International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards
Page 527
8.7.3
Share appreciation rights (SARs)
A share appreciation right (SAR) is a grant whereby the employee will become entitled
either to shares or, more commonly, to a future cash payment based on the increase in
the entity’s share price from a specified level over a period of time (see further
discussion at 9 below on cash-settled awards). This essentially has the same payoff as a
call option, except the award is generally cash- rather than equity-settled.
8.7.4 Performance
rights
A performance right is the right to acquire further shares after vesting, upon certain
criteria being met. These criteria may include certain performance conditions which
can usually be modelled with either a Black-Scholes-Merton formula or a binomial
lattice model or a Monte Carlo Simulation depending on the nature of the conditions
attached to the rights. Such awards may be structured as matching share awards, as
discussed in more detail at 15.1 below.
8.8
Awards whose fair value cannot be measured reliably
IFRS 2 acknowledges that there may be rare cases where it is not possible to determine
the fair value of equity instruments granted. In such cases, the entity is required to adopt
a method of accounting based on the intrinsic value of the award (i.e. the price of the
underlying share less the exercise price, if any, for the award). This is slightly puzzling
in the sense that, for unlisted entities, a significant obstacle to determining a reliable fair
value for equity instruments is the absence of a market share price, which is also a key
input in determining intrinsic value. In fact, the intrinsic value model is arguably more
onerous than the fair value model since, as discussed further in 8.8.1 and 8.8.2 below, it
requires intrinsic value to be determined not just once, but at initial measurement date
and each subsequent reporting date until exercise.
8.8.1
Intrinsic value method – the basic accounting treatment
Under the intrinsic value method:
(a) the entity measures the intrinsic value of the award at each reporting date between
grant date and settlement (whether through exercise, forfeiture or lapse);
(b) at each reporting date during the vesting period the cumulative expense should be
determined as the intrinsic value of the award at that date multiplied by the expired
portion of the vesting period, with all changes in the cumulative expense
recognised in profit or loss; and
(c) once options have vested, all changes in their intrinsic value until settlement should
be recognised in profit or loss. [IFRS 2.24(a)].
The cumulative expense during the vesting period, like that for awards measured at fair
value, should always be based on the best estimate of the number of awards that will
actually vest (see 6 above). However, the distinction between market vesting conditions,
non-market vesting conditions and non-vesting conditions that would apply to equity-
settled awards measured at fair value (see 6.1 to 6.4 above) does not apply in the case of
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awards measured at intrinsic value. [IFRS 2.24(b)]. In other words, where an award
measured at intrinsic value is subject to a market condition or non-vesting condition
that is not met, there is ultimately no accounting expense for that award. This is
consistent with a model requiring constant remeasurement.
The cost of awards measured at intrinsic value is ultimately revised to reflect the
number of awards that are actually exercised. However, during the vesting period the
cost should be based on the number of awards estimated to vest and thereafter on the
number of awards that have vested. In other words, any post-vesting forfeiture or lapse
should not be anticipated, but should be accounted for as it occurs. [IFRS 2.24(b)].
Example 30.34 is based on IG Example 10 in the implementation guidance to IFRS 2
and illustrates the intrinsic value method. [IFRS 2 IG Example 10].
Example 30.34: Intrinsic value method
At the beginning of year 1, an entity grants 1,000 share options to 50 employees.
The share options will vest at the end of year 3, provided the employees remain in service until then. The
options can be exercised at the end of year 4, and then at the end of each subsequent year up to and including
year 10. The exercise price, and the entity’s grant date share price, is €60. At the date of grant, the entity
concludes that it cannot estimate reliably the fair value of the share options granted.
At the end of year 1, the entity estimates that 10 of the employees will have left employment by the end of
the vesting period and so 80% of the share options will vest. At the end of year 2, the entity revises the number
of leavers to 7 and its estimate of the number of share options that it expects will vest to 86%.
During the vesting period, a total of 7 employees leave, so that 43,000 share options vest.
