This briefing document provides a comprehensive overview of IFRS 2 Share-based Payment, drawing on various sources to highlight key themes, important ideas, and factual information, including direct quotes where appropriate.

1. Introduction to IFRS 2 Share-based Payment

IFRS 2, issued in 2004, addresses the accounting for share-based payment transactions, which involve an entity receiving goods or services in exchange for either its own equity instruments or cash/other assets whose amounts are based on the value of the entity’s equity instruments. The standard’s introduction marked a significant shift, requiring entities to recognize an expense for share-based awards at their fair value in the income statement, a concept initially considered “revolutionary.”

Key Features:

• Scope: IFRS 2 applies broadly to transactions where shares or other equity instruments are granted to employees and non-employees in exchange for goods or services. It also covers cash payments that are “share-based” because their value is tied to the entity’s share price (e.g., cash share appreciation rights).
• Purpose: The standard aims to ensure that entities account for the consumption of resources when they issue valuable shares or share options, thereby providing a faithful representation of financial performance.
• Evolution: The standard has undergone several amendments since its inception, including clarifications on group cash-settled share-based payment transactions and the treatment of vesting and non-vesting conditions.

2. Scope and Exclusions of IFRS 2

IFRS 2 defines and outlines which transactions fall under its purview and which are excluded.

Transactions within Scope:

• Equity-settled share-based payments: Transactions where the entity receives goods or services as consideration for its own equity instruments (shares or share options).
• Cash-settled share-based payments: Transactions where the entity acquires goods or services by incurring a liability to transfer cash or other assets to the supplier, with amounts based on the price or value of the entity’s equity instruments.
• Group share-based payments: Arrangements where a group entity, or a shareholder of any group entity, settles a share-based payment transaction on behalf of the entity receiving the goods or services.
• For example, if a parent grants its equity instruments to a subsidiary’s employees, or a subsidiary grants its parent’s equity instruments to its own employees, these are in scope.

Exclusions from Scope:

• Transactions with counterparties acting as shareholders: “a transaction with an employee (or other party) in his/her capacity as a holder of equity instruments of the entity is not a share-based payment transaction.” This applies when rights are granted to all shareholders, and an employee receives such a right due to their shareholder status, not their employee services.
• Business combinations: IFRS 2 does not apply to transactions “in which the entity acquires goods as part of the net assets acquired in a business combination as defined by IFRS 3 Business Combinations.” However, equity instruments granted to employees of the acquired entity in their capacity as employees (e.g., for continued service) are within the scope of IFRS 2.
• Contracts within the scope of financial instruments standards (IAS 32/IFRS 9): IFRS 2 excludes contracts to acquire non-financial items that fall under financial instrument standards, such as commodity contracts entered into for speculative purposes (not “own use” contracts).
• Acquisition of associates or joint ventures: IAS 28 is the specific standard for these transactions.

3. Recognition Principles

IFRS 2 mandates the recognition of goods or services received in a share-based payment transaction.

• Timing: “An entity shall recognise the goods or services received or acquired in a share-based payment transaction when it obtains the goods or as the services are received.”
• Corresponding Entry: A “corresponding increase in equity is recognised if the goods or services were received in an equity-settled transaction. A liability is recognised if the goods or services were acquired in a cash-settled transaction.” [IFRS 2.7]
• Expense Recognition: If the goods or services do not qualify for recognition as assets, “they are recognised as an expense.” [IFRS 2.8] Services are typically consumed immediately and recognized as an expense as the counterparty renders service.

4. Measurement of Share-based Payments

The core of IFRS 2 lies in its measurement principles, distinguishing between equity-settled and cash-settled transactions.

4.1. Equity-Settled Share-based Payment Transactions (ESBP)

• General Principle: ESBP transactions are measured at the fair value of the goods or services received.
• Employee Services: For transactions with employees, “it is usually not possible to measure the services received for specific components of an employee’s remuneration package…Therefore, an entity should measure the fair value of employee services by reference to the fair value of the equity instruments granted as of the grant date.”
• Measurement Date: The “measurement date is grant date.” [IFRS 2.A] Grant date is defined as the date when the entity and the counterparty have a shared understanding of the terms and conditions of the arrangement, and the entity confers the right to equity instruments.
• If grant date occurs after the service commencement date (e.g., due to shareholder approval), the entity estimates the grant-date fair value for services received between the service commencement date and grant date, revising this estimate once the actual grant date fair value is established.
• Fair Value Determination:Shares: Fair value is the market price, “adjusted to take into account the terms and conditions upon which the shares were granted (except for vesting conditions that are excluded from the measurement of fair value in accordance with paragraphs 19–21).” This includes factoring in if employees are not entitled to dividends during the vesting period or post-vesting transfer restrictions, but only to the extent they affect a knowledgeable, willing market participant’s price.
• Share Options: When market prices are unavailable, fair value is determined using a valuation technique, typically an option pricing model.
• Common models include Black-Scholes, binomial, and Monte Carlo. The Black-Scholes-Merton formula “does not allow for the possibility of exercise before the end of the option’s life and may not adequately reflect the effects of expected early exercise.” [IFRS 2.B5] More flexible models like binomial or Monte Carlo can accommodate early exercise behavior and varying volatility.
• Inputs: Models incorporate factors such as exercise price, current share price, expected term, expected future volatility, expected dividends, and the risk-free interest rate.
• Expected Volatility (Unlisted Entities): Unlisted entities may use internal market data or “the historical or implied volatility of similar listed entities.” [IFRS 2.B27]
• Expected Life: Different groups of employees may have homogeneous exercise behaviors, warranting separate expected life estimates for better accuracy.
• Non-Measurable Fair Value: In rare cases where fair value cannot be reliably measured, the grant is “initially measured at its intrinsic value and adjusted at each reporting date for any change in intrinsic value until the options are either exercised, forfeited or lapse.” [IFRS 2.46]
• Reload Features: “the reload feature shall not be taken into account when estimating the fair value of options granted at the measurement date. Instead, a reload option shall be accounted for as a new option grant, if and when a reload option is subsequently granted.” [IFRS 2.22]

4.2. Cash-Settled Share-based Payment Transactions (CSBP)

• Measurement: “the goods or services acquired and the liability incurred are measured at the fair value of the liability.” [IFRS 2.30]
• Remeasurement: “Until the liability is settled, the liability is remeasured at fair value at each reporting date (and the settlement date). Any changes in fair value are recognised in profit or loss for the period.” [IFRS 2.30]
• Accrual: The services received and the liability are recognized as employees render service. If rights vest immediately (e.g., some SARs), the expense and liability are recognized immediately.

4.3. Vesting and Non-Vesting Conditions

• Vesting Conditions: Conditions that determine whether the counterparty becomes entitled to the equity instrument.
• Market Conditions: (e.g., target share price) “shall be taken into account when estimating the fair value of the equity instruments granted.” [IFRS 2.21] The expense continues regardless of whether the market condition is met, assuming other vesting conditions are satisfied.
• Non-Market Vesting Conditions: (e.g., service period, performance targets not related to share price) “shall not be taken into account when estimating the fair value of the shares or share options at the measurement date. Instead, … shall be taken into account by adjusting the number of equity instruments included in the measurement of the transaction amount so that, ultimately, the amount recognised… shall be based on the number of equity instruments that eventually vest.” [IFRS 2.19]
• This involves a “true-up” mechanism, where estimates of vesting are revised, and the cumulative expