IFRS 2 Basics
IFRS 2 is the International Financial Reporting Standard for every kind of share based compensation respectively ESOP.
IFRS 2 vs. IAS 19 (other employee benefits)
IFRS 2 and IAS 19 are two distinct accounting standards that address different aspects of financial reporting. While the former primarily focuses on share based compensation transactions, IAS 19 deals with employee benefits.
Scope of IFRS 2
As mentioned earlier, IFRS 2 specifically addresses the accounting treatment of share based compensation transactions. It applies to transactions where a company grants equity instruments (such as shares or share options) or cash payments. Such payments must be based on real equity instruments. Beneficiaries of these grants are employees and other parties. On the other hand, IAS 19 focuses on employee benefits. These include short-term employee benefits (such as salaries and bonuses), post-employment benefits (such as pensions and retirement benefits). Other long-term employee benefits such as compensated absences are also within the scope of IAS 19.
Types of transactions
Equity settled and cash settled share based compensation transactions are the prime focus of IFRS 2. In the case of cash payments, the amount must be tied to the development of real equity instruments.
Measurement of transaction
Share based compensation according to IFRS 2 requires the measurement of the transactions at their fair value at grant date. The fair value is recognized as expenses over the vesting period. In case of cash settled share based compensation, the fair value is updated on every reporting date. IAS 19 prescribes different measurement approaches for several types of employee benefits. For example, it requires the recognition of the present value of defined benefit obligations for pensions and post-employment benefits.
Summary
While both accounting standards pertain to financial reporting, they have distinct scopes and purposes. IFRS 2 specifically deals with share based compensation transactions. IAS 19 focuses on a broader spectrum of employee benefits, covering various types of compensation arrangements and their accounting treatment, including pensions, post-employment benefits, and short-term and long-term employee benefits.
Equity vs. cash settled
Share based compensation in the scope of IFRS 2 is either the grant of real equity instruments or a cash payment. In the case of cash payment, the amount must be based on the value of real equity instrument.
Equity settled share based compensation
IFRS 2 requires companies to measure the fair value of the equity instruments granted at the grant date. The fair value is recognized as expenses in the income statement over the vesting period. Vesting conditions, which specify the relevant criteria before recipients become entitled to the shares, determine the length of the vesting period. Fair value measurement is based on appropriate valuation methods, considering factors like market conditions.
Cash settled share based compensation
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 to employees or other parties. ESOP in the sense of IFRS 2 also requires companies to measure the fair value of cash-settled share-based payment transactions at the grant date and recognize this fair value as expenses in the income statement over the vesting period. For cash settled transaction, the fair value is updated on every reporting date. A liability’s fair value for cash settled share based payments is determined using appropriate valuation methods, considering factors such as market conditions and vesting conditions.
Journal entries in IFRS 2
Debit booking: With a grant to employees, the debit journal entry is personnel expense in case of equity and cash
settled share based compensation.
Credit booking: While for equity settled transaction, the credit booking is within equity, in case of cash settled
transaction it is liability.
Summary
By providing clear accounting guidelines for equity and cash settled plans, IFRS 2 enhances transparency and consistency in financial reporting. This 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 arrangement. In other words, it’s the date when the company and the recipient agree on the granting of equity 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 equity instruments granted, the exercise or vesting conditions, the exercise or grant price, 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.
Fair Value Measurement
The fair value of the equity instruments granted is determined as of the grant date. One uses this fair value to recognize the related compensation expense over the vesting period. Only in case of a cash settled share based compensation, the fair value is updated on every reporting date.
Summary
As a fundamental concept within IFRS 2, grant date serves as the starting point for accounting and recognizing the expense associated with ESOP. It ensures that companies record the cost of share-based payments accurately and consistently in their financial statements. The aim is to reflect the economic reality of the compensation provided to employees or other parties.
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 vesting conditions as defined by IFRS 2.
IFRS 2 Service Conditions
Every service condition requires the recipients to provide services (i.e., work for the company) during a specified vesting period. Typically, equity instruments granted to employees are subject to service conditions. Hence vesting occurs as the recipient fulfills the required service over time.
Example
Company ABC, 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
- Vesting 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 employees must remain in continuous employment with Company ABC for the entire three-year vesting period to be eligible to exercise the options.
- Now, let’s consider the scenario of two employees:
Employee A:
Hired on January 1, 20X1 Remains with the company until January 1, 20X4 (the end of the 3-year vesting period) For Employee A: The service condition is satisfied because they remained employed for the entire vesting period. 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 vesting period) For Employee B: The service condition is not satisfied because they did not remain employed for the entire vesting period. B forfeits their right to exercise the options. Employee B does not become a shareholder and receives no benefit from the stock options.
In this example: A met the service condition by staying with the company for the full vesting period and became a shareholder by exercising the options. B did not meet the service condition because they left the company before the end of the vesting period and received 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 vesting conditions. Common examples of vesting conditions according to IFRS 2 include:
- Minimum years of service: Recipients must work for the company for a specified number of years to become entitled to the equity instruments.
- Achievement of revenue targets: Recipients must meet predetermined revenue goals or other financial metrics to vest in their equity instruments.
- Attainment of specific project milestones: Vesting occurs when recipients achieve particular project-related milestones.
- Continuation of employment: Beneficiaries must remain employed by the company until the vesting date to be eligible for the equity instruments.
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 of the equity instruments as an expense over the vesting period. Consequently, vesting conditions play a crucial role in ensuring accurate and consistent financial reporting for share-based compensation.
IFRS 2 group plans
IFRS 2 covers transactions involving shares of both the company and other entities within the same group.
Receiving, settling and reference entity within IFRS 2
In this context, the “receiving entity” receives goods or services in a share-based payment whereas the “settling entity” handles the settlement of share-based payment. The “reference entity” relates to the equity instruments granted or on which a cash payment is based. Group share-based payment involves entities within the same group, determined from the perspective of the ultimate parent company. If an external shareholder settles a share-based payment but the reference entity is part of the same group as the receiving entity, it falls within the scope of the standard for the receiving entity. A receiving entity classifies it as equity settled when not obliged to settle. Conversely, a settling entity classifies it as equity settled when it must use its equity instruments for settlement; otherwise, it is cash settled. IFRS 2 applies recognition and measurement requirements to both equity-settled and cash-settled share-based payment transactions.
Notes disclosure
IFRS 2 requires companies 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 disclosures 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 equity instruments
Disclose the methods and significant assumptions used to estimate the fair value of equity instruments at the grant date. 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. Disaggregate it into various expense components (e.g., personnel expenses, research and development expenses, etc.).
Share based compensation plans
IFRS 2 requires to disclose information about each specific share-based payment plan in place during the reporting period. This includes the number and types of equity instruments granted, the exercise or vesting prices, and the terms and conditions.
Reconciliation of instruments
Present a reconciliation of the number of outstanding equity instruments (options, shares, or other instruments) at the beginning and end of the reporting period, showing movements due to grants, exercises, forfeitures, and any other changes.
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.
Fair value of services rendered
If applicable, disclose the fair value of services received or acquired when equity instruments are granted to non-employees or parties other than employees.
Cash settled share based compensation
Report about cash settled arrangements, including the measurement of the fair value of the liability, changes in fair value, and amounts settled during the reporting period.
Dilution and EPS in IFRS 2
Disclose the potential dilution effect of unexercised share options or unvested equity instruments on earnings per share (EPS).
Summary
These disclosure notes are intended to provide a comprehensive understanding of share based compensation transactions within a company’s financial statements. Companies should tailor their disclosures to the specific details and complexities of their share based payment arrangements, ensuring compliance with IFRS 2’s disclosure requirements. IFRS 2 disclosure notes should be clear, concise, and accessible to users of the financial statements.