The intrinsic value of the options, and the number of share options exercised during years 4-10, are as follows:
Share price at
Intrinsic
Number
year end
value
exercised at
Year
€
€
year end
1 63
3
2 65
5
3 75
15
4 88
28
6,000
5 100
40
8,000
6 90
30
5,000
7 96
36
9,000
8 105
45
8,000
9 108
48
5,000
10 115
55
2,000
The expense recognised under IFRS 2 will be as follows. In the period up to vesting the ‘cumulative expense’
methodology used in the examples at 6.1 to 6.4 above can be adopted to derive the expense for each period:
Cumulative
Expense for
Year Calculation of cumulative expense
expense (€)
period (€)
1 50,000 options × €3 × 80% × 1/3
40,000
40,000
2 50,000 options × €5 × 86% × 2/3
143,333
103,333
3 43,000 options × €15
645,000
501,677
In years 4 to 10 it is more straightforward to calculate the expense directly. Since all options exercised during
each year are exercised at the end of that year, the annual expense can be calculated as the change in intrinsic
value during each year of the options outstanding at the start of the year.
Share-based
payment
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Expense for
Year
period (€)
4 43,000 options × €(28 – 15)
559,000
5 43,000 – 6,000 = 37,000 options × €(40 – 28)
444,000
6 37,000 – 8,000 = 29,000 options × €(30 – 40)
(290,000)
7 29,000 – 5,000 = 24,000 options × €(36 – 30)
144,000
8 24,000 – 9,000 = 15,000 options × €(45 – 36)
135,000
9 15,000 – 8,000 = 7,000 options × €(48 – 45)
21,000
14,000
If, more realistically, the options had been exercisable, and were exercised, at other dates,
it would have been necessary to record as an expense for those options the movement in
intrinsic value from the start of the year until exercise date. For example, if the 6,000
options in year 4 had been exercised during the year when the intrinsic value was €20, the
expense for that period would have been €511,000 comprising €481,000 change in value
for the options outstanding at the end of year [37,000 options × €(28 – 15)] and €30,000
change in value of options exercised during the period [6,000 options × €(20 – 15)].
Since the intrinsic value method will initially be applied at the date at which the entity
obtains the goods or the counterparty renders service and continues to be applied at the
end of each reporting period until the date of final settlement, in our view the entity
should continue to apply this method of measurement throughout the life of such an
award even if it becomes possible to measure the fair value of the award at some stage
prior to its settlement.
8.8.2
Modification, cancellation and settlement
The methodology of the intrinsic value method has the effect that modification or
cancellation is dealt with automatically, and the rules for modification and cancellation
of awards measured at fair value (see 7 above) therefore do not apply. [IFRS 2.25].
Where an award accounted for at intrinsic value is settled in cash, the following
provisions apply, which are broadly similar to the rules for settlement of awards
accounted for at fair value.
If settlement occurs before vesting, the entity must treat this as an acceleration of
vesting and ‘recognise immediately the amount that would otherwise have been
recognised for services received over the remainder of the vesting period’. [IFRS 2.25(a)].
The wording here is the same as that applicable to settlement of awards accounted for
at fair value, which we discuss in more detail at 7.4.3 above.
Any payment made on settlement must be deducted from equity, except to the extent
that it is greater than the intrinsic value of the award at settlement date. Any such excess
is accounted for as an expense. [IFRS 2.25(b)].
8.9
Awards with reload features
Some share options contain a reload feature (see 5.5.1 above). Reloads commonly
provide that, where an exercise price is satisfied in shares of the issuing entity rather
than cash, there is a new grant of at-the-money options over as many shares as are equal
to the exercise price of the exercised option. For example, if there were 100 options
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with an exercise price of $10, and the new share price were $15, 67 options (€1,000 ÷
€15) would be re-issued.
Even though the reload feature (i.e. the possibility that additional options would be
issued in the future) is a feature of the original option, and can be readily incorporated
into the valuation of the original option using a lattice model, the IASB concluded that
the fair value of a reload feature should not be incorporated into the estimate of the fair
value of the award at grant date. As a result, subsequent grants of reload awards under
the reload feature would be accounted for as new awards and measured on their
respective grant dates. [IFRS 2.BC188-192].
On the assumption that the exercise price of an award is at least the share price at
grant date, the grant-date fair value of the reload award will generally be greater
than the incremental value of the reload feature as at the date the original award
was granted. This is because the reload award will only be granted if the original
option is in-the-money and is exercised. As a result, the award would have increased
in the period between the original grant date and the reload grant date, and the
higher share price would be used to value the reload grant. However, from the
perspective of the aggregate compensation cost, this result is mitigated by the fact
that, as the value of the underlying share increases, fewer shares must be tendered
to satisfy the exercise price requirement of the exercised option and, therefore,
fewer reload options will be granted (as above when only 67 options are re-issued
for the 100 originally issued).
