IFRS 2 - Share-based payments

Academic Resource Center Share-based payments and earnings per share Page 2 Typical coverage of US GAAP ► Share-based payments (SBP): ► Scope ► Stock compensation ► Measurement ► Cost allocation ► Employee stock purchase plans ► SBP to non-employees ► Presentation and disclosure

Academic Resource Center Share-based payments and earnings per share Page 3 Executive summary SBP: ► The accounting for SBP is fairly well converged at this point. While there are a number of detailed differences discussed below, the basics of accounting for SBP are the same under both IFRS and US GAAP. ► In the case of graded vesting, IFRS must recognize compensation expense by measuring each tranche separately. Under US GAAP, companies have the choice between this accelerated approach or the straight-line approach, which does not separate the tranches.

Academic Resource Center Share-based payments and earnings per share Page 4 Primary pronouncements US GAAP ► ASC 718, Compensation – Stock Compensation ► ASC , Equity-Based Payments to Non-Employees IFRS ► IFRS 2, Share-based Payments

Academic Resource Center Share-based payments and earnings per share Page 5 Progress on convergence SBP: ► No further convergence planned at this time.

Academic Resource Center Share-based payments and earnings per share Page 6 SBP Scope Guidance applies to transactions with employees and non-employees and the accounting is applicable to all companies. Guidance applies to transactions whereby an entity: (1) acquires goods or services in exchange for issuing shares or share options or other equity instruments, or (2) incurs liabilities that are based, at least in part, on the price of its shares or that may require settlement in its shares. Similar IFRSUS GAAP

Academic Resource Center Share-based payments and earnings per share Page 7 SBP Stock compensation: measurement Requires a fair-value-based approach in accounting for share-based payment arrangements. The fair value of the shares to be measured is based on market price, if available, or is estimated using an option-pricing model. The intrinsic value can be used if the market value cannot be determined. Similar IFRSUS GAAP

Academic Resource Center Share-based payments and earnings per share Page 8 SBP Stock compensation: measurement IFRS ► If an entity modifies stock option vesting terms, then the entity must, at a minimum, recognize the original amount of the expense of the award under its original terms. ► If the fair value of the award at the modification date is less than the fair value at the grant date, then there is no reduction in cost. US GAAP ► The original grant-date fair value is no longer used to measure compensation cost under any circumstances. Rather, the fair value of the options at the modification date is used to measure the compensation expense. Entities that grant stock options or SBP, in many cases, decide to make modifications to the vesting terms for a variety of reasons, such as to maintain high employee morale or reward outstanding employees. This is especially true when it is improbable that the vesting conditions will be met and the entity wants to provide compensation to an employee. For this scenario:

Academic Resource Center Share-based payments and earnings per share Page 9 SBP Stock compensation: measurement IFRS ► Modification of terms (continued): ► However, if the fair value at the modification date is greater than the fair value of the award at the grant date, then the incremental fair value (the difference between the fair value at the original grant date and the fair value at the modification date) must be recognized at cost. US GAAP Entities that grant stock options or SBP, in many cases, decide to make modifications to the vesting terms for a variety of reasons, such as to maintain high employee morale or reward outstanding employees. This is especially true when it is improbable that the vesting conditions will be met and the entity wants to provide compensation to an employee. For this scenario:

Academic Resource Center Share-based payments and earnings per share Page 10 Example 1 – Bull’s Eye Inc. (BEI) granted 1,000 share options to certain sales employees on January 1, The share options vest at the end of three years (cliff vesting) but are conditional upon selling 150,000 dartboard units over the three-year service period. The grant-date fair value of each option is $ No forfeitures are expected to occur, unless the sales target of 150,000 units is not met. BEI is expensing the cost of the options on a straight-line basis over the three-year period at $5,000 per year (1,000 options x $15 ÷ 3 = $5,000). On January 1, 2009, BEI’s management believes the original sales target of 150,000 units will not be met because only 30,000 dartboard units were sold in 2008, and there has been a general economic business decline. Management modifies the sales target to 100,000 units, which it believes is achievable. No other terms or conditions of the grant are modified. The fair value of each option at January 1, 2009, is $8.00. Modification of vesting terms that are improbable of achievement example ► How should BEI account for the compensation expense under US GAAP and IFRS in 2008, 2009 and 2010? Show the necessary journal entries.

