• share appreciation rights (SARs), where employees are entitled to a cash payment
equivalent to the gain that would have arisen from a holding of a particular number
of shares from the date of grant to the date of exercise; or
• phantom options, where employees are entitled to a cash payment equivalent to
the gain that would have been made by exercising options at a notional price over
a notional number of shares and then selling the shares at the date of exercise.
[IFRS 2.31].
However, IFRS 2 looks beyond the simple issue of whether an award entitles an
employee to receive instruments that are in form shares or options to the terms of those
instruments. For example, an award of shares or options over shares whose terms
provide for their redemption either mandatorily according to their terms (e.g. on
cessation of employment) or at the employee’s option would be treated as a cash-
settled, not an equity-settled, award under IFRS 2. [IFRS 2.31]. This is consistent with the
fact that IAS 32 would regard a share with these terms as a financial liability rather than
an equity instrument of the issuer (see Chapter 43 at 4).
In some cases the boundary between equity-settled and cash-settled schemes may
appear somewhat blurred, so that further analysis may be required to determine
whether a particular arrangement is equity-settled or cash-settled. Some examples of
such arrangements are discussed at 9.2 below.
9.2
What constitutes a cash-settled award?
There are a number of possible circumstances in which, on, or shortly after, settlement
of an equity-settled award either:
• the entity incurs a cash outflow equivalent to that which would arise on cash-
settlement (e.g. because it purchases shares in the market at fair value to deliver to
counterparties); or
• the counterparty receives a cash inflow equivalent to that which would arise on
cash-settlement (e.g. because the shares are sold in the market for cash on behalf
of the counterparty).
Such situations raise the question of whether such schemes are in fact truly equity-
settled or cash-settled.
Examples of relatively common mechanisms for delivering the cash-equivalent of an
equity-settled award to employees are discussed below. It emerges from the analysis
below that, in reality, IFRS 2 is driven by questions of form rather than substance. To
put it rather crudely, what matters is often not so much whether the entity has made a
cash payment for the fair value of the award, but rather the name of the payee.
Share-based
payment
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The significance of this is that the analysis affects the profit or loss charge for the award,
as illustrated by Example 30.36 below.
Example 30.36: Equity-settled award satisfied with market purchase of treasury
shares
An entity awards an employee a free share with a fair value at grant date of £5 which has a fair value of £8 at
vesting. At vesting the entity purchases a share in the market for £8 for delivery to the employee. If the scheme
were treated as cash-settled, there would be a charge to profit or loss of £8 (the fair value at vesting date –
see 9.3 below). If it were treated as equity-settled (as required in this case by IFRS 2), profit or loss would
show a charge of only £5 (the fair value at grant date), with a further net charge of £3 in equity, comprising
the £8 paid for the share accounted for as a treasury share (see Chapter 43 at 9) less the £5 credit to equity
(being the credit entry corresponding to the £5 charge to profit or loss – see 4.2 above).
The analyses below all rely on a precise construction of the definition of a cash-settled
share-based payment transaction, i.e. one ‘in which the entity acquires goods or services
by incurring a liability to transfer cash or other assets to the supplier of those goods or
services for amounts that are based on the price (or value) of equity instruments
(including shares or share options) of the entity or another group entity’ (emphasis
added). [IFRS 2 Appendix A]. Thus, if the entity is not actually required – legally or
constructively – to pay cash to the counterparty, there is no cash-settled transaction
under IFRS 2, even though the arrangement may give rise to an external cash flow and,
possibly, a liability under another standard.
9.2.1
Formal and informal arrangements for the entity to purchase illiquid
shares or otherwise settle in cash (awards to be treated as cash-
settled, including unlisted company schemes)
Some share-based payment awards, particularly when made by unlisted entities, might
appear to be equity-settled in form but, in our view, will need to be accounted for as cash-
settled awards under IFRS 2. This reflects either specific arrangements put in place by the
entity (or a shareholder) for the employees to sell their shares or, more generally, the
illiquid market in the shares which, in the absence of compelling evidence to the contrary,
is likely to result in a cash payment by the entity to the counterparty at some stage.
This is similar to the assessment for awards where the agreement states that entities
have a choice of settlement in equity or cash (see 10.2.1.A below).
9.2.2
Market purchases of own equity used to satisfy awards
It is common for an entity to choose to settle equity-settled transactions using shares
previously purchased in the market rather than by issuing new shares. This does not
mean that the transaction is cash-settled, since there is no obligation to deliver cash to
the counterparty. [IFRS 2.B48-49].
The purchase of own shares is accounted for in accordance with the provisions of IAS 32
relating to treasury shares and other transactions over own equity (see Chapter 43 at 9).
A question sometimes asked is whether the entity should recognise some form of
liability to repurchase its own equity in situations where the entity has a stated policy
of settling equity-settled transactions using previously purchased treasury shares. In our
view, the normal provisions of IAS 32 apply. For example, a public commitment to settle
equity-settled transactions by purchasing treasury shares is no different in substance to
2648 Chapter 30
a commitment to a share buyback programme. There would be no question under
IAS 32 of recognising a liability to repurchase own equity on the basis merely of a
declared intention. It is only when the entity enters into a forward contract or a call
option with a third party that some accounting recognition of a future share purchase
may be required.
9.2.3
Market purchases of own equity following equity-settlement of
award
An entity might sometimes make a market purchase of its own shares shortly after
issuing a similar number of shares in settlement of an equity-settled transaction. This
raises the question of whether such a scheme would be considered as in substance
cash-settled.
In our view, further enquiry into the detailed circumstances of the market purchase is
required in order to determine the appropriate analysis under IFRS 2.
Broadly speaking, so long as there is no obligation (explicit or implicit) for the entity to
settle in cash with the counterparty, such market purchase arrangements will not
require a scheme to be treated as cash-settled under IFRS 2. This will be the case even
where the entity, as a means of managing the dilutive impact on earnings per share of
equity-settlement, routinely buys back shares broadly equivalent to the number issued
in settlement.
However, in our view, there might be situations in which post-settlement market share
purchases are indicative of an obligation to the counterparty, such that treatment as a
cash-settled scheme would be appropriate.
For example, the shares might be quoted in a market which is not very deep, or in which
the entity itself is a major participant. If the entity were to create an expectation by
employees that any shares awarded can always be liquidated immediately, because the
entity will ensure that there is sufficient depth in the market to do so, it could well be
appropriate to account for such a scheme as cash-settled. The treatment of schemes in
which the entity has a choice of settlement, but has created an expectation of cash-
settlement, provides a relevant analogy (see 10.2.1 below).
A more extreme example of such a situation would be where the entity has arranged for
the shares delivered to the counterparty to be sold on the counterparty’s behalf by a
broker (see 9.2.4 below), but has at the same time entered into a contract to purchase
those shares from the broker. In that situation, in our view, the substance is that:
• the entity has created an expectation by the counterparty of a right to receive cash;
and
• the broker is no more than an agent paying that cash to the counterparty on behalf
of the entity.
Accordingly, it would be appropriate to account for such an arrangement as a cash-
settled award.
In a situation where the entity had pre-arranged to purchase some, but not all, the shares
from the broker, in our view it would generally be appropriate to treat the award as
cash-settled only to the extent of the shares subject to the purchase agreement.
Share-based
payment
2649
9.2.4
Arrangements to sell employees’ shares including ‘broker settlement’
Many recipients of share awards, particularly employees in lower and middle ranking
positions within an entity, do not wish to become long-term investors in the entity and
prefer instead to realise any equity-settled awards in cash soon after receipt. In order to
facilitate this, the entity may either sell the shares in the market on the employees’
behalf or, more likely, arrange for a third party broker to do so.
Such an arrangement (sometimes referred to as ‘broker settlement’) does not of itself
create a cash-settled award, provided that the entity has not created any obligation to
provide cash to the employees. If, however, the entity has either created an expectation
among employees that it will step in to make good any lack of depth in the market, or
has indeed itself contracted to repurchase the shares in question, that may well mean
that analysis as a cash-settled scheme is more appropriate (see also 9.2.3 above).
Broker settlement arrangements may raise a general concern that an entity may be
masking what are really issues of shares to raise cash to pay its employees as sales of
shares on behalf of employees. If an entity were simply to issue shares (or reissue
treasury shares) for cash, and then use that cash to pay an employee’s salary, the
normal accounting treatment for such a transaction would be to credit equity with the
proceeds of issue or reissue of shares, and to charge the payment to the employee to
profit or loss.
By contrast, a sale of shares on behalf of an employee is undertaken by the entity as
agent and does not give rise to an increase in equity and an expense, although an
expense will be recognised for the award of shares under IFRS 2. However, the entity
may enter into much the same transaction with a broker whether it is selling shares on
its own behalf or on behalf of its employees. The challenge is therefore for the entity to
be able to demonstrate the true economic nature of the transaction.