If the reload feature were incorporated into the valuation of the original grant, then not
only would a lower price be used, but the valuation would consider the possibility that
the original option would never be exercised and, therefore, that the reload options
would not be granted. Under the approach in IFRS 2, if the original award expires
unexercised, no compensation cost results from the reload feature, so that the
compensation cost is lower than would be the case if the value of the reload feature
were incorporated into the measurement of the original award. Effectively, the
approach in IFRS 2 incorporates subsequent share price changes into the valuation of a
reload award.
8.10 Awards of equity instruments to a fixed monetary value
Entities may make an award of shares to a fixed monetary value (see 5.3.5 above). This
is commonly found as part of a matching share award where an employee may be
offered the choice of receiving cash or shares of an equivalent value, or a multiple of
that value (see 15.1 below).
IFRS 2 does not address directly the valuation of such awards. Intuitively, it might seem
obvious that an award which promises (subject to vesting conditions) shares to the value
of €10,000 must have a grant date fair value of €10,000, adjusted for the time value of
money, together with market conditions and non-vesting conditions. However, matters
are not so clear-cut, as Example 30.35 illustrates:
Share-based
payment
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Example 30.35: Award of shares to a fixed monetary value
At the beginning of year 1 the reporting entity grants:
• to Employee A an award of 1,000 shares subject to remaining in employment for three years; and
• to Employee B €10,000 subject to remaining in employment for three years, to be paid in as many shares
as are (at the end of year 3) worth €10,000.
Both awards vest, and the share price at the end of year 3 is €10, so that both employees receive 1,000 shares.
The IFRS 2 charge for A’s award is clearly 1000 × the fair value as at the beginning of year 1 of a share deliverable
in three years’ time. What is the charge for B’s award? A number of potential alternatives exist including:
• the number of shares actually delivered multiplied by the fair value at the grant date (start of year 1);
• an amount based on a grant date estimate of the number of shares (which is not subsequently revisited
due to the existence of a market condition);
• €10,000, adjusted for the time value of money.
The Basis for Conclusions to IFRS 2 creates some confusion over this point.
Paragraphs BC106 to BC118 discuss in general terms why IFRS 2 adopts a definition of
equity instrument different from that in IAS 32. Paragraphs BC107 to BC109 particularly
note that the IASB did not believe it appropriate that a fixed-cost award and a variable-
cos
t award ultimately delivered in shares should be classified, and measured, (as would
be the case under IAS 32) as, respectively, equity and a liability. [IFRS 2.BC106-118].
Whilst the primary focus of the discussion in the Basis for Conclusions is whether
variable equity-settled awards should be liabilities (as they would be under IAS 32) or
equity (as they are under IFRS 2), the reference to measurement as well as
classification of awards can be read as meaning that the IASB believed that two awards
that ultimately deliver 1,000 shares (as in Example 30.35 above) should have the same
grant date fair value.
Some argue that an award of shares to a given monetary amount contains a market
condition, since the number of shares ultimately delivered (and therefore vesting)
depends on the market price of the shares on the date of delivery. This allows the award
to be valued at a fixed amount at grant date. We acknowledge that a literal reading of
the definition of ‘market condition’ in IFRS 2 supports this view, but question whether
this can really have been intended. In our view, the essential feature of a share-based
payment transaction subject to a market condition must be that the employee’s ultimate
entitlement to the award depends on the share price rather than the share price simply
being used to determine the number of shares.
In our view, the principal question is whether the measurement under IFRS 2 should be
based on the overall award or on each share or share equivalent making up the award.
In the absence of clear guidance in IFRS 2 as to the appropriate unit of account, entities
may take a number of views on how to value awards of shares to a given value, but
should adopt a consistent approach for all such awards (and to other areas of share-
based payment accounting where the unit of account issue is significant – see, for
example, 5.3.6, 7.3.4 and 7.5 above).
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9 CASH-SETTLED
TRANSACTIONS
Throughout the discussion in this section, ‘cash’ should be read as including ‘other
assets’ in accordance with the definition of a cash-settled share-based payment
transaction (see 2.2.1 above).
9.1
Scope of requirements
Cash-settled share-based payment transactions include transactions such as: