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International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards

Page 542

by International GAAP 2019 (pdf)


  *

  Increase in investment to 31 December 20x1 is 6/36 × 3000 × £1.80 [reporting date fair value] = £900.

  Increase for year ended 31 December 20x2 is 18/36 × 3000 × £2.70 = £4,050 less £900 charged in 20x1

  = £3,150 and so on (refer to Example 30.37 at 9.3.2 above). In practice, where options were granted to

  a group of individuals, or with variable performance criteria, the annual charge would be based on a

  continually revised cumulative charge (see further discussion at 9 above).

  Where the parent entity was also the employing entity (and therefore receiving goods

  or services), it would apply the same accounting treatment in its separate financial

  statements as in its consolidated financial statements (see 12.6.1 above).

  12.6.3 Employing

  subsidiary

  The employing subsidiary accounts for the transaction as equity-settled, since it

  receives services, but incurs no obligation to its employees (see 12.2.3 and 12.2.6 above).

  This gives rise to the following accounting entries.

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  £

  £

  y/e 31.12.20x1

  Profit or loss*

  750

  Equity

  750

  y/e 31.12.20x2

  Profit or loss*

  1,500

  Equity

  1,500

  y/e 31.12.20x3

  Profit or loss*

  1,500

  Equity

  1,500

  y/e 31.12.20x4

  Profit or loss*

  750

  Equity

  750

  *

  Charge for period to 31 December 20x1 is 6/36 × 3000 × £1.50 [grant date fair value] = £750, and so

  on. In practice, where options were granted to a group of individuals, or with variable performance

  criteria, the annual charge would be based on a continually revised cumulative charge (see further

  discussion at 6.1 to 6.4 above).

  The effect of this treatment is that, while the group ultimately records a cost of £10,500,

  the subsidiary records a cost of only £4,500.

  However, there may be cases where the subsidiary records a higher cost than the group.

  This would happen if, for example:

  • the award vests, but the share price has fallen since grant date, so that the value of

  the award at vesting (as reflected in the consolidated financial statements) is lower

  than the value at grant (as reflected in the subsidiary’s financial statements); or

  • the award does not actually vest because of a failure to meet a market condition

  and/or a non-vesting condition (so that the cost is nil in the consolidated financial

  statements) but is treated by IFRS 2 as vesting in the subsidiary’s financial

  statements, because it is accounted for as equity-settled (see 6.3 and 6.4 above).

  12.7 Employee transferring between group entities

  It is not uncommon for an employee to be granted an equity-settled share-based

  payment award while in the employment of one subsidiary in the group, but to transfer

  to another subsidiary in the group before the award is vested, but with the entitlement

  to the award being unchanged.

  In such cases, each subsidiary measures the services received from the employee by

  reference to the fair value of the equity instruments at the date those rights to equity

  instruments were originally granted, and the proportion of the vesting period served by the

  employee with each subsidiary. [IFRS 2.B59]. In other words, for an award with a three-year

  vesting period granted to an employee of subsidiary A, who transfers to subsidiary B at the

  end of year 2, subsidiary A will (cumulatively) record an expense of 2/3, and subsidiary B

  1/3, of the fair value at grant date. However, any subsidiary required to account for the

  transaction as cash-settled in accordance with the general principles discussed at 12.2

  above accounts for its portion of the grant date fair value and also for any changes in the

  fair value of the award during the period of employment with that subsidiary. [IFRS 2.B60].

  After transferring between group entities, an employee may fail to satisfy a vesting

  condition other than a market condition, for example by leaving the employment of the

  group. In this situation each subsidiary adjusts the amount previously recognised in

  respect of the services received from the employee in accordance with the general

  Share-based

  payment

  2717

  principles of IFRS 2 (see 6.1 to 6.4 above). [IFRS 2.B61]. This imposes upon the original

  employing entity the rather curious burden of tracking the service record of its former

  employees, where the accounting impact is expected to be significant.

  12.8 Group

  reorganisations

  Following a group reorganisation, such as the insertion of a new parent entity above an

  existing group, share-based payment arrangements with employees are often amended

  or replaced so that they relate to the shares of the new parent. Group reorganisations

  of entities under common control are not within the scope of IFRS 3 and so the

  requirements set out at 11 above are not directly applicable.

  In some cases, the terms and conditions of a share-based payment arrangement will

  contain provisions relating to restructuring transactions (see 5.3.8.A above) so that the

  application of any changes is not necessarily considered to be a modification in IFRS 2

  terms. Where no such provision is made, the situation is less clear-cut.

