MIDTERM: Share-Based Payment 1

MODIFICATIONS, CANCELLATIONS AND SETTLEMENTS

- An entity sometimes modifies or cancels share-based payment awards before they vest because the vesting conditions become too onerous to achieve, or the share price of an equity instrument has dropped so far below the exercise price that it is unlikely it will ever be "in the money' during its life. - In such circumstances, an entity may replace the original vesting conditions of the share-based payment award with less onerous conditions, making it easier for the employee to meet the conditions of the award. - lf an entity modifies a vested award, it recognises any additional fair value given on the modification date. If the fair value of the new instruments is lower than the fair value of the old instruments, recognition is based on the original grant date fair value i.e. such modifications are ignored the original fair value of the equity instruments granted should be expensed as if the modification never occurred. If the fair value of the new instruments is greater than the fair value of the old instruments, recognition is the sum of: - The original grant date fair value; and - The incremental fair value - The incremental amount is recognized over the remaining vesting period (or immediately if modification happens after the vesting period), which may differ from The vesting date of the original award. - Any increase or decrease in the fair of an award as a result of a modification is determined at the modification date.

NON-VESTING CONDITIONS

- Conditions that neither the entity nor the counterparty can choose to meet •Inflation must not be higher than 5% •Price of gold must increase by more than 3% - Conditions that the counterparty can choose to meet • Holding participation shares over the holding period • Paying monthly contributions to a share purchase plan - Conditions that the entity can choose to meet •Continuation of the plan by the entity

SCOPE

- Equity-settled share-based payment transactions. - Cash-settled share-based payment transactions. - Share-based payment transactions with cash alternatives. - Group share-based payment plans. - Goods do not include financial assets, but do include inventories, consumables, property, plant and equipment, intangibles, and other non-financial assets. - - Even if an entity cannot specifically determine the goods or services it receives in return for its shares, it must apply PFRS 2.

DEALING WITH VESTING CONDITIONS

- Here, the principal question is whether vesting condition exists or not. - NO: If the share-based payment is vested immediately, or there are no vesting conditions, then PFRS 2 regards this transaction as granted in return for the supplier's (employee's) service in the past. - Therefore, an entity needs to recognize the services received immediately in full at the grant i date, with the corresponding increase in equity. - YES: If the share-based payment does not vest until the counterparty meets some vesting conditions, then P FRS 2 regards this transaction as granted in return for the supplier's (employee's) service rendered during the vesting period. - In this case, an entity should recognize an amount for the goods or services received during the vesting period based on the best available estimate of the number of equity instruments expected to vest.

VESTING CONDITIONS

- If there are some specified vesting conditions, these must be met before receiving any share-based payment. - Some share-based payment transactions include vesting conditions that must be met before any payment is made. - vesting condition is a condition that determines whether the entity receives the services that entitle the counterparty to receive cash, other assets or equity instruments of the entity, under a share- based payment arrangement.

SHARE-BASED PAYMENT TRANSACTION

- Share-based payment arrangement is an agreement between the entity and another party (including an employee) whereby the other party receives cash or other assets of the entity for amounts that are based on the price (or value) of equity instruments (including shares or share options) of the entity or another group entity. - This type of arrangement is cash-settled share-based payment transaction. - Alternatively, the other party can receive equity instruments (including shares or share options) of the entity or another group entity. This type is called equity-settled share-based payment - There is also the third type of share-based payment arrangements: transactions in which either the entity or the supplier has a choice of settlement (to receive equity instruments or cash/other assets).

MULTIPLE VESTING PERIOD

- Share-based payment awards frequently have one grant date and different vesting periods. - An entity must separately determine the fair value of each award with a different vesting period and recognise the expense over the vesting period.

IMPACT OF CONDITIONS ON MEASURING SHARE-BASED PAYMENTS

- Under PFRS 2, the nature of the condition (i.e., vesting or non-vesting, service, performance, market or non-market) affects the timing of when the expense is recognised and, in some cases, The measurement of the expense. - In addition, if a condition is not. met, whether or not the entity may reverse the previously recognised compensation expense depends on the nature of the condition that was not met - Therefore, the classification of a condition is a critical step in accounting for share-based payments transactions. - Market conditions are only taken into account when estimating the fair value of the award at the grant date. - Non-market vesting conditions are not taken into account when estimating the fair value of the shares or share options at the grant date. - Instead, these vesting conditions are taken into account by adjusting the number of equity instruments included in the measurement of the transaction amount so as to reflect the number of awards that are expected to vest. - Such non-market vesting conditions include a service condition. - Performance conditions can either be market conditions or non-market conditions. - Under PFRS 2, an entity only recognises compensation expense for options with non-market performance conditions if such awards ultimately vest. - Therefore, if an entity grants options to a large number of employees on one grant date, the entity would need to estimate the number of employees that will terminate employment prior to meeting the non-market performance conditions, i.e., the number of employees that will forfeit awards. - The entity adjusts its estimate of awards that will vest at each reporting date so that, on the vesting date, the expense recognis equals the grant date fair value of the options that have vested.

GROUP SHARE-BASED PAYMENT PLANS

- it is common practice for a group to operate a single share scheme covering several subsidiaries. - MFRS 2 provides requirements in respect of transactions settled in the equity of either the entity or the parent, as well as cash-settled transactions that are settled by a group entity other than the entity receiving the goods or services. A parent might decide to grant equity-settled awards to employees of its subsidiary. - The subsidiary must account for the services received from its employees as an equity-settled award in its own financial statements. - A subsidiary might grant its employees rights to equity instruments of the parent. - The subsidiary accl)unts for the transaction with its employees as cash- settled. This applies irrespective of how a subsidiary obtains the equity instruments to satisfy its obligation to its employees. - MFRS 2 considers arrangements in which the parent has an obligation to make cash payments to the employees of a subsidiary that are linked to the price of either the subsidiary's equity instruments or its own equity instruments. - In both cases, the subsidiary has no obligation to settle the transaction. Therefore, the subsidiary accounts for the transaction as equity-settled, recognizing a corresponding credit in equity as a contribution from its parent. - The subsidiary subsequently re-measures the cost of the transaction only for any changes resulting from non-market vesting conditions not being met in accordance with the provisions of IFRS 2. -This will differ from the measurement of the transaction as cash-settled in the consolidated financial statements of the group. In both cases (where the parent has an obligation to make cash payments to the employees of the subsidiary that are linked to the price of either the subsidiary's equity instruments or is own equity instruments), the parent has an obligation to settle the transaction in cash. Accordingly, the parent accounts for the transaction as cash-settled in both its consolidated and separate financial statements

RECOGNIZING CASH-SETTLED SHARE-BASED PAYMENT TRANSACTIONS

-For cash-settled share-based payments, the entity recognises the services received and the liability for those services as the employees render them. - lf an employee is not required to provide a service, as is the case for some share appreciation rights, the entity recognises the expense and liability immediately upon grant date - If the employee is required to provide services over for a specified period in order to vest in the cash-settled award, the entity recognises the expense and the liability over the vesting period, while reconsidering the likelihood of achieving vesting conditions and re-measuring the fair value f the liability at the end of each reporting period. Typical examples of cash-settled share-based payment transactions are: - Share appreciation rights: employee is entitled to the cash payment in the future based on the increase of entity's share price over specified period of time from a specified level; - Rights to redeemable shares employee will receive the shares in the future that are redeemable in cash. - Similarly as in the equity-settled share-based payment transaction, the goods or services received are measured at the fair value of the liability. - The fair value of the liability has to be re-measured at each reporting date until this liability is settled and any changes of fair value are recognized in profit or loss. - The ultimate cost of a cash-settled award is the cash paid to the counterparty, which is the fair value at settlement date. - Until the award is settled, an entity presents the cash-settled award as a liability and not within equity. - Thus, changes in the measurement of the liability are reflected in the statement of profit or loss and other comprehensive income. - MFRS 2 does not specifically address the impact of vesting conditions within the context of cash-settled share-based payment transactions. - Vesting conditions are treated in the similar manner as in the equity-settled share-based payment transactions.

RECOGNIZING SHARE-BASED PAYMENTS

-The basic recognition principle is to recognize goods or services received in a share-based payment transaction when the goods are obtained or as the services are received. - Goods or services acquired should be recognized as expenses in profit or loss unless they qualify for recognition as assets. That is the debit side of an accounting entry. The credit side depends on the type of share- based payment arrangement: - If the goods or services were acquired in an equity-settled share-based payment transaction, then the corresponding increase is recognized in equity. - If the goods or services were acquired in a cash-settled share-based payment transaction, then the corresponding increase is recognized as a liability.

MARKET OR NON-MARKET CONDITIONS

A market condition is a performance condition and the performance conditions are related to the market price (or value) of the entity's equity instruments, such as: - attaining a specified share price, or - achieving a specified target that is based on the market price (or value) of the entity's equity instruments relative to an index of market prices of equity instruments of other entities - A condition linked to a purely internal financial performance measure, such as profit or earnings per share, is not a market condition. - Such measures will affect the share price, but are not directly linked to it, and hence are not market conditions. - In order for a market condition to be treated as a performance vesting condition rather than a non- vesting condition, there must also be an implicit or explicit condition.

DISCLOSURES

Among other things, MFRS 2 requires entities to disclose the following: - The type and scope of agreements existing during the reporting period. - Descriptions of each type of arrangement, including general terms and conditions of the arrangement (e.g., settlement methods, vesting conditions) - The number and weighted-average exercise price of share options (outstanding at the beginning of the reporting period and at the end of the reporting period, granted, vested, exercised, expired and forfeited during the period). - The average share price of exercised options. The range of exercise prices and weighted average remaining contractual life of options outstanding at the end of the reporting period. - The valuation method used to estimate the fair value of the awards (model and input values, etc.). - The impact on the income statement (i.e., total expense) and the financial position (e.g., carrying amount of liabilities) of share- based payment awards. -Detailed disclosure requirements in MFRS 2 are limited to stock option plans. -Hence, judgment is needed to apply the disclosure principles to the wide variety of plans that exist in practice. - Entities must also consider the impact of any interaction with the disclosure requirements in MFRS 124 Related Party Disclosures on key management compensation. - In addition, entities may need to consider additional local disclosure requirements on compensation.

BASIC PRINCIPLES

At each subsequent reporting date until vesting, the entity calculates a best estimate of the cumulative charge to profit or loss at that date, being the product of: - The grant date fair value of the award. - The current best estimate of the number of awards that will vest. - The expired portion of the vesting period. - The charge (or credit) to profit or loss for the period is the cumulative amount calculated above less the amounts already charged in previous periods. - An expense (or an asset if the goods and/or services received meet the criteria for recognising an asset) - A corresponding increase in equity (for transactions settled in equity instruments) or in liabilities (for cash-settled transactions). - Once the awards have vested, no further accounting adjustments are made to the cost of the award, except in respect of certain modifications to the award.

MEASURING EQUITY-SETTLED SHARE-BASED PAYMENT

EMPLOYEE measurement basis: - Fair value of equity instruments awarded measurement date: - Grant date recognition date: - Date services received NON-EMPLOYEE measurement basis: - Fair value of goods or services received measurement date: - Date goods or services received recognition date: - Date goods or services received

DETERMINING THE FV OF EQUITY INSTRUMENTS GRANTED - NON- EMPLOYEES

Measured directly at the fair value of goods and services received - If the fair value of goods and services cannot be estimated reliably, measure the fair value of equity instrument. - If the fair value of the equity instrument granted cannot be estimated reliably (only in very rare cases), equity instruments are measured at their intrinsic value. Measured at the date the goods or services are obtained - As opposed to grant date. - Means "daily" if services are rendered. - Simplification method: "regular intervals".

