value of £5, conditional upon continuous service and performance targets over a 3-year period from grant
date. The number of shares awarded varies according to the extent to which targets (all non-market vesting
conditions) have been met, and could result in each employee still in service at the end of year 3 receiving a
minimum of 600, and a maximum of 1,000 shares.
Half way through year 2 (i.e. 18 months after grant date), A is acquired by B, following which A cancels all
of its share awards. At the time of the cancellation, 130 of the original 150 employees were still in
employment. At that time, it was A’s best estimate that, had the award run to its full term, 120 employees
would have received 900 shares each. Accordingly the cumulative expense recognised by A for the award as
at the date of takeover would, under the normal estimation processes of IFRS 2 discussed at 6.1 to 6.4 above,
be £270,000 (900 shares × 120 employees × £5 × 18/36).
How should A account for the cancellation of this award?
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The opening phrase of paragraph 28(a) – ‘the entity shall account for the cancellation ... as an acceleration
of vesting’ – suggests that A should recognise a cost for all 130 employees in service at the date of
cancellation. However, the following phrase – ‘[the entity] shall therefore recognise immediately the
amount that would otherwise have been recognised for services received over the remainder of the vesting
period’ – suggests that the charge should be based on only 120 employees, the best estimate, as at the date
of cancellation of the number of employees in whom shares will finally vest. In our view, either reading
of paragraph 28(a) is possible.
There is then the issue of the number of shares per employee that should be taken into account in the
cancellation charge. Should this be 1,000 shares per employee (the maximum number that could vest) or
900 shares per employee (the number expected by the entity at the date of cancellation actually to vest)?
In our view, it is unclear from the standard whether the intention was that the cancellation charge should be
based on the number of shares considered likely, as at the date of cancellation, to vest for each employee
(900 shares in this example) or whether it should be based on the maximum number of shares (1,000 shares
in this example). Given the lack of clarity, in our view an entity may make an accounting policy choice.
In extreme cases, the entity’s best estimate, as at the date of cancellation, might be that
no awards are likely to vest. In this situation, no cancellation expense would be
recognised. However, there would need to be evidence that this was not just a rather
convenient assessment made as at the date of cancellation. Typically, the previous
accounting periods would also have reflected a cumulative IFRS 2 expense of zero on
the assumption that the awards would never vest.
An effect of these requirements is that IFRS 2 creates an accounting arbitrage between
an award that is ‘out of the money’ but not cancelled (the cost of which continues to be
spread over the remaining period to vesting) and one which is formally cancelled (the
cost of which is recognised immediately). Entities might well prefer to opt for
cancellation so as to create a ‘one-off’ charge to earnings rather than continue to show,
particularly during difficult trading periods, significant periodic costs for options that no
longer have any real value. However, such early cancellation of an award precludes any
chance of the cost of the award being reversed through forfeiture during, or at the end
of, the vesting period if the original vesting conditions are not met.
7.4.4 Replacement
awards
The required accounting treatment of replacement awards, whilst generally clear,
nevertheless raises some issues of interpretation. Most of this sub-section addresses the
replacement of unvested awards but the treatment of vested awards is addressed
at 7.4.4.C below.
As set out at 7.4 above, a new award that meets the criteria in paragraph 28(c) of IFRS 2
to be treated as a replacement of a cancelled or settled award is accounted for as a
modification of the original award and any incremental value arising from the granting
of the replacement award is recognised over the vesting period of that replacement
award. Where the criteria are not met, the new equity instruments are accounted for as
a new grant (in addition to accounting for the cancellation or settlement of the original
arrangement). The requirements are discussed in more detail below.
7.4.4.A
Designation of award as replacement award
Whether or not an award is a ‘replacement’ award (and therefore recognised at only its
incremental, rather than its full, fair value) is determined by whether or not the entity
designates it as such on the date that it is granted. In other words, the accounting
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treatment effectively hinges on declared management intent, notwithstanding the
IASB’s systematic exclusion of management intent from many other areas of financial
reporting. The Basis for Conclusions does not really explain the reason for this
approach, which is also hard to reconcile with the fact that the value of an award is
unaffected by whether, or when, the entity declares it to be a ‘replacement’ award for
the purposes of IFRS 2. Presumably, the underlying reason is to prevent a retrospective,
and possibly opportunistic, assertion that an award that has been in issue for some time
is a replacement for an earlier award.
Entities need to ensure that designation occurs on grant date as defined by IFRS 2
(see 5.3 above). For example, if an entity cancels an award on 15 March and notifies an
employee in writing on the same day of its intention to ask the remuneration committee
to grant replacement options at its meeting two months later, on 15 May, such
notification (although formal and in writing) may not strictly meet IFRS 2’s requirement
for designation on grant date (i.e. 15 May). However, in our view, what is important is
that the entity establishes a clear link between the cancellation of the old award and the
granting of a replacement award even if there is later formal approval of the replacement
award following the communication of its terms to the counterparty at the same time as
the cancellation of the old award.
As drafted, IFRS 2 gives entities an apparently free choice to designate any newly
granted awards as replacement awards. In our view, however, such designation cannot
credibly be made unless there is evidence of some connection between the cancelled
and replacement awards. This might be that the cancelled and replacement awards
involve the same counterparties, or that the cancellation and replacement are part of
the same arrangement.
7.4.4.B
Incremental fair value of replacement award
Where an award is designated as a replacement award, any incremental fair value must
be recognised over the vesting period of the replacement award. The incremental fair
value is the difference between the fair value of the replacement award and the ‘net fair
value’ of the cancelled or settled award, both measured at the date on which the
re
placement award is granted. The net fair value of the cancelled or settled award is the
fair value of the award, immediately before cancellation, less any compensation
payment that is accounted for as a deduction from equity. [IFRS 2.28(c)]. Thus the ‘net fair
value’ of the original award can never be less than zero (since any compensation
payment in excess of the fair value of the cancelled award would be accounted for in
profit or loss, not in equity – see Example 30.27 at 7.4.3 above).
There is some confusion within IFRS 2 as to whether a different accounting treatment
is intended to result from, on the one hand, modifying an award and, on the other hand,
cancelling it and replacing it with a new award on the same terms as the modified award.
This is explored in the discussion of Example 30.29 below, which is based on the same
fact pattern as Example 30.19 at 7.3.1.A above.
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Example 30.29: Replacement awards – is there an accounting arbitrage between
accounting for a modification and accounting for cancellation
and a new grant?
At the beginning of year 1, an entity grants 100 share options to each of its 500 employees. Each grant is
conditional upon the employee remaining in service over the next three years. The entity estimates that the
fair value of each option is €15.
By the end of year 1, the entity’s share price has dropped. The entity cancels the existing options and issues
options which it identifies as replacement options, which also vest at the end of year 3. The entity estimates
that, at the date of cancellation, the fair value of each of the original share options granted is €5 and that the
fair value of each replacement share option is €8.
40 employees leave during year 1. The entity estimates that a further 70 employees will leave during years 2
and 3, so that there will be 390 employees at the end of year 3 (500 – 40 – 70).
During year 2, a further 35 employees leave, and the entity estimates that a further 30 employees will leave
during year 3, so that there will be 395 employees at the end of year 3 (500 – 40 – 35 – 30).
During year 3, 28 employees leave, and hence a total of 103 employees ceased employment during the
original three year vesting period, so that, for the remaining 397 employees, the replacement share options
vest at the end of year 3.
The intention of the IASB appears to have been that the arrangement should be accounted for in exactly the
same way as the modification in Example 30.19 above, since the Basis for Conclusions to IFRS 2 notes:
‘...the Board saw no difference between a repricing of share options and a cancellation of share options
followed by the granting of replacement share options at a lower exercise price, and therefore concluded
that the accounting treatment should be the same.’ [IFRS 2.BC233].
However, it is not clear that this intention is actually reflected in the drafting of IFRS 2, paragraph 28 of
which reads as follows:
‘If a grant of equity instruments is cancelled or settled during the vesting period (other than a grant
cancelled by forfeiture when the vesting conditions are not satisfied):
(a) the entity shall account for the cancellation or settlement as an acceleration of vesting, and shall
therefore recognise immediately the amount that otherwise would have been recognised for services
received over the remainder of the vesting period.
(b) any payment made to the employee on the cancellation or settlement of the grant shall be accounted
for as the repurchase of an equity interest, i.e. as a deduction from equity, except to the extent that the
payment exceeds the fair value of the equity instruments granted, measured at the repurchase date. Any
such excess shall be recognised as an expense. [...]