  In our view, in the consolidated financial statements, such changes to share-based

  payments would generally be construed as a cancellation and replacement to which

  modification accounting could be applied (see 7.4.4 above). However, in most cases, the

  changes made to the share-based payment awards following a group reorganisation are

  likely to be such that there is no incremental fair value arising from the cancellation and

  replacement, the intention being simply to replace like with like.

  A subsidiary receiving the services of employees but with no obligation to settle the amended

  award would continue to apply equity-settled accounting in its own financial statements and,

  as for the consolidated financial statements, would strictly account for the changes as a

  cancellation and replacement of the original award. The accounting consequences would be

  more complicated if the subsidiary itself had an obligation to settle the award in the shares of

  its new parent, when previously it had had to settle in its own shares, as this would mean a

  change from equity-settled to cash-settled accounting (see 9.4 above). However, we would

  expect this to be a rare occurrence in practice (see 12.2.5.B above in relation to the grantor

  of an award in a situation involving parent and subsidiary entities).

  The new parent entity becomes a party to the share-based payment arrangements for

  the first time and, assuming it has no employees of its own but is considered to have

  granted and to have the obligation to settle the awards, needs to account for the awards

  to the employees of its subsidiaries (see 12.2.4 and 12.2.5 above). The requirements of

  IFRS 2 in this situation are unclear and one could argue:

  • either that this is a new award by the parent and so should be valued as at the date

  of the new award; or

  • in accordance with the general principle t
hat there is no overall change as a

  consequence of a reorganisation of entities under common control, that the parent

  should use the same (original grant date) fair value as the subsidiary.

  In our view, either approach is acceptable provided it is applied consistently.

  12.9 Share-based payments to employees of joint ventures or associates

  The majority of share-based payment transactions with employees involve payments

  to employees of the reporting entity or of another entity in the same group.

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  Occasionally, however, share-based payments may be made to employees of significant

  investees of the reporting entity such as joint ventures or associates. For example, if one party

  to a joint venture is a quoted entity and the other not, it might be commercially appropriate

  for the quoted venturer to offer payments based on its quoted shares to employees of the

  joint venture, while the unquoted party contributes to the venture in other ways.

  Such arrangements raise some questions of interpretation of IFRS 2, as illustrated by

  Example 30.56 below. References to an associate in the example and discussions below

  should be read as also referring to a joint venture.

  Example 30.56: Share-based payment to employees of associate

  At the beginning of year 1, an entity grants an award of free shares with a fair value at that date of €600,000

  to employees of its 40% associate. The shares vest over a three-year period. It is assumed throughout the

  vesting period of the award that it will vest in full, which is in fact the case.

  12.9.1

  Financial statements of the associate or joint venture

  For the financial statements of the associate, the transaction does not strictly fall within

  the scope of IFRS 2. In order for a transaction to be in the scope of IFRS 2 for a reporting

  entity, it must be settled in the equity of the entity itself, or that of another member of

  the same group. A group comprises a parent and its subsidiaries (see Chapter 6 at 2.2),

  and does not include associates.

  Nevertheless, we believe that it would be appropriate for the associate to account for

  the transaction as if it did fall within the scope of IFRS 2 by applying the ‘GAAP

  hierarchy’ in IAS 8 – Accounting Policies, Changes in Accounting Estimates and Errors

  (see Chapter 3 at 4.3). The investor has effectively made a capital contribution to the

  associate (in the form of the investor’s own equity), no less than if it made a capital

  contribution in cash which was then used to pay employees of the associate.

  If the investor in the associate had instead granted an award settled in the equity of the

  associate, the transaction would have been in the scope of IFRS 2 for the associate, as

  being the grant of an award over the equity of the reporting entity by a shareholder of

  that entity (see 2.2.2.A above).

  If the award is, or is treated as being, within the scope of IFRS 2 for the associate, the

  following entries are recorded:

  €000

  €000

  Year 1

  Employee costs†

  200

  Equity

  200

  Year 2

  Employee costs

  200

  Equity

  200

  Year 3

  Employee costs

  200

  Equity

  200

  †

  Grant date fair value of award €600,000 × 1/3. The credit to equity represents a capital contribution from

  the investor.

  12.9.2

  Consolidated financial statements of the investor

  The investor has entered into a share-based payment transaction since it has granted an

  award over its equity to third parties (the employees of the associates) in exchange for

  Share-based

  payment

  2719

  their services to a significant investee entity. However, employees of an associate are

  not employees of a group entity and are therefore not employees of the investor’s group.

  The issue for IFRS 2 purposes is, therefore, whether the award should be regarded as

  being made to persons providing similar services to employees (and therefore measured

  at grant date) or to persons other than employees or those providing similar services to

  employees (and therefore measured at service date) – see 5.2 to 5.4 above.

  In our view, it is more appropriate to regard such awards as made to persons providing

  similar services to employees and therefore measured at grant date.

  There are then, we believe, two possible approaches to the accounting. In our view, in

  the absence of clear guidance in the standard, an entity should choose the more

  appropriate approach based on the specific circumstances.

  In any event, the investor’s consolidated financial statements must show a credit to

  equity of €200,000 a year over the vesting period. The accounting issue is the analysis

  of the corresponding debit.

  It seems clear that the investor must as a minimum recognise an annual cost of €80,000

  (40% of €200,000), as part of its ‘one-line’ share of the result of the associate. The issue

  then is whether it should account for the remaining €120,000 as a further cost or as an

  increase in the cost of its investment in its associate.

  The argument for treating the €120,000 as an expense is that the associate will either

  have recorded nothing or, as set out in 12.9.1 above, an entry that results in no net

  increase in the equity of the associate. Therefore there has been no increase in the

  investor’s share of the net assets of the associate, and there is no basis for the investor

  to record an increase in its investment. This is broadly the approach required under

  US GAAP (although US GAAP requires the associate itself to recognise the expense and

  a corresponding capital contribution).

  It may be possible to conclude in some situations that the €120,000 is an increase in the

  cost of the investment in associate. IAS 28 – Investments in Associates and Joint

  Ventures – defines the equity method of accounting as (emphasis added):

  ‘a method of accounting whereby the investment is initially recognised at cost and

  adjusted thereafter for the post-acquisition change in the investor’s share of the

  investee’s net assets’. [IAS 28.3].

  For example, there may be cases where another shareholder has made, or undertaken

  to make, contributions to the associate that are not reflected in its recognised net assets

  (such as an undertaking to provide knowhow or undertake mineral exploration).

  Where an entity takes the view that the €120,000 is an increase in the cost of its

  investment, it is essential to ensure that the resulting carrying value of the investment is

  sustainable. This may be the case if, for example:

  • the fair value of the investment in the associate exceeds its carrying amount; or

  • the investor has agreed to enter into the transaction while another major

  shareholder has agreed to bear equivalent costs.

  2720 Chapter 30

  In other circumstances, the carrying amount of the investment may not be sustainable,

  and the investor may need to recognise an impairment of its investment in accordance

  with IAS 36 (see Chapter 20).

  12.9.3

  Separate financial statements of the investor
>
  The discussion below assumes that the investor accounts for its investment in the

  associate at cost in its separate financial statements (see Chapter 8).

  The issues here are much the same as in 12.9.2 above. The investor has clearly entered

  into a share-based payment transaction since it has granted an award over its equity to

  third parties (the employees of the associates) in exchange for their services to a

  significant investee entity. As in 12.9.2 above, we believe that this is most appropriately

  characterised as a transaction with persons providing similar services to employees and

  therefore measured at its grant date fair value.

  In any event, the investor’s separate financial statements must show a credit to equity

  of €200,000 a year over the vesting period but, as in 12.9.2 above, the analysis of the

  debit entry is more complex.

  13 DISCLOSURES

  IFRS 2 requires three main groups of disclosures, explaining:

  • the nature and extent of share-based payment arrangements (see 13.1 below);

  • the valuation of share-based payment arrangements (see 13.2 below); and

  • the impact on the financial statements of share-based payment transactions

  (see 13.3 below).

  All of the disclosure requirements of IFRS 2 are subject to the overriding materiality

  considerations of IAS 1 – Presentation of Financial Statements (see Chapter 3 at 4.1.5).

  However, depending on the identity of the counterparty and whether, for example, the

  individual is a member of key management, it will be necessary to assess whether an

  arrangement is material by nature even if it is immaterial in monetary terms.

  13.1 Nature and extent of share-based payment arrangements

  IFRS 2 requires an entity to ‘disclose information that enables users of the financial

  statements to understand the nature and extent of share-based payment arrangements

  that existed during the period’. [IFRS 2.44].

  Share-based

  payment

  2721

  In order to satisfy this general principle, the entity must disclose at least:

  (a) a description of each type of share-based payment arrangement that existed at any

 

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