Chapter 3 Share Based Payments Ifrs

Chapter 3: Share-based payment

Discussion Questions

1. Why do standard setters formulate rules on the measurement and recognition of share-based payment transactions?

Prior to the introduction of AASB 2 Share-based payment, there was no requirement to recognize the cost of compensation payments to employees and transactions for the acquisition of goods and services from others in the financial statement. This situation can be criticized as reducing the transparency and reliability of financial statements. Standard setters have argued that recognizing the cost of share-based payments in the financial statements of entities improves the relevance, reliability and comparability of that financial information and helps users of financial information to understand better the economic transactions affecting an enterprise and supports resource allocation decisions.

1. What is the hierarchy, contained in AASB 2, to be used in determining the accounting treatment for a share-based payment transaction?

The hierarchy contained in AASB 2 to be used in determining the accounting treatment for a share-based payment transaction is as follows:

• Cash-settled share-based payment transactions are recognized as an increase in goods or services received and a corresponding increase in a liability (debt), measured at the fair value of the liability. The fair value of the liability is remeasured at each reporting date and on settlement date.
• Equity-settled share-based payment transactions are recognized as an increase in the goods or services received and a corresponding increase in equity measured at the grant date at the fair value of the goods or services received, or if the fair value of the goods or services cannot be estimated reliably, indirectly by reference to the fair value of the equity instruments granted.

1. Why are services received in share-based payment transactions classified initially as assets rather than expenses?

An asset is regarded as a resource controlled by an enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise

An expense is regarded as a decrease in economic benefits during an accounting period in the form of outflows or depletions of assets or the incurrence of liabilities that result in decreases in equity, other than those relating to distributions to equity participants.

Usually an expense is recognized when goods or services are consumed. For example, services provided by employees and professional and advisory services are normally consumed immediately, in which case an expense for the consumption of the economic benefit would be recognized immediately. If goods are consumed over a period of time, such as in the case of inventories and stores, the cost of the goods is normally recognized initially as an asset, and recognized progressively as an expense when the inventories are sold or the stores are consumed. In other cases, goods or services that might initially be recognized as assets must be recognized instead as an expense because they do not qualify for recognition as an asset under other standards.

1. What is the difference between equity-settled and cash-settled share-based payment transactions?

Equity-settled share-based payment transactions arise when an entity receives goods or services as consideration for its own equity instruments (including shares and share options).

Cash-settled share-based payment transactions arise when an entity acquires goods or receives services by incurring liabilities (debt) for amounts based on the value of its own equities.

Other share-based payment transactions may arise in which the entity receives or acquires goods or services and either the entity or the supplier has the choice of whether the transaction is settled in cash or equity instruments.

1. What is the different accounting treatment for instruments classified as debt and those classified as equity?

Instruments classified as debt (liabilities) are accounted for by recognizing an increase in an expense (or asset) and a corresponding increase in debt (a liability). The fair value of such liabilities determines the measurement of the transaction. Additionally, the debt (liability) must be remeasured at each reporting date and at settlement date.

Instruments classified as equity are accounted for by recognizing an increase in an expense (or asset) and a corresponding increase in equity. The fair value of the goods or services received is measured at the grant date fair value of the goods or services received and it is not subsequently remeasured. If the fair value of the goods or services received cannot be measured reliably, the transaction amount is determined indirectly by reference to the fair value of the equity instruments granted.

1. Why might market prices not be available for some equity instruments such as share options?

Market prices will not exist for equities of unlisted entities. The equities of newly listed entities may be thinly (infrequently) traded, and a reliable historical pattern may not have been established. Other entities may have only small trade volumes for their equities which also may not establish a representative pattern or price.

Some equities may have embedded features such as restrictions on transfer post-vesting date, or reload features that provide for an automatic grant of additional share options whenever the option holder exercises previously granted options, using the entity’s shares rather than cash, to satisfy the exercise price. These features are not normally embedded in exchange traded equities, and so no point of reference exists for determining the market price of equity instruments which contain such features.

1. What are the factors required under AASB 2 to be taken into account in option pricing models?

Appendix B of AASB 2 supplies a list of factors that all option pricing models take into account as a minimum. These include:

• the exercise price of the option
• the life of the option
• the current price of the underlying shares
• the expected volatility of the share price
• the dividends expected on the shares
• the risk-free interest rate for the life of the option.

Appendix B also contains a discussion of the valuation issues in the context of applying options pricing models. The student should refer to the discussion in AASB 2 Appendix B. In brief, the following important matters are discussed in Appendix B.

Expected volatility – is a measure of the amount by which a price is expected to fluctuate during a period. Volatility is typically expressed in annualized terms, for example, daily or monthly price observations. Often a range of reasonable expectations about future volatility can be determined, and if so, an expected value should be calculated by weighting each amount within the range by its associated probability of occurrence.

Expectations about the future are generally based on experience, modified if the future is reasonably expected to differ from the past. There may be cases where historical patterns may not be the best indicator of reasonable expectations for the future, for instance where a significant business segment has been acquired or disposed of.

Whether dividends should be taken into account depends on the counterparty’s entitlement to those dividends. Generally assumptions about dividends are to be based on publicly available information.

The risk-free interest rate is the implied yield currently available on zero-coupon government issues of the country in whose currency the exercise price is expressed, with a remaining term equal to the expected term of the option being valued.

1. When is it appropriate to use another interest rate in place of the ‘risk-free’ interest rate?

An appropriate substitute for the risk-free interest rate may need to be used if the implied yield on zero-coupon government issues is not representative of the risk-free interest rate. This may occur, for example, in high inflationary economies.

1. Distinguish between vesting and non-vesting conditions.

Vesting conditions comprise service and performance conditions only. Other features of share-based payment transactions are not regarded as vesting conditions.

Whether or not a condition is a vesting condition or a non-vesting condition is illustrated in the following flowchart.

[pic 1]

Does the condition determine whether the

entity receives the services that entitle the

counter-party to the share-based payment?

[pic 2][pic 3]

                NO                                           YES

[pic 4][pic 5]

        Non-vesting                                         Does the condition require only a

condition                                        specified period of service to