(c) if new equity instruments are granted to the employee and, on the date when those new equity
instruments are granted, the entity identifies the new equity instruments granted as replacement equity
instruments for the cancelled equity instruments, the entity shall account for the granting of replacement
equity instruments in the same way as a modification of the original grant of equity instruments, in
accordance with paragraph 27 and the guidance in Appendix B. [...]’. [IFRS 2.28].
As a matter of natural construction, paragraph (a) requires the cancellation of the existing award to be treated
as an acceleration of vesting – explicitly and without qualification. In particular there is no rider to the effect
that the requirement of paragraph (a) is to be read as ‘subject to paragraph (c) below’.
Paragraph (c) requires any ‘new equity instruments’ granted to be accounted for in the same way as a
modification of the original grant of equity instruments. It does not require this treatment for the cancellation
of the original instruments, because this has already been addressed in paragraph (a).
Moreover, in order to construe paragraphs (a) and (c) in a manner consistent with the Basis for Conclusions
to the standard, it would be necessary to read paragraph (c) as effectively superseding paragraph (a). However,
for this to be a valid reading, it would also be necessary to read paragraph (b) as also superseding paragraph
(a), and this would produce a manifestly incorrect result, namely that, if an award is cancelled and settled,
there is no need ever to expense any part of the cancelled award not yet expensed at the date of cancellation.
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The application of, firstly, the main text of IFRS 2 and, secondly, the Basis for Conclusions to IFRS 2 to the
entity in Example 30.29 is set out below.
The main text in IFRS 2 appears to require the entity to recognise:
• The entire cost of the original options at the end of year 1 (since cancellation has the effect that they are
treated as vesting at that date), based on the 390 employees expected at that date to be in employment at
the end of the vesting period. This is not the only possible interpretation of the requirement of
paragraph 28(a) – see below and the broader discussion in Example 30.28 at 7.4.3 above.
• For the options replacing the 390 cancelled awards, the incremental fair value of the replacement options
at repricing date (€3 per option, being the €8 fair value of each replacement option less the €5 fair value
of each cancelled option) over a two year vesting period beginning at the date of cancellation (end of
year 1), based on the (at first estimated and then actual) number of employees at the end of year 3 (i.e.
the final number could be less than the estimate of 390).
• For any additional replacement options (i.e. replacement options awarded in excess of the 390 × 100
options that were expected to vest at cancellation date), the full incremental fair value at repricing date
(being the €8 fair value of each replacement option) over a two year vesting period beginning at the
repricing date (end of year 1). The expense is based on the (at first estimated and then actual) number of
employees in excess of 390 at the end of year 3.
This would be calculated as follows:
Cumulative
Expense for
Year Calculation of cumulative expense
expense (€)
period (€)
Original award
Replacement award
1 390 employees × 100
options × €15
–
585,000
585,000
2 390 employees × 100
390 employees × 100
options × €15
options × €3 × 1/2
5 employees × 100
options × €8 × 1/2
645,500
60,500
3 390 employees × 100
390 employees × 100
options × €15
options × €3
7 employees × 100
options × €8
707,600
62,100
By contrast, the accounting treatment implied by the Basis for Conclusions is as follows (see Example 30.19 above):
Cumulative
Expense for
Year Calculation of cumulative expense
expense (€)
period (€)
Original award (a)
Modified award (b)
(a+b)
1 390 employees × 100
options × €15 × 1/3
–
195,000
195,000
2 395 employees × 100
395 employees × 100
options × €15 × 2/3
options × €3 × 1/2
454,250
259,250
3 397 employees × 100
397 employees × 100
options × €15
options × €3
714,600
260,350
It will be seen that both the periodic allocation of expense and the total expense differ
under each interpretation. This is because, under the first interpretation, the cost of the
original award is accelerated at the end of year 1 for all 390 employees expected at that
date to be in employment at the end of the vesting period, whereas under the second
interpretation a cost is recognised for the 397 employees whose awards finally vest. The
difference between the two total charges of €7,000 (€714,600 – €707,600) represents
397 – 390 = 7 employees @ €1,000 [100 options × €10[€15 + €3 – €8]] each = €7,000.
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We believe that either interpretation is valid, and an entity should adopt one or other
consistently as a matter of accounting policy.
In Example 30.29 above, we base the cancellation calculations on 390 employees (the
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 520