as at the time of writing and does not appear to have this matter on its
agenda following its IFRS 2 research project.22
6.3.6.B
Independent market conditions and non-vesting conditions
Arrangements are also seen where a share-based payment transaction vests on the
satisfaction of either a market condition or a non-vesting condition.
In our view, an entity granting an award on the basis of a service condition (and any other
non-market vesting conditions) plus either a market condition or a non-vesting condition
should measure the fair value of the award at grant date taking into account the probability
that either the market condition or the non-vesting condition will be met. The fact that
there are two alternative conditions on which the award might vest means that, unless the
two conditions are perfectly correlated, the grant date fair value of such an award will be
higher than that of an award where there is only one possible basis on which the award
might vest. Irrespective of whether the market condition and/or the non-vesting
conditions are met, the entity will recognise the grant date fair value provided all other
service and non-market vesting conditions are met (i.e. the expense recognition is
consistent with that of any award with market and/or non-vesting conditions).
6.3.7
Transactions with hybrid or interdependent market conditions and
non-market vesting conditions
Awards may sometimes have a performance condition which depends simultaneously
on a market element and a non-market element, sometimes known as ‘hybrid’
conditions. Examples of such conditions include:
• a particular price-earnings (PE) ratio (calculated by reference to share price, a
market condition, and earnings, a non-market vesting condition); and
• a maximum level of discount of market capitalisation (a market condition) below
net asset value (a non-market vesting condition).
Such awards are rather curious, in the sense that these ratios may remain fairly constant
irrespective of the underlying performance of the entity, so that a performance
condition based on them is arguably of limited motivational value.
In our view, in contrast to our suggested treatment of awards with independent market
and non-market vesting conditions discussed at
6.3.6.A above, awards with
interdependent market and non-market vesting conditions must be accounted for entirely
as awards with market conditions. These awards contain at least one element that meets
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the definition of a market condition but which cannot be completely split from the non-
market element for separate assessment. An indicator such as the PE ratio, or discount of
market capitalisation below net asset value, is a market condition as defined since it is
‘related to the market price ... of the entity’s equity instruments’ (see 6.3.1 above).
6.3.8
Awards based on the market value of a subsidiary or business unit
Awards with a market condition are usually based on the market price or value of the
(typically quoted) equity instruments of the parent entity. However, a group might
consider the parent’s share price to be a somewhat blunt instrument for measuring the
performance of the employees of a particular subsidiary or business unit. Indeed, it is not
difficult to imagine situations in which a particular subsidiary might perform well but the
parent’s share price might be dragged down by other factors, or conversely where the
parent’s share price might rise notwithstanding poor results for that subsidiary.
Accordingly, some entities implement share-based remuneration schemes which aim to
reward employees by reference to the ‘market’ value of the equity of the business unit
for which they work. The detail of such schemes varies, but the general effect is
typically as follows:
• at grant date, the employee is allocated a (real or notional) holding in the equity of
the employing subsidiary, the market value of which is measured at grant date; and
• the employee is granted an award of as many shares of the listed parent as have a
value, at a specified future date (often at, or shortly after, the end of the vesting period
but sometimes at a later date), equal to the increase over the vesting period in the
market value of the employee’s holding in the equity of the employing subsidiary.
Some take the view that such a scheme contains a market condition, since it depends on the
fair value of the subsidiary’s shares, with the result that the grant date fair value per share:
• reflects this market condition (see 6.3.2 above); and
• is fixed, irrespective of how many parent company shares are finally issued, since
the entity has effectively issued a market-based award with multiple outcomes
based on the market value of the equity of a subsidiary (see 6.3.5 above).
In our view, however, the treatment of such schemes under IFRS 2 is not as
straightforward as suggested by this analysis. A fundamental issue is wh
ether any award
dependent on the change in value of the equity of an unquoted entity contains a market
condition at all. IFRS 2 defines a market condition (see 6.3.1 above) as one dependent
on the ‘market price (or value)’ of the entity’s equity. Prima facie, if there is no market,
there is no market price or value.
Notwithstanding the absence of a market, some argue that there are generally accepted
valuation techniques for unquoted equities which can yield a fair value as a surrogate
for market value. The difficulty with that argument, in our view, is that the IASB refers
in the definition of ‘market condition’ to ‘market price (or value)’ and not to ‘fair value’.
The latter term is, of course, used extensively elsewhere in IFRS 2, which suggests that
the IASB does not see the two terms as equivalent. This concern is reinforced by that
fact that, even though it does not apply to the measurement of awards accounted for
under IFRS 2, the ‘valuation hierarchy’ in IFRS 13 gives a quoted market price as the
preferred (but not the only) method of arriving at fair value (see Chapter 14 at 16).
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An entity implementing such an award must therefore make an assessment, in any
particular situation, of whether the basis on which the subsidiary equity is valued truly
yields a ‘market price (or value)’ or merely a fair value according to a valuation model.
Furthermore, in order for there to be a market condition, as defined in IFRS 2, there
needs to be a specified performance target. It is not always clear in such situations that
there is such a target if the various outcomes depend on an exchange of shares
regardless of the level of market price or value achieved by the subsidiary.
If it is considered that there is no market condition within the arrangement and there is
simply an exchange of shares – in effect, using one entity’s shares as the currency for the
other – then the arrangement might nonetheless be viewed as containing a non-vesting
condition (similar to when an arrangement depends on the performance of an index, for
example (see 3.2 above and 6.4 below)). Like a market condition, a non-vesting condition
would be taken into account in determining the fair value of the award and would result
in a fixed grant date fair value irrespective of the number of shares finally delivered.
6.3.8.A
Awards with a condition linked to flotation price
The situations discussed above and at 2.2.4.F above relate to ongoing conditions linked
to the calculated value of an unlisted entity’s equity instruments and therefore differ
from those where the condition is linked to the market price at which a previously
unlisted entity floats. On flotation there is clearly a market and a market price for the
entity’s equity instruments and the achievement of a specific price on flotation would,
in our view, be a market condition when accompanied by a corresponding service
requirement (see 15.4 below).
6.4 Non-vesting
conditions
The accounting treatment for awards with non-vesting conditions has some similarities
to that for awards with market conditions in that:
• the fair value of the award at grant date is reduced to reflect the impact of the
condition; and
• an expense is recognised for the award irrespective of whether the non-vesting
condition is met, provided that all vesting conditions (other than market
conditions) are met. [IFRS 2.21A].
However, in some situations the accounting for non-vesting conditions differs from that
for market conditions as regards the timing of the recognition of expense if the non-
vesting condition is not satisfied (see 6.4.3 below).
6.4.1
Awards with no conditions other than non-vesting conditions
The effect of the treatment required by IFRS 2 is that any award that has only non-
vesting conditions (e.g. an option award to an employee that may be exercised on a
trade sale or IPO of the entity, irrespective of whether the employee is still in
employment at that time) must be expensed in full at grant date. This is discussed further
at 3.2 above and at 15.4 below, and illustrated in Example 30.5 at 6.1 above.
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6.4.2
Awards with non-vesting conditions and variable vesting periods
IFRS 2 does not explicitly address the determination of the vesting period for an
award with a non-vesting condition but a variable vesting period (e.g. an award
which delivers 100 shares when the price of gold reaches a given level, but without
limit as to when that level must be achieved, so long as the employee is still in
employment when the target is reached). However, given the close similarity
between the required treatment for awards with non-vesting conditions and that for
awards with market conditions, we believe that entities should follow the guidance
in the standard for awards with market conditions and variable vesting periods
(see 6.3.4 above).
6.4.3
Failure to meet non-vesting conditions
As noted above, the accounting for non-vesting conditions sometimes differs from that
for market conditions as regards the timing of the recognition of expense if the non-
vesting condition is not satisfied. The treatment depends on the nature of the non-
vesting condition, as follows:
• if a non-vesting condition within the control of the counterparty (e.g. making
monthly savings in an SAYE scheme or holding a specified number of shares in a
matching share arrangement) is not satisfied during the vesting period, the failure
to satisfy the condition is treated as a cancellation (see 7.4 below), with immediate
recognition of any expense for the award not previously recognised;
[IFRS 2.28A, IG24, IG Example 9A]
• if a non-vesting condition within the control of the entity (e.g. continuing to
operate the scheme) is not satisfied during the vesting period, the failure to satisfy
the condition is treated as a cancellation (see 7.4 below), with immediate
recognition of any expense for the award not previously recognised; [IFRS 2.28A, IG24]
but
• if a non-vesting condition within the control of neither the counterparty nor the
entity (e.g. a financial market index reaching a minimum level) is not satisfied, there
is no change to the accounting and the expense continues to be recognised over
the vesting period, unless the award is otherwise treated as forfeited by IFRS 2.
[IFRS 2.BC237A, IG24]. In our view, the reference to the vesting period would include
any deemed vesting period calculated as described in 6.4.2 above.
If an award is forfeited due to a failure to satisfy a non-vesting condition after the end
of the vesting period (e.g. a requirement for an employee not to work for a competitor
for a two year period after vesting), no adjustment is made to the expense previously
recognised, consistent with the general provisions of IFRS 2 for accounting for awards
in the post-vesting period (see 6.1.3 above). This would be the case even if shares
previously issued to the employee were required to be returned to the entity on
forfeiture (see 3.1.1 and 3.2.3 above for further discussion of clawback arrangements and<
br />
non-compete arrangements respectively).
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7
EQUITY-SETTLED TRANSACTIONS – MODIFICATION,
CANCELLATION AND SETTLEMENT
7.1 Background
It is quite common for equity instruments to be modified or cancelled before or after
vesting. Typically this is done where the conditions for an award have become so onerous
as to be virtually unachievable, or (in the case of an option) where the share price has
fallen so far below the exercise price of an option that it is unlikely that the option will
ever be ‘in the money’ to the holder during its life. In such cases, an entity may take the
view that the equity awards are so unattainable as to have little or no motivational effect,
and accordingly replace them with less onerous alternatives. Conversely, and more rarely,
an entity may make the terms of a share award more onerous (possibly because of
shareholder concern that targets are insufficiently demanding). In addition an entity may
‘settle’ an award, i.e. cancel it in return for cash or other consideration.
A target entity might modify existing share-based payment arrangements in the period
leading up to a business combination. In this situation, it needs to be determined
whether the guidance in IFRS 2 is applicable or whether the modification is being made
for the benefit of the acquirer or the combined entity, in which case the guidance in
IFRS 3 is likely to apply (see 11.2 below).
IFRS 2 contains detailed provisions for modification, cancellation and settlement.
Whilst these provisions (like the summary of them below) are framed in terms of share-
based payment transactions with employees, they apply to transactions with parties
other than employees that are measured by reference to the fair value of the equity
instruments granted (see 5.4 above). In that case, however, all references to ‘grant date’
should be taken as references to the date on which the third party supplied goods or
rendered service. [IFRS 2.26].
In the discussion below, any reference to a ‘cancellation’ is to any cancellation, whether
instigated by the entity or the counterparty. As well as more obvious situations where
an award is cancelled by either the entity or the counterparty, cancellations include:
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 516