Academic Resource Center Share-based payments and earnings per share Page 11 Example 1 solution: US GAAP: With the modification, there is a remeasurement of the fair value of the grant at the modification date, which leads to a fair value compensation cost of $8,000 (1,000 shares x $8.00 = $8,000) over the vesting period or $2,667 ($8,000 ÷ 3 = $2,667) per year. Since BEI already recognized $5,000 of compensation cost in 2008, the only costs to be recognized in 2009 and 2010 would be $1,500 ($8,000 - $5,000 = $3,000 ÷ 2 = $1,500), for a total recognized compensation cost of $8,000. IFRS: BEI must recognize, at a minimum, the original amount of the expense under the award, even if the modification reduces the fair value of the award. In this example, under IFRS, BEI would continue to recognize the original expense of $15,000 as $5,000 per year for each of the three years. Modification of vesting terms that are improbable of achievement example

Academic Resource Center Share-based payments and earnings per share Page 12 Modification of vesting terms that are improbable of achievement example US GAAPIFRS 2008 Compensation expense $5,000 Additional paid-in capital $5,000 Compensation expense $5,000 Additional paid-in capital $5, Compensation expense $1,500 Additional paid-in capital $1,500 Compensation expense $5,000 Additional paid-in capital $5, Compensation expense $1,500 Additional paid-in capital $1,500 Compensation expense $5,000 Additional paid-in capital $5,000 Total expense $8,000Total expense $15,000 Example 1 solution: (continued):

Academic Resource Center Share-based payments and earnings per share Page 13 SBP Stock compensation: cost allocation Compensation expense is recognized over the service period. The service period is assumed to be the vesting period, unless specified otherwise. In the case of cliff vesting (the entire award vests at the end of the vesting period), the expense is recognized using a straight-line approach. Similar IFRSUS GAAP

Academic Resource Center Share-based payments and earnings per share Page 14 SBP Stock compensation: allocation IFRS ► In the case of graded vesting, companies must recognize compensation expense on an accelerated basis. US GAAP ► In the case of graded vesting (portions of the award vest at different dates throughout the vesting period), for awards containing only service conditions, entities make an accounting policy election to recognize compensation expense either on a straight-line basis (the award is valued as a single award with an average expected life) or on an accelerated basis (each tranche is measured as a separate award with its own expected life).

Academic Resource Center Share-based payments and earnings per share Page 15 Example 2 On January 2, 2010, ABC’s Board of Directors approved granting 3,000 stock options to a select group of senior employees. The requisite service period is three years, with 33% of the options vesting each calendar year in 2010, 2011 and 2012 (graded vesting). An option-pricing model was used (Black-Scholes-Merton) to calculate fair value, which was determined to be $10 on the grant date. No forfeitures are assumed. Graded vesting of stock compensation expense example ► How should ABC account for the compensation expense under US GAAP (assuming the straight-line election has been made) and IFRS in 2010, 2011 and 2012? Show the necessary journal entries.

Academic Resource Center Share-based payments and earnings per share Page 16 Example 2 solution: US GAAP: ABC would recognize $30,000 of compensation expense calculated as 3,000 shares at $10 each multiplied by a 0% forfeiture rate. The expense each year would be as follows under the straight-line method ($30,000/3 years = $10,000 per year). Graded vesting of stock compensation expense example Year Compensation expense 2010$10, , ,000 $30,000

Academic Resource Center Share-based payments and earnings per share Page 17 Example 2 solution (continued): IFRS: ABC would recognize the same total expense of $30,000 as under US GAAP. ABC would allocate the expense to three tranches equally since there are three vesting periods. Each tranche is then allocated equally over its vesting period as follows: Note that these amounts have been rounded for presentation purposes. The 2010 tranche is 100% expensed in 2010 since it is wholly vested at the end of year one. The 2011 tranche is 50% expensed in 2010 and 2011 since it vests in two years. The 2012 tranche is 33% expensed in 2010, 2011 and 2012 since it vests in three years. Graded vesting of stock compensation expense example Year Compensation expense $10,000 $ – ,0005,000 – ,000 3,333 $30,000$18,333$8,333$3,333

