ACCA P2 (INT) Corporate Reporting - Study text - 2010 (Emile Woolf)
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Chapter 14: Employee benefits and share based payments
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subsequent year-ends is not relevant: in normal circumstances, the share options are
not re-valued each year.
No vesting conditions
Where the right to the equity instruments, such as share options, vests immediately,
so that there are no vesting conditions, it is assumed that the services (or goods)
provided that create the entitlement to the equity instruments have already been
provided.
The accounting treatment is therefore simply:
Debit: Cost of recognised services already received (usually an employment cost)
Credit: Equity
(Cost = fair value of the share options awarded.)
Example
PQR buys some inventory on 1 January 20X7 for $100,000, but instead of settling in
cash it pays for the inventory by issuing 10,000 $1 shares to the supplier on 31
January 20X7.
The direct measurement method will be used to measure the fair value of this equity
settled share based transaction.
$ $
DRPurchases 100,000
CRSharecapital(nominalvalue)
10,000
CRSharepremium(balance)
90,000
Example
PQR awards 1,000 shares to its top sales team at the end of the year. The shares have
a nominal value (par value) of $1 and a market value of $5 each.
This is another equity-settled share based transaction but here it is not possible to
measure the contribution provided by the sales team to the company. As it is not
possible to fair value their services, the direct method cannot be used. Instead, the
indirect method is used and the transaction is measured using the fair value of the
shares granted, $5,000 (1,000 shares × $5).
$ $
DRWagesandsalaries 5,000
CRSharecapital(nominalvalue)
1,000
CRSharepremium(balance)
4,000
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Vesting conditions and a vesting period
The rights to the equity instruments may not vest immediately, but only after the
end of a vesting period. For example, the right to exercise share options may not
‘vest’ until after a period of three years after the options are granted. (If the right to
exercise share options depends on achieving a performance target, the length of the
vesting period should be estimated.)
In such cases, the cost of the equity instruments should be spread over the vesting
period, on a straight-line basis. This is because it is assumed that the services (or
goods) to which the equity instruments relate are provided to the entity during the
vesting period.
In accounting for share options, the cost of the options that have been granted
accumulates over the vesting period. Vesting conditions are taken into account by
adjusting the number of equity instruments included in the measurement of
accumulated cost.
For example, suppose that an employee is granted 30,000 share options and a
vesting condition is that the employee should work for three more years in order to
earn the right to exercise the options.
At the end of Year 1, the number of options taken into consideration in
measuring the cost of the share options is 10,000 (30,000 × 1 year/3 years).
At the end of Year 2, the number of options taken into consideration in
measuring the cost of the share options is 20,000 (30,000 × 2 years/3 years).
At the end of Year 3, the number of options taken into consideration in
measuring the cost of the share options is the actual number of options for which
the exercise rights are vested. This is 30,000.
The amount charged as an employment cost in the income statement each year is
the difference between:
the accumulated cost of the options as at the end of the current year, and
the accumulated cost of the options as at the end of the previous year.
Failure to satisfy vesting conditions
Eventually, the cost of the services (or goods) received by the entity in return for
equity instruments should be based on the actual number of equity instruments
(such as options) that actually vest. So on a cumulative basis, no cost is recognised
for services (or goods) if the equity instruments do not vest because of a failure to
satisfy the vesting conditions.
For example, suppose that an employee is granted share options which may be
exercised on condition that he should work for the company for at least three more
years. If the employee is still working for the company after one year, the
cumulative cost should be based on the cost of 1/3 of the options granted. If the
employee then leaves the company in the following year, the cumulative cost at the
end of year 2 is reduced to 0 options, because the employee has failed to satisfy the
vesting conditions, and the options will not vest at the end of three years.
Chapter 14: Employee benefits and share based payments
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IFRS 2 requires that an entity should recognise an amount for services (or goods)
received during the vesting period, based on the best estimate of the number of
options (or other equity instruments) that are expected to vest. Where appropriate,
the best estimate should be revised at the end of each financial period. At vesting
date, the cumulative cost of the options (or other equity instruments) should be
based on the number of options that actually vest.
Example
A company grants 1,000 share options to each of 200 employees. Each grant is
conditional on the employees working for at least three years for the company.
The value of the options at the grant date is estimated at $12 per option, using an
option pricing model.
Year 1
The company estimates that 20% of the employees will leave within three years and
so will lose their right to their options. During Year 1, 13 employees leave the
company, and the estimate that 20% will leave within three years is not changed.
The cost of the share options in Year 1, recorded as an employment cost and an
addition to equity, is:
1/3 × 200,000 options × 80% × $12 = $640,000.
This is recorded as:
DR Employment costs $640,000
CR Equity $640,000
Year 2
During Year 2, another 12 employees leave, and the company does not change its
estimate that 20% will leave within three years. The cost of the options (employment
cost and addition to equity) is calculated for Year 2 as follows:
$
Cumulativecost,endofYear2
2/3×200,000options×80%×$12 1,280,000
Cumulativecost,endofYear1 (seeabove) 640,000
Year2cost
640,000
Year 3
At the end of Year 3, a total of 40 employees have left the company, and the
remaining 160 receive the right to exercise their share options. The cost of the
options (employment cost and addition to equity) is calculated for Year 3 as follows:
$
Cumulativecost,endofYear3
160,000options×$12 1,920,000
Cumulativecost,endofYear2 (seeabove) 1,280,000
Year3cost
640,000
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In practice, however, the estimate of the number of share options that will
eventually vest is likely to change each year. The cumulative cost each year should
be based on the best current estimates of the number of equity instruments that will
eventually vest.
Example
A company grants 1,000 share options to each of 200 employees. Each grant is
conditional on the employees working for at least three years for the company.
The value of the options at the grant date is estimated at $12 per option, using an
option pricing model. Initially, the company expects that 20% of these employees
will leave before the end of the three years.
Year 1
During Year 1, 18 employees leave the company, and the company revises its
estimate of the number of employees who will leave from 20% to 25%. The current
value of the share options is now $14.
The cost of the share options in Year 1, recorded as an employment cost and an
addition to equity, is:
1/3 × 200,000 options × 75% × $12 = $450,000.
(The current value of the options is irrelevant.)
Year 2
During Year 2, only 5 more employees leave the company, and the company revises
its estimate of the number of employees who will leave from 25% to 15%.
The cost of the options (employment cost and addition to equity) is calculated for
Year 2 as follows:
$
Cumulativecost,endofYear2
2/3×200,000options×85%×$12 1,360,000
Cumulativecost,endofYear1 (seeabove) 450,000
Year2cost
910,000
Year 3
At the end of Year 3, a total of 38 employees have left the company, and the
remaining 162 receive the right to exercise their share options. The cost of the
options (employment cost and addition to equity) is calculated for Year 3 as follows:
$
Cumulativecost,endofYear3
162,000options×$12 1,944,000
Cumulativecost,endofYear2 (seeabove) 1,360,000
Year3cost
584,000
Chapter 14: Employee benefits and share based payments
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2.4 Cash-settled share based payments
Cash-settled share based payment transactions occur when goods or services are
paid for at amounts that are based on the price of the company’s equity instruments.
The expense for cash-settled transactions is the cash paid by the company. For
example, share appreciation rights entitle employees or other third parties to cash
payments equal to the increase in the share price of a number of an entity’s shares
over a specified period of time.
Where a company pays for goods or services by incurring a liability linked to their
share price, the transaction should be measured at the fair value of the liability.
Until the liability is settled, the entity must re-measure the liability at the end of
each reporting period, and again at the date of settlement.
If there is a vesting period, the expense is spread over this period in the same way as
for equity-settled schemes.
Example
Entity X grants 100 cash-settled share appreciation rights (SARs) to each of its 500
employees. The grant is conditional on the employee working for Entity X for the
next three years.
By the end of year 1, 400 employees are expected to stay for three years and collect
their rights. Over the year, the company’s share price has increased by $9.
