IFRS 2 summary and illustrative examples

This article will make an IFRS 2 summary and a series of illustrative examples to easily understand this standard.

Share-based payments are a consideration an entity makes to a third party or an employee for the giving up of goods and services in exchange for the company’s equity instruments.

For example, company A agrees to purchase 100 computers of company B for $10,000 for 150 entity A shares.

Illustrative Example 1: Share-based payments with third parties:

A company agrees with another entity on the acquisition of 10 buildings; the fair value of each asset is 130,000 dollars; this transaction is made in change to 10,000 shares of the company with a fair value of 110 dollars.

How should the entity carry out the accounting recognition?

In this case, it can see the fair value of the assets received can be reliably determined.

For this reason, the obligation must be recognized by reference to the fair value of assets received.

If this value was not available, the transaction would be carried out by reference to the equity instruments’ fair value.

Therefore, the accounting recognition is as follows:

accounting recognition 1 IFRS 2

Illustrative Example 2: Share-based payments with employees:

An entity agrees with 12 company executives to give 200 shares with a market price of $100 to provide their services for two years.

The salary of each executive is $ 4.000 per month.

The entity established the only requirement that the employees remain working for the company for two years; if they resign earlier, it will annul their right to the shares.

Solution :

In this example, each executive has a salary of $4.000.

However, this data is not relevant since, according to IFRS 2 paragraph 11, share-based payments with employees will always be measured by the fair value of the equity instruments given up.

This is so because the standard assumes that the fair value of the services provided by employees is not easily determinable.

Something very different happens with agreements with third parties that aren’t employees.

In this case, the fair value can be determinable because, in general, there is an active market for this type of goods and service.

However, as we said before, when the fair value of services received it’s not readily determinable, we will measure the transaction based on the fair value of the goods and services given up.

In this way, the entity must recognize a labor expense of $24,000 is equivalent to 200 shares X $10 of the share price in the market X 12 employees.

The accounting record is as follows:

accounting recognition 2 IFRS 2

IFRS 2 divides share-based payments into two categories, it to explain below:

Examples Share-based Payment

The share-based payments settled in cash refer to payments where a third party or an employee doesn’t have access to an entity shares; simply, it receives a consideration will be based on the company shares price.

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Share-based payments settled with equity instruments

 

Exist Share-based payments with company employees or independent third parties.

In other words, an entity may agree with an employee to provide services in exchange for the entity’s equity instruments.

In general, this type of share-based payment is made with senior entity executives in exchange for the fulfillment of goals.

To share-based payments settled with equity instruments understand, it’s necessary to analyze the scheme presented below:

Share-based Payment

Reference from IFRS 2 standard https://www.ifrs.org/

IFRS 2 incorporates a term known as vesting condition; this concept refers to a series of requirements a third party or an employee must meet to access the entity’s equity instruments.

IFRS 2 sets out two conditions, service conditions and performance conditions.

IFRS EXAMPLE1-min

The service conditions are presented when an entity agrees with a worker to provide its services in exchange for the entity’s equity instruments.

And besides, the worker must provide his services for the entity for a certain period.

If the worker resigns earlier, it will nullify his rights over the equity instruments.

Will be nullified his rights to his equity instruments

On the other hand, in addition to service conditions,  there are the performance conditions, 

These can be market-related and non-market-related.

Conditions performance market-related 

This agreement must meet two requirements.

In the first instance, the employee must remain working for the entity for a specified time, and in addition to this, the share price must increase by a certain percentage.

If these two conditions mentioned above are met, a worker can access the entity’s equity instruments.

In the non-market conditions, it is also necessary for the employee to provide his services for a certain period.

Additionally, the company’s profit must increase by a specific amount or sales grow by a certain percentage.

As you can see, in the performance conditions, two requirements must be met: a service condition and, on the other hand, a condition referring to the market or not referring to the market.

Finally, there are conditions other than those of vesting.

In no vesting condition, an entity only requires that a condition referred or not to the market be met.

But at no time is it necessary that the employee provide their services during a period.

Illustrative Example 3 Share-based payments with service conditions

 

A company makes an agreement with 600 of its employees.

If they provide their services for three years, they will have access to 300 shares of the company, which has a market value of 150 dollars.

The company estimates that as of December 31, year 3, 20% of the workers will leave the company, that is, 120 workers.

As of December 31, year 1, 60 workers have left the company, and based on this information, the entity considers it must make a new estimate about the workers who will renounce their rights at the end of year 3.

Based on this new information, the company believes that 25% of the workers will resign at the end of the agreement.

 The accounting record in year 1 is as follows:

Example 3 - 1

The calculation is as follows: 25% of workers 150 (600×15%) X number of shares 300 X share price 150 X 1/3 time = 2,250,000.

At the end of year 2, 40 more workers have left the entity; therefore, the entity considers it should increase its estimate by 28%.

The accounting record is as follows.

Example 3 - 2

The calculation: 28% of workers 168 (600X28%) X number of shares 300 X share price 150 X 2/3 of the time = 5,040,000.

Adjustment: ending balance – beginning balance.

Adjustment: 5,040,000 – 2,250,000 = 2,790,000.

Finally, at the end of year 3, another 70 workers leave the entity; this gives a total of 170 employees who will not be able to exercise the rights over the shares.

The accounting record is as follows:

Example 3 - 3

Calculate: 170 real workers who left the entity X number of shares 300 X share price 150 = 7,650,000.

Accounting adjustment = Ending balance – accumulated balance.

Accounting adjustment = 7,650,000 – 5,040,000.

Accounting adjustment = 2,610,000

 

Illustrative Example 4: share-based payments with a market-related performance condition

 

An entity agrees with ten employees to provide its services in exchange for 300 shares of the entity at $11 per share.

The company sets out a performance condition related to the market; in other words, the employee must provide his services for two years and the share price at the end of the agreement period must increase to 20 dollars.

The entity estimates a third party in a transaction carried out in conditions of mutual independence would only pay 8 dollars to buy these incentives; in other words, the fair value of the stock option is 8 dollars.

As of December of year 2, the share value is 18 dollars.

Solution:

According to IFRS 2, when we refer to market-related performance conditions, the transaction must reflect the fair value of the share.

Something very different happens with performance conditions not related to the market.

There, it is indifferent if the share price increases because in this type of operation, the requirement established by the entity is the company’s production increases by 5%, or the sale price grows by a specific percentage, for example.

Thus, in the market-related performance conditions, the company’s expense to recognize share-based payments must consider the shares options’ fair value.

The accounting recognition is as follows:

 

accounting recognition 4 IFRS 2

As you can see, the personnel expense takes into account the share price of $8; therefore, the calculation is determined as follows:

Share-based payments: Fair value of the share X number of employees X number of shares X ½ time

Share-based payments year 1: (8X10X300) X1 / 2 = 12.000

Year 2 Share-based Payments: (8X10X300)X2/2 = 24.000

Year 2 adjustment: Ending balance – less beginning balance

Year 2 adjustment: 24,000 – 12,000 = 12,000

Finally, it is essential to say, although the share did not reach the price requirement because it only reached a value of $18, this doesn’t indicate the entity shouldn’t recognize the labor expense resulting from the agreement.

This is so because the said possibility was considered when estimating the stock options’ fair value at $8 on the grant date.

Illustrative Example 5: Share-based payments with a performance condition NOT related to the market.

 

An entity agrees with 30 of its employees the rendering of its services in exchange for 400 shares at $15.

The company determined as a requirement that the worker must remain giving his services for two years, and the entity’s sales must be increased by more than 8% throughout the vesting period.

As of December 31 of year 2, the fair value of the shares is $20, and sales increased by 10%.

 The accounting recognition is shown below: 

accounting recognition 5 IFRS 2

The calculation is as follows:

Year 1 share-based payments: (number of employees X number of shares X share price) X time elapsed.

Year 2 share-based payments: (number of employees X number of shares X share price) X time elapsed.

Share-based payments year 1: (30X15X400) X1 / 2 = 90,000.

Year 2 share-based payments: (30X15X400) X2 / 2 = 180,000.

Accounting adjustment year 2: ending balance – beginning balance.

Accounting adjustment year 2: 180,000 – 90,000 = 90,000.

As you can see, in this example, the $20 share fair value is indifferent because this transaction is a not referred market performance condition.

Therefore, only is it necessary for the sales to increase by more than 8%, and the employee keeps giving his services during the agreement term.

Therefore, only is it necessary for the sales to increase by more than 8%, and the employee keeps giving his services during the agreement term.

Illustrative Example 6: share-based payments with a condition other the vesting.

 

At the beginning of year 1, an entity agrees with 10 of its employees that if the company’s profit increases by 18% in 2 years, the workers will obtain 120 entity shares with a market price of 12 dollars.

The entity doesn’t require that the employee remains for a specified period rendering his services for the entity.

In year 1, the profit increased by 12%.

Based on this information, the entity considers that it will meet the goal of reaching 18%

How should the entity recognize this transaction?

accounting recognition 6 IFRS 2

Calculation: (10 employees X 120 shares X market price)

As it’s not a performance condition market related, the option price it’s not reflected in the fair value of the option; for this reason, at the end of year 2, the entity must reverse the transaction because the increase in sales is less than the threshold imposed by the entity.

Share-based payments settled in cash

 

In this type of share-based payment transaction, the employee or third party with whom the entity agrees does not have access to the entity’s equity instruments.

In these types of agreements, the worker receives a payment in cash based on the company’s share price.

Share-based payments settled in cash example

 

An entity agrees with 20 company employees to pay 100 rights on the revaluation of shares.

The employees only can exercise these rights until the end of the agreement.

At the end of year one, the fair value of the share is $15, and 6 employees leave the entity.

At the end of year two, the fair value of the share was $28, and 3 other employees left the entity.

Solution

Cash share-based payments = (number of employees X number of shares X share price) X time elapsed.

Share-based cash payments year 1 = (14 X 100 X 15) X1 / 2 = 10,500

Cash share-based payments year 2 = (11 X 100 X 28) X2 / 2 = 10,500

Opening balance = 10,500

Ending balance = 30,800

Year 2 adjustment = 20,300

The accounting recognition is shown below:

accounting recognition 7 IFRS 2

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