DETERMINING THE FV OF EQUITY INSTRUMENTS GRANTED EMPLOYEE

Measuring Fair Value - Measure employee services indirectly, based on fair value of equity instruments granted. - Fair value of equity instruments measured at market price for instruments with similar terms and conditions (rarely available) - If no market exists, fair value is estimated by applying a valuation model (e.g. option pricing model). - If fair value is not measurable reliably (only in very rare cases), then services are measured at the intrinsic value of the equity instruments. Date of measurement - Fair value is measured at grant date. -As there are often no quoted market prices for share-based payment awards, PFRS 2 requires entities to estimate the grant date fair value of their share-based payment awards using option- pricing models. - PFRS 2 does not require entities to use a specific option-pricing model to calculate fair value. - However, it does require that the adopted valuation technique is consistent with generally accepted valuation methodologies for pricing financial instruments. - PFRS 2 requires that, at a minimum, the entity must use six inputs in whichever model is selected.

PFRS 2 recognizes 2 types of vesting conditions:

Service conditions: they require the counterparty to complete a specified period or service; Performance conditions: they require the counterparty to complete a specified period of services and specified performance targets to be met. - A performance condition is further defined as either a market condition or a non-market condition.

The objective of PFRS 2

Share-based payment is to specify the financial reporting by an entity when it undertakes a share- based payment transaction. PFRS 2 requires an entity to reflect the effect of share-based payment transactions (including share options to employees) in its profit or loss and statement of financial position.

SHARE-BASED PAYMENT TRANSACTION

Share-based payment transaction is a transaction in which the entity: - receives goods or services from the supplier (including employee) in a share-based payment arrangement; or - incurs an obligation to settle the transaction with the supplier in a share-based payment arrangement when another group entity receives those goods or services.

Scope of PFRS 2

The requirement to account for various share-based payment transactions is relatively new and are included in PFRS 2 Share-Based Payment. In the past, many share-based transaction were not attributed a cost (for example, share options provided to employees) despite the fact that the use of such instruments as share options in employee reward structures was widespread. There was great disparity in treatment of share-based payment transactions. Made inter-firm comparison difficult. This lead to a perceived need for an accounting standard. However, the introduction of PFRS 2 was relatively unpopular with business as it forced them to put a cost on transactions that were previously often treated as being of no cost.

DETERMINING THE FAIR VALUE OF EQUITY INSTRUMENTS GRANTED

There is a whole guidance on how to determine the fair value of equity instruments granted in PFRS 2 and PFRS 13 Fair Value Measurement, too albeit differs in some respects with regards to the definition of fair value.

TIMELINE OF A SHARE OPTION AWARD

Vesting period - the period during which all the specified vesting conditions are to be satisfied Grant date - the date at which the entity and the counter party have a shared understanding of the terms and conditions of the arrangement Vesting date- the date when the vesting conditions for entitlement are satisfied Exercise date- is the date when awards (e.g. options) are exercised.

CANCELLATION/ SETTLEMENT

When an award is cancelled or settled during the vesting period, it is treated as an acceleration of vesting. - Recognise immediately the remaining unrecognized amount that otherwise would have been recognised for services over the remaining vesting period. - Cancellations by the employer and by the employee. When an entity pays compensation for a cancelled or settled award: - Any compensation paid up to the fair value of the award at cancellation or settlement date (whether before or after vesting) is accounted for as a deduction from equity, as being equivalent to the redemption of an equity instrument. - Any compensation paid in excess of the fair value of the award at cancellation or settlement date (whether before or after vesting) is accounted for as an - Any payment made to settle a liability component is accounted for as an extinguishment of the liability

arrangement, it needs to determine:

When an entity enters into a share-based payment - The classification of the share-based payment i.e. whether it is equity-settled or cash-settled. - The grant date. Vesting conditions, if any, and whether they are market or non-market related. - The period over which the award vests. - The fair value at grant date.

NON-VESTING CONDITIONS IPFRS 2

does not specifically define a non-vesting condition, but uses the term to describe a condition that is neither a service condition nor a performance condition - performance condition is distinguished from a non-vesting condition in that it has an explicit or implicit service requirement whereas a non-vesting condition does not. - This means that, if an employee is entitled to an award on the grant date and is not required to provide any future services to the entity, such a condition is not regarded as a vesting condition for the purpose of PFRS2. Instead, it is referred to as a non-vesting condition. - Examples of non-vesting conditions include a non-complete clause, a target based on a commodity index or the employees paying contributions towards the exercise price of a share- based payment award.