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employees share options, the vesting of which is conditional upon a flotation or sale of
the shares at a price of at least €5 per share within five years, and the employee still
being in employment at the time of the flotation or sale.
Taken alone, the requirement for a flotation or sale to occur is a non-market
performance condition (see further below and at 15.4.3 above). However, if a minimum
market price has to be achieved, the question arises as to whether, in addition to the
service requirement, such an award comprises:
• a single market performance condition (i.e. float or sell within five years at a share
price of at least €5); or
• two conditions:
• a market performance condition (share price at time of flotation or sale of at
least €5); and
• a non-market performance condition (flotation or sale achieved within five years).
The significance of this is the issue discussed at 6.3 above, namely that an expense must
always be recognised for all awards with a market condition, if all the non-market
vesting conditions are satisfied, even if the market condition is not. In either case,
however, there is a market condition which needs to be factored into the valuation of
the award.
If the view is that ‘flotation or sale at €5 within five years’ is a single market condition,
the entity will recognise an expense for the award for all employees still in service at
the end of the five year period, since the sole non-market vesting condition (i.e. service)
will have been met. Note that this assumes that the full five-year period is considered
the most likely vesting period at grant date (see 6.3.4 and 15.4.2 above).
If, on the other hand, the view is that ‘flotation or sale within five years’ and ‘flotation
or sale share price €5’ are two separate conditions, and no flotation or sale occurs, no
expense will be recognised since the performance element of the non-market vesting
condition (i.e. ‘flotation or sale within five years’) has not been satisfied. However, even
on this second analysis, if a sale or flotation is achieved at a price less than €5, an
expense must be recognised, even though the award does not truly vest, since the non-
market condition (i.e. ‘flotation or sale within five years’ with its associated service
requirement) will have been met.
In our view, the appropriate analysis is to regard ‘flotation or sale within five years’ and
‘flotation or sale share price €5’ as two separate conditions.
The example above assumes that there is a service condition equal in duration to the
other conditions attached to the award and hence the analysis above only considers
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vesting conditions. If the fact pattern were such that there was no service condition, or
a service condition that was of a shorter duration than the other conditions, then those
conditions would need to be treated as non-vesting conditions rather than as
performance vesting conditions (see 3.1 and 3.2 above).
15.4.5
Awards ‘purchased for fair value’
As noted at 2.2.4.D above, entities that are contemplating a flotation or trade sale
may invite employees to subscribe for shares (often a special class of share) for a
relatively nominal amount. In the event of a flotation or trade sale occurring, these
shares may be sold or will be redeemable at a substantial premium. It is often argued
that the initial subscription price paid represents the fair value of the share at the
time, given the inherent high uncertainty as to whether a flotation or trade sale will
in fact occur.
The premium paid on the shares in the event of a flotation or trade sale will typically be
calculated in part by reference to the price achieved. The question therefore arises as
to whether such awards fall within the scope of IFRS 2. It might be argued for example
that, as the employee paid full fair value for the award at issue, there has been no share-
based payment and, accordingly, the instrument should be accounted for under IAS 32
and IFRS 9.
In our view, in order to determine whether the arrangement falls within the scope of
IFRS 2, it is necessary to consider whether the award has features that would not be
expected in ‘normal’ equity transactions – in particular, a requirement for the holder of
the shares to remain in employment until flotation or sale and/or individual buyback
arrangements. If this is the case, regardless of the amount subscribed, the terms suggest
that the shares are being awarded in connection with, and in return for, employee
services and hence that the award is within the scope of IFRS 2. This may mean that,
even if the award has no material fair value once the subscription price has been taken
into account (and therefore gives rise to no IFRS 2 expense), it may be necessary to
make the disclosures required by IFRS 2.
Moreover, even if the amount paid by the employees can be demonstrated to be fair
value for tax or other purposes, that amount would not necessarily constitute fair value
under IFRS 2. Specifically, a ‘true’ fair value would take into account non-market
vesting conditions (such as a requirement for the employee to remain in employment
until flotation or a trade sale occurs). However, a valuation for IFRS 2 purposes would
not take such conditions into account (see 5.5 and 6.2.1 above) and would therefore
typically be higher than the ‘true’ fair value.
If the arrangement relates to a special class of share rather than ordinary equity shares,
the underlying shares might well be classified as a liability rather than as equity under
IAS 32. However, if the redemption amount is linked to the flotation price of the ‘real’
equity, the arrangement will be a cash-settled share-based payment transaction under
IFRS 2 (see 2.2.4.A above).
It is common in such situations for the cost of satisfying any obligations to the special
shareholders to be borne by shareholders rather than by the entity itself. This raises a
number of further issues, which are discussed at 2.2.2.A above and at 15.4.6 below.
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The approach outlined in this section, i.e. that there will generally be no additional
IFRS 2 expense to recognise when the counterparty subscribes for a share at fair value,
is the approach most commonly applied in practice by entities accounting under IFRS.
In this type of arrangement, the subscription price, or market value if lower, is often
refundable to employees who leave employment before the shares vest. In such cases,
subscription amounts paid by the counterparty for the shares are generally classified as
a liability by the entity until such time as the shares finally vest (at which point the cash
paid will be treated as the proceeds of issuing shares).
However, this is not the only approach seen in practice. US GAAP, for example, requires
in certain circumstances the recognition of an expense (representing the amount
potentially at risk) in cases where an employee subscribes for a share at fair value but
risks forfeiting some, or all, of the price paid for that share, together with any subsequent
increases in value, should he fail to fulfil the service conditi
on. In determining whether
an expense must be recognised for the amount risked by the employee, an entity
applying US GAAP must establish that there is a clear business purpose for the employee
taking such a risk. In our view, in the absence of specific guidance, the recognition of
such an expense is not a requirement based on IFRS 2 as currently drafted.
15.4.6
‘Drag along’ and ‘tag along’ rights
An award might be structured to allow management of an entity to acquire a special
class of equity at fair value (as in 15.4.5 above), but (in contrast to 15.4.5 above) with no
redemption right on an exit event. However, rights are given:
• to any buyer of the ‘normal’ equity also to buy the special shares (sometimes called
a ‘drag along’ right);
• to a holder of the special shares to require any buyer of the ‘normal’ equity also to
buy the special shares (sometimes called a ‘tag along’ right).
Such schemes are particularly found in entities where the ‘normal’ equity is held by a
provider of venture capital, which will generally be looking for an exit in the medium term.
It may well be that, under the scheme, the entity itself is required to facilitate the
operation of the drag along or tag along rights, which may involve the entity collecting
the proceeds from the buyer and passing them on to the holder of the special shares.
This raises the issue of whether such an arrangement is equity-settled or cash-settled.
The fact that, in certain circumstances, the entity is required to deliver cash to the
holder of a share suggests that the arrangement is an award requiring cash settlement in
specific circumstances, the treatment of which is discussed at 10.3 above.
However, if the terms of the award are such that the entity is obliged to pass on cash to
the holder of the share only if, and to the extent that, proceeds are received from an
external buyer, in our view, the arrangement may be economically no different to the
broker settlement arrangements typically entered into by listed entities, as discussed
at 9.2.4 above. This could allow the arrangement to be regarded as equity-settled because
the entity’s only involvement as a principal is in the initial delivery of shares to employees,
provided that consideration is given to all the factors (discussed at 9.2.4 above) that could
suggest that the scheme is more appropriately regarded as cash-settled.
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In making such an assessment, care needs to be taken to ensure that the precise facts of
the arrangement are considered. For example, a transaction where the entity has some
discretion over the amount of proceeds attributable to each class of shareholder might
indicate that it is inappropriate to treat the entity simply as an agent in the cash payment
arrangement. It might also be relevant to consider the extent to which, under relevant
local law, the proceeds received can be ‘ring fenced’ so as not to be available to settle
other liabilities of the entity.
It is also the case that arrangements that result in employees obtaining similar amounts
of cash can be interpreted very differently under IFRS 2 depending on how the
arrangement is structured and whether, for example:
• the entity is required to pay its employees cash on an exit (having perhaps held
shares itself via a trust and those shares having been subject to ‘drag along’ rights); or
• the employees themselves have held the right to equity shares on a restricted basis
with vesting – and ‘drag along’ rights – taking effect on a change of control and the
employees receiving cash for their shares.
The appropriate accounting treatment in such cases requires a significant amount of
judgement based on the precise facts and circumstances.
15.5 South African black economic empowerment (‘BEE’) and similar
arrangements
As part of general economic reforms in South Africa, arrangements – commonly referred
to as black economic empowerment or ‘BEE’ deals – have been put in place to encourage
the transfer of equity, or economic interests in equity, to historically disadvantaged
individuals. Similar arrangements have also been put in place in other jurisdictions. These
arrangements are intended to give disadvantaged individuals, or entities controlled by
disadvantaged individuals, a means of meaningful participation in the economy.
An entity can enhance its BEE status in a number of ways (through employment equity,
skills development or preferential procurement policies to name but a few). This section
focuses on BEE deals involving transfers of equity instruments, or interests in equity
instruments, to historically disadvantaged individuals at a discount to fair value.
Such transfers have generally been concluded at a discount to the fair value of the equity
instruments concerned, even where the fair value takes into account any restrictions on
these equity instruments. As a result of having empowered shareholders, the reporting
entity is able to claim its ‘BEE credentials’, thus allowing the reporting entity greater
business opportunities in the South African economy. These arrangements raise a
number of practical issues of interpretation, and indeed led to the scope of IFRS 2 being
extended to include transactions where the consideration received appears less than
the consideration given, as discussed further at 2.2.2.C above.
The goods or services received from the disadvantaged people or entities controlled by
them in return for the equity instruments may or may not be specifically identifiable. As
explained in guidance issued by the South African Institute of Chartered Accountants
(SAICA),37 it is therefore the case that IFRS 2 applies to the accounting for BEE
transactions where the fair value of cash and other assets received is less than the fair
value of equity instruments granted to the BEE partner, i.e. to the BEE equity credentials.
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BEE deals are typically complex and their specific structures and terms may vary
considerably. However, they do exhibit certain features with some regularity, as
discussed below.
Typically BEE arrangements have involved the transfer of equity instruments to:
• empowerment companies controlled by prominent BEE qualifying individuals;
• BEE qualifying employees of the reporting entity; or
• beneficiaries in the BEE qualifying communities in which the entity operates.
The arrangements generally lock the parties in for a minimum specified period and if
they want to withdraw they are able to sell their interest only to others with qualifying
BEE credentials, usually with the lock-in provision also transferred to the buyer.
Generally these individuals have not been able to raise sufficient finance in order to
purchase the equity instruments. Accordingly, the reporting entity often facilitates the
transaction and assists the BEE party in securing the necessary financing.
A BEE arrangement often involves the creation of a trust or corporate entity, with the
BEE party holding beneficial rights in the trust which in turn holds equity instruments
of the reporting entity (or a member of its group).
The awards made by the trust may be in the form of:
• the equity instruments originally transferred to the trust;
• units in the trust itself, usually with a value linked in some way to the value of the
equity instruments of the reporting entity originally transferred to the trust; or
• payments made from the proceeds (dividends received, sale of equity instruments
etc.) that the trust generates.
The accounting issues arising from such schemes include:
• the nature of the trust (specifically, whether it meets the criteria for consolidation
by the reporting entity);
• whether any charge arises under IFRS 2 and, if so, the grant date and therefore,
under a grant date model, the amount of the charge; and
• whether awards are equity-settled or cash-settled.
15.5.1
Nature of the trust
The first issue to consider in any accounting analysis is whether any trust to which the
equity instruments of the reporting entity have been transferred meets the requirements
for consolidation by the reporting entity under IFRS 10 (see Chapter 6). Factors that
may indicate that the trust should be consolidated include:
• the reporting entity is involved in the design of the trust and the trust deed at inception,
the intention being that the design is such that the desired BEE credentials are obtained;
• the potential beneficiaries of the trust are restricted to persons in the employment
of, or otherwise providing services to, the reporting entity;
• the reporting entity has a commitment to ensure that the trust operates as designed
in order to maintain its BEE credentials;
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• the reporting entity has the right to control (on ‘autopilot’ or otherwise), or does in
practice control, the management of the trust; or
• the relevant activities of the trust are to service the loan and to make distributions
to the beneficiaries in line with the trust deed,
but all the IFRS 10 control criteria will need to be assessed.
The generic form of a BEE arrangement normally requires the reporting entity either to
finance the acquisition of the shares by the trust or to provide cross guarantees to the
financiers of the trust. Alternative methodologies that have been employed include