Academic Resource Center Share-based payments and earnings per share Page 18 Graded vesting of stock compensation expense example US GAAPIFRS 2010 Compensation expense $10,000 Additional paid-in capital $10,000 Compensation expense $18,333 Additional paid-in capital $18, Compensation expense $10,000 Additional paid-in capital $10,000 Compensation expense $8,333 Additional paid-in capital $8, Compensation expense $10,000 Additional paid-in capital $10,000 Compensation expense $3,333 Additional paid-in capital $3,333 Total expense $30,000Total expense $30,000* * Rounded for presentation purposes. Example 2 solution (continued):

Academic Resource Center Share-based payments and earnings per share Page 19 SBP Employee stock purchase plans Addresses employee share purchase plans, which allow employees to purchase shares of an entity, at a discount, less than market price. Similar IFRSUS GAAP

Academic Resource Center Share-based payments and earnings per share Page 20 SBP Employee stock purchase plans IFRS ► All employee purchase plans are deemed to be compensatory, thus compensation expense is recorded for the amount of the discount. US GAAP ► If a plan is deemed to be non-compensatory, no compensation expense is recorded. A plan would be deemed non-compensatory if: ► The proceeds received by the employer are not less than the proceeds it would receive in an offering of shares through an underwriter (or the discount is consistent with that offered to all shareholders — 5% is generally accepted as the usual discount). ► Substantially all eligible employees may participate on an equitable basis. ► The plan does not include option features to allow employees to cancel their participation.

Academic Resource Center Share-based payments and earnings per share Page 21 Example 3 The Delicious Doughnuts Company (DDC) adopted an employee share purchase plan effective January 1, The plan provides all DDC employees who have worked for DDC more than 90 days, the right to purchase DDC common stock ($1 par value per share) at a 5% discount from the market price at the end of each payroll period, based on the average market price of the common stock during the same period. The plan does not allow cancellation of any purchase subsequent to the payroll period. During the first quarter of 2010, 4,500 employees elected to participate in the plan (75% of eligible employees) and purchased 45,000 shares of common stock at an average market price of $50 per share, with an average discount of $2.50 per share. Noncompensatory share purchase plans example ► How should DDC account for the compensation expense under US GAAP and IFRS during the first quarter of 2010? Show the necessary journal entries.

Academic Resource Center Share-based payments and earnings per share Page 22 Example 3 solution: US GAAP: As the plan is deemed non-compensatory, DDC does not record any compensation expense. Common stock: 45,000 shares x $47.50 ($ ) = $2,137,500 Cash$2,137,500 Common stock$ 45,000 Additional paid-in capital 2,092,500 Noncompensatory share purchase plans example

Academic Resource Center Share-based payments and earnings per share Page 23 Example 3 solution (continued) IFRS: All employee purchase plans are deemed compensatory so DDC must record an expense for the amount of the discount for the shares issued, or $112,500 calculated as 45,000 shares x $2.50 discount per share. Common stock: 45,000 shares x $50 per share = $2,250,000 Cash$2,137,500 Compensation expense 112,500 Common stock$ 45,000 Additional paid-in capital 2,205,000 Noncompensatory share purchase plans example

Academic Resource Center Share-based payments and earnings per share Page 24 SBP SBP to nonemployees Share-based awards to non-employees should be measured and recognized using the fair value method. Similar IFRSUS GAAP

Academic Resource Center Share-based payments and earnings per share Page 25 SBP SBP to non-employees IFRS ► The fair value of the transaction should be based on the fair value of the goods or services received and only on the fair value of the equity instruments if the fair value of the goods or services cannot be reliably determined. ► If using the fair value of the equity instruments, the measurement date is based on a service model approach using the date the entity obtains the goods or as the counterparty renders the services. If the goods or services are received on a number of dates over a period, the fair value at each date should be used. There is no performance commitment concept under IFRS. US GAAP ► The share-based award should be valued at either the fair value of the goods or services received or the fair value of the equity instruments issued, whichever is more reliable. If the fair value of the equity instruments issued is used, then the fair value is measured at the earlier of: (a) The date at which a commitment for performance by the counterparty is reached. (b) The date at which the counterparty’s performance is complete (i.e., goods or services fully received).

Academic Resource Center Share-based payments and earnings per share Page 26 Example 4 – On January 15, 2010, the purchasing manager of a large computer manufacturer, Supercomputer (Super), obtained approval from management and the Board of Directors to enter into a contract with a manufacturing software supplier to issue 1,000 shares of Super’s common stock ($1.00 par value per share) for delivery of a newly completed software program to be used in Super’s manufacturing process. The fair market value of the common stock was $50 per share on January 15, The purchasing manager reached an agreement with the vendor on January 31, 2010, and a contract was signed that day. The fair market value of the common stock was $52 per share on January 31, The vendor agreed to deliver the completed software on February 28, Measurement basis for non-employees example ► Assuming the software is delivered on February 28, 2010, at which time the fair market value of the common stock was $48 per share, what amount would Super record for this purchase under US GAAP and IFRS? Show the necessary journal entries. The vendor has sold similar software to other manufacturers, sometimes for common stock and sometimes for cash, usually at a negotiated amount. The vendor believes the selling price of the software should be about $75,000, or around that range (which, for this example, is an unreliable estimate).

Academic Resource Center Share-based payments and earnings per share Page 27 Example 4 solution: US GAAP: Because the purchase price of the vendor’s software can vary, the fair market value of the manufacturing entity’s common stock would seem to be a better indicator of the value. Under US GAAP, according to ASC , the earlier of either the date at which a commitment for performance is reached or when the performance is complete is used. Therefore, the commitment date is used, which is January 31, 2010 (1,000 shares x $52 = $52,000). Purchased manufacturing software $52,000 Par value — common stock $ 1,000 Additional paid-in capital 51,000 Measurement basis for non-employees example

Academic Resource Center Share-based payments and earnings per share Page 28 Example 4 solution (continued): IFRS: The fair market value of the goods or services or the fair market value of the common stock is also used to determine fair value, whichever is more reliable. Again, in this situation, the fair market value of the common stock would appear to be a better measure of fair value. However, under IFRS, the transaction is recorded when the entity obtains the software, which is February 28, 2010, and the fair value of the software at that time is determined to be $48,000 (1,000 shares x $48 = $48,000). Purchased manufacturing software $48,000 Par value – common stock $ 1,000 Additional paid-in capital 47,000 If the vendor’s estimate was reliable and thus the measure of fair value, the basis of the software would be $75,000 and Super would prepare the following journal entry using either US GAAP or IFRS: Purchased manufacturing software $75,000 Par value – common stock $ 1,000 Additional paid-in capital 74,000 Measurement basis for non-employees example

Academic Resource Center Share-based payments and earnings per share Page 29 Presentation and disclosure SBP Has extensive disclosure requirements related to share compensation plans, including measurement and recognition criteria. The pronouncements contain basic requirements to disclose the: ► Type and scope of arrangements existing during the period. ► Description of the agreements (settlement methods, vesting conditions, etc.). ► Number and average exercise price of share options by category, including: ► Options outstanding at the beginning of the period. ► Options outstanding at the end of the period. ► Options granted, vested, exercised and forfeited during the period. ► Options exercisable at the end of period. Similar, although the pronouncements are less detailed than those under US GAAP. IFRSUS GAAP

Academic Resource Center Share-based payments and earnings per share Page 30 Presentation and disclosure SBP Basic requirements (continued): ► Average share price of exercised options. ► Range of exercise prices and remaining contractual life of options outstanding at the balance sheet date. ► Method of calculating the fair value of the transactions. ► Valuation methods (model and input values, etc.) and their impact on the statement of income and the financial position of SBP transactions (expense and carrying amount of debts, etc.). Similar, although the pronouncements are less detailed than those under US GAAP. IFRSUS GAAP

Academic Resource Center Share-based payments and earnings per share Page 31 Presentation and disclosure SBP IFRS ► Has less detailed and less specific disclosures. US GAAP ► Although the disclosures are similar, US GAAP has more detailed and specific disclosures.

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