For this reason, some take the view that a sale of shares can be regarded as part of a
broker settlement arrangement only if the shares are first legally registered in the name
of the employee. Whilst we understand the concerns that lie behind this view, we
nevertheless question whether legal registration is necessary to demonstrate the
substance of a broker settlement arrangement. For example, suppose that 100 shares
vest in each of 10 employees who all express a wish that the entity sell the shares on
their behalf, and the entity then sells 1,000 treasury shares on behalf of the employees,
but without first re-registering title to the shares to the employees. We do not believe
that the entity should automatically be precluded from regarding this as a broker
settlement arrangement, particularly where the treasury shares are held not by the
entity directly but through an employee benefit trust or similar vehicle (see 12.3 below)
that is permitted to hold or sell shares only for the benefit of employees.
By contrast, the entity might regularly purchase and sell treasury shares, but identify
some of the sales as being undertaken on behalf of employees only after they have
occurred. Such an arrangement, in our view, is more difficult to construe as a true
broker-settlement arrangement.
Where shares are sold on behalf of an employee, they will typically attract transaction
costs, such as brokerage fees or taxes. If such costs are borne by the entity, they should,
2650 Chapter 30
in our view, be included within profit or loss as an additional component of employment
costs, rather than deducted from equity as a cost of a transaction in own shares.
This highlights a commercial disadvantage of broker settlement arrangements. The
entity may have to:
• purchase shares in the market (incurring transaction costs) on behalf of an
employee who does not want them and then sell them back into the market on the
employee’s behalf (incurring more transaction costs); or
• sell shares in the market (incurring transaction costs) on behalf of an employee who
does not want them and then buy them back in the market on behalf of another
employee who does want them (incurring more transaction costs).
In order to avoid this, entities may try to structure arrangements with their brokers
involving back-to-back sale and purchase contracts, under which shares are never
physically delivered, but the entity makes a cash payment to the broker in purported
settlement of the purchase by the broker of shares on behalf of the entity and the broker
passes it on to the employee in purported settlement of the sale of the shares by the
broker on behalf of the employee.
In our view, such arrangements cannot be seen as equity-settled transactions with
broker settlement, but must be regarded as cash-settled share-based payment
transactions, using the broker as paying agent.
Related issues are raised by the ‘drag along’ and ‘tag along’ rights that are often a feature
of awards designed to reward employees for a successful
flotation or other exit event
(see 15.4.6 below).
9.3
Cash-settled transactions: required accounting
9.3.1
Basic accounting treatment
It is clear that the ultimate cost of a cash-settled transaction must be the actual cash
paid to the counterparty, which will be the fair value at settlement date. Moreover,
the cumulative cost recognised until settlement is clearly a liability, not a component
of equity.
The liability is recognised and measured as follows:
• at each reporting date between grant and settlement the fair value of the award is
determined in accordance with the specific requirements of IFRS 2;
• during the vesting period, the liability recognised at each reporting date is the
IFRS 2 fair value of the award at that date multiplied by the expired portion of the
vesting period;
• from the end of the vesting period until settlement, the liability recognised is the
full fair value of the liability at the reporting date.
All changes in the liability are recognised in profit or loss for the period.
[IFRS 2.30-33D, IG Example 12, IG Example 12A]. Where the cost of services received in a cash-
settled transaction is recognised in the carrying amount of an asset (e.g. inventory) in
the entity’s statement of financial position, the carrying amount of the asset is not
adjusted for changes in the fair value of the liability. [IFRS 2.IG19].
Share-based
payment
2651
The fair value of the liability should be determined, initially and at each reporting
date until it is settled, by applying an option pricing model, taking into account the
terms and conditions on which the cash-settled transaction was granted, and the
extent to which the employees have rendered service to date. [IFRS 2.33]. As part of
the June 2016 amendments (see 1.2 above), the wording of paragraph 33 was
expanded to make clear that the determination of fair value is subject to the
requirements of paragraphs 33A to 33D of IFRS 2. [IFRS 2.33]. These paragraphs
clarify the treatment of vesting and non-vesting conditions and are discussed further
at 9.3.2 below.
This has the effect that, although the liability will ultimately be settled at its then
intrinsic value, its measurement at reporting dates before settlement is based on its
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