The company must settle in cash, which means that each time the share price rises
the cost to the company of issuing the rights increases.
EndofYear1
Totalexpectedexpense:
$
400employees×100SARs×fairvalue$9 360,000
3yearstovest
×2/3
Expensetodate
120,000
$
$
DRWagesandSalaries
120,000
CRLiability
120,000
By the end of year 2, 410 employees are expected to stay until the rights vest. The
fair value of a right is now $11.
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EndofYear2
Totalexpectedexpense:
$
410employees×100SARs×fairvalue£11 451,000
3yearstovest
×2/3
Expensetodate
300,667
Minus:Expenserecordedinyear1 (120,000)
Expenseforyear2 180,667
$
$
DRWagesandSalaries
180,667
CRLiability
180,667
2.5 Share based payments and deferred tax
In some tax jurisdictions, a tax allowance is given for share based transactions.
Sometimes, this allowance amounts to the intrinsic value of the share option (the
difference between the market value of the shares and the exercise price for the
option). This leads to a deferred tax asset.
For example, if the fair value of a share option at the grant date is $10m, the tax
allowance on the intrinsic value is $8m and the tax rate is 30%. The options vest in 4
years.
The deferred tax assets is $8m × 30% × ¼ = $600,000.
This deferred tax assets can only be recognised if there are sufficient future profits to
offset against.
2.6 IFRS 2: disclosure requirements
IFRS 2 requires an entity to disclose information that will enable users of its
financial statements to understand the nature and extent of share-based payment
transactions that have existed during the financial period.
The required disclosures include:
A description of each type of share-based payment arrangement that existed at
any time during the financial period, including their general terms and
conditions such as vesting conditions
The number and weighted average price of share options for each of the
following ‘groups’ of options
− options outstanding at the beginning of the year
− options granted during the year
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− options forfeited during the year
− options that were exercised during the year
− options that expired (and were not exercised) during the year
− options outstanding at the end of the year
− of these, options that could already be exercised as at the end of the year
For the share options exercised during the year, the weighted average share
price at the exercise dates
For the share options outstanding at the end of the year, the range of exercise
prices and their weighted average remaining contractual life.
2.7 Comments on IFRS 2
IFRS 2 is the first IFRS to deal with accounting for share-based payments. A very similar
standard already existed in the US, but in some countries, companies have been able to
avoid accounting for such items.
In the UK, guidance in UITF 17 required rewards of share options to be accounted for at
their intrinsic value, rather than fair value. Intrinsic value is the difference between the
market value of the shares and the exercise price for the option. (This is the price at
which the holder of the options can apply to buy new shares when the options vest.)
When share options are first issued, their exercise price is often higher than the current
market price and so the intrinsic value is zero. So a move to ‘fair values’ for options
would considerably increase the cost recorded in a company’s income statement.
It is therefore not surprising that IFRS 2 met with considerable criticism. Many
companies have threatened to withdraw their share based payment schemes, because
they lower their reported profit and affect their EPS.
IFRS 2 is also very complicated, particularly in the valuation of share options.
Option pricing models such as Black-Scholes or the Binomial model were not
previously used by companies and the models are complicated to apply.
The IASB believe that the value of share-based payment transactions, including
employee share options, must be reflected in the accounts. It does not feel that it is
the responsibility of the IASB to design accounting standards around the ‘political’
needs of companies.
2.8 IFRIC Interpretation 11: IFRS 2 – Group and treasury share transactions
IFRIC 11 deals with whether the following transactions should be accounted for as
equity-settled or as cash-settled under the requirements of IFRS 2:
(a) An entity grants to its employees rights to equity instruments of the entity (e.g.
share options), and either chooses or is required to buy the equity instruments
(i.e. treasury shares) from another party, to satisfy its obligations to its employees.
(b) An entity’s employees are granted rights to equity instruments of the entity (e.g.
share options), either by the entity itself or by its shareholders, and the
shareholders of the entity provide the equity instruments needed.
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IFRIC 11 states that share-based payment transactions in which an entity receives
services as consideration for its own equity instruments shall be accounted for as
equity-settled. This applies regardless of whether the entity chooses or is required to
buy those equity instruments from another party to satisfy its obligations to its
employees under the share-based payment arrangement. It also applies regardless
of whether:
(a) the employee’s rights to the entity’s equity instruments were granted by the
entity itself or by its shareholder(s) or
(b) the share-based payment arrangement was settled by the entity itself or by its
shareholder (s)
The second issue dealt with in IFRIC 11 concerns share-based payment arrangements
that involve two or more entities within the same group. For example, employees of a
subsidiary might be granted rights to equity instruments of its parent as consideration
for the services provided to the subsidiary. However, IFRS 2 does not give guidance on
how to account for such transactions in the individual or separate financial statements
of each group entity.
IFRIC 11 states that where a parent grants rights to the employees of the subsidiary,
(provided that the share-based arrangement is accounted for as equity-settled in the
consolidated financial statements of the parent) the subsidiary shall measure the
services received from its employees in accordance with the requirements applicable to
equity-settled share-based payment transactions, with a corresponding increase
recognised in equity as a contribution from the parent.
Where a subsidiary grants rights to equity instruments of its parent to its employees,
the subsidiary shall account for the transaction with its employees as cash settled.
2.9 IFRIC Interpretation 8: Scope of IFRS 2
IFRIC deals with a share-based payment where the entity cannot identify some or
all of the benefits received in return for a share-based payment. For example, an
entity might grant shares to some individuals (other than employees) who are
members of a local community, possibly as a means of enhancing its reputation
amongst customers. The company might expect long-term economic benefits from
the granting of shares, but cannot identify the specific benefits that it will receive.
IFRIC 8 states that for this type of transaction, the entity should account for the
share-based payment in accordance with IFRS 2. The unidentifiable goods or
services received should be measured at the fair value (at the grant date) of the
equity instruments granted.
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Paper P2 (INT)
Corporate Reporting
CHAPTER
15
Taxation
Contents
1 Current tax and deferred tax
2 Deferred tax: principles
3 Deferred tax: individual company
4 Deferred tax: business combinations
5 Tax: presentation and disclosure
6 ED 2009/2: Income tax (withdrawn in October
2009)
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Current tax and deferred tax
Current tax
Deferred tax
1 Current tax and deferred tax
IAS 12: Income taxes deals with accounting for tax on the profits of entities. It deals with
both current tax and deferred tax.
1.1 Current tax
The rules on accounting for current tax are set out briefly below.
A company’s profits are subject to income tax. Under the accruals concept, the tax
expense and current tax liability are recognised at the same time as the associated gain
or loss, not when the tax is paid.
The income tax expense is usually charged to profit and loss. However if the gain
or loss being taxed was recognised as other comprehensive income (and directly in
equity, for example as a revaluation gain) then the tax effect should also be
recognised in other comprehensive income and directly in equity, and should not
be included in profit or loss.
Tax payable is not settled immediately and so there will be a liability in the
statement of financial position for the current tax that is payable.
The total current tax charge for the year is estimated for the purposes of preparing
the year-end accounts, but is not finalised by the tax authorities until after the year
end.
Under-provision or over-provision of tax in the previous period
If the final amount collected differs from the estimated amount charged, the under-
provision or over-provision is adjusted through the next year’s profit and loss. A prior
year adjustment must not be recorded when adjusting an accounting estimate.
Any such under- or over-provisions are dealt with in profit or loss for the following
accounting period.
Example
Entity X has a current tax liability at the end of Year 1 of $90,000. During Year 2 the
actual tax liability for Year 1 was finally agreed as $85,000 and this tax was paid. The
tax liability for Year 2 was estimated at $100,000.
$
EstimatedtaxliabilityforYear1
(90,000)
ActualtaxliabilityforYear1 (85,000)
Over‐provisionfortaxinYear1
(5,000)