IFRS 2 is the International Financial Reporting Standard for every kind of share based compensation respectively ESOP.
Dominik Konold CEO/founder of Findiy GmbH, specializes in banking and corporate finance. With a background in audit and investment banking, he's a certified Professional Risk Manager and also serves as a lecturer in banking and accounting.
Scope of IFRS 2 share-based payment
IFRS 2 share-based payment accounting standard (and its accompanied comments published by the IFRS Interpretations Committee) specifically addresses the accounting treatment of share based compensation transactions. The standard was mainly developed for the classification and measurment of share-based payment transactions.
It applies to transactions where a company grants equity instruments (such as shares, share options or share appreciation rights) or cash for goods or services received.
Such payments must be based on the price equity instruments. It covers transaction with employees or other parties.
The aim of the International Accounting Standards Board (IASB) was to develop clear and uniform regulations for the accounting of share-based payment. This is demonstrated by the continuous amendments to IFRS 2.
Types of transactions
Equity-settled and cash settled share based compensation transactions are the prime focus of IFRS 2 whereas similar standards such as IFRS 9 focus in the treatment of financial instruments. In the case of cash payments, the amount must be tied to the development of the share price. Special rules for the treatment of share-based compensation within business combinations are included in IFRS 3.
IFRS 2: Equity vs. cash settled
Share-based payment in the scope of IFRS 2 is either the grant of stocks/ shares or a cash in exchange for services. In the
case of cash, the amount must be based on the value of real equity instrument.
Equity-settled share-based payment
Companies who apply IFRS 2 need to measure the fair value of the goods and services or of the equity instruments at the grant date according to IFRS 2 share-based payment. Vesting conditions, which specify the relevant criteria before recipients become entitled to the shares, determine the length of the expense period.
Fair value measurement is based on appropriate valuation methods, considering factors like market conditions.
Cash-settled share-based payment
Cash-settled share based compensation, on the other hand, does not involve the issuance of equity instruments. Instead,
the company settles the share based compensation by making cash payments.
Companies have to measure the fair value of cash-settled share-based payment transactions at the grant date. For cash-settled transaction, the fair value is updated on every reporting date.
Journal entries in IFRS 2
- Debit booking: With a grant to employees, the debit journal entry is personnel expense in case of equity-settled and cash-settled share based compensation.
- Credit booking: The credit booking is within equity, in case of cash-settled transaction it is liability.
Summary
By providing clear international accounting guidelines for equity-settled and cash-settled plans, IFRS 2 accounting standard enables all stakeholders to make well-informed decisions based on a company’s financial health and performance. For a detailed description of the concept of equity and cash-settled share based compensation, please see our Blog Post .
IFRS 2 Grant date
According to IFRS 2, grant date is the date at which an entity and the beneficiary reach a mutual understanding of the
terms and conditions of a share-based payment transaction. In other words, it’s the date when the company and the
recipient agree on the granting of instruments (such as shares or share options).
Mutual Understanding
It’s the point at which both parties involved agree on the essential terms of the share-based payment arrangement. This
includes details such as the number of instruments granted, the exercise or other conditions and any other significant terms.
Irrevocable Grant
Once the grant date is established, the entity is irrevocably committed to the share-based payment arrangement. Any subsequent changes in the terms and conditions result in modifications, subject to specific accounting treatment under IFRS 2.
IFRS 2 vesting conditions
IFRS 2 related share based compensation requires satisfaction of vesting conditions. They determine when the recipients
gain the right to the benefits of the equity instruments. These conditions critically affect accounting for share-based
payments.
There are two main types of such conditions as defined by IFRS 2 accounting standard.
Service Conditions
Every service condition requires the recipients to provide services during a specified period. Typically, instruments granted to employees are subject to service conditions. Hence vesting
occurs as the recipient fulfills the required service over time.
Example
Company ABC (which receives goods or services), a publicly-traded tech company, grants its employees stock options. The stock option grant falls within the scope of IFRS 2. Stock options grant with the following terms:
- Grant Date: January 1, 20X1
- Expense Period: 3 years
- Exercise Price: $50 per share
- Total Options Granted: 1,000 shares
- Service Condition: Stock options granted to employees are subject to a service condition. Service condition specifies
that the counterparty must remain in continuous employment with Company ABC for the entire three-year period.
Employee A:
- Hired on January 1, 20X1
- Remains with the company until January 1, 20X4 (the end of the 3-year period)
- For Employee A: The service condition is satisfied.
- Employee A is eligible to exercise their options and purchase 1,000 shares at the exercise price of $50 per share. A exercises the options on January 1, 20X4, and becomes a shareholder by paying $50,000 (1,000 shares * $50 per share).
Employee B:
- Hired on January 1, 20X1
- Leaves the company on June 30, 20X3 (before the end of the 3-year period)
- For Employee B: The service condition is not satisfied. B forfeits their right to exercise the options. Employee B does not become a shareholder and receives no benefit from the stock options.
Performance Conditions within IFRS 2
Performance conditions are based on specific performance targets or goals that the recipients must achieve in addition to providing services. Companies often link these conditions to their performance metrics, financial performance, or other corporate objectives. Both service and performance criteria must be met for vesting to occur.
Examples
Share based payment terms and company policies significantly influence the conditions. Common examples of such conditions according to IFRS 2 include:
- Achievement of revenue targets: Recipients must meet predetermined revenue goals or other financial metrics to receive their grant.
- Continuation of employment: Beneficiaries must remain employed by the company until the vesting date to be eligible for the exercise or payout.
Non-vesting conditions
Non-vesting conditions, not explicitly defined in the standard, essentially encompass all conditions except vesting
conditions.
Summary
Treatment of vesting conditions within IFRS 2 is important because they impact when expense related to share based compensation affects P&L. We recognize the fair value as an expense over the vesting period.
Share-based payment notes disclosure
The accounting standard requires an entity to disclose information to provide transparency and enables stakeholders to understand the
nature and impact of share based compensation arrangements on a company’s financial statements. These notes help stakeholders assess the potential effects of share based compensation transactions on financial performance.
- General information according to IFRS 2
Provide an overview of the company’s share based compensation arrangements, including the nature of the awards, the number of grants as well as specific program features. - Fair value of the equity instruments
Disclose methods and assumptions used to estimate the fair value of the equity instruments. Include details of any valuation models or techniques employed. - Share based compensation expense
Present the total share based payment expense recognized in the income statement. - Share based compensation plans
IFRS 2 requires to disclose information about each specific share-based payment plan in place during the financial reporting period. This includes the number and types of equity instruments granted, the exercise and the terms and conditions. - Forfeitures
Inform about the impact of forfeitures on the number and terms of equity instruments granted, including the number of forfeited instruments during the reporting period. - Dilution and EPS in IFRS 2
Disclose the potential dilution effect of unexercised share options or other equity instruments on earnings per share (EPS).
Summary
The disclosure notes are intended to provide a comprehensive understanding of share based compensation transactions within a company’s financial statements. Companies should tailor their notes to the specific details and complexities of their share based payment arrangements, ensuring compliance with IFRS 2’s disclosure requirements. IFRS 2 disclosure notes, developed by the international accounting standard board (the standard setting body within the ifrs), should be clear, concise, and accessible to users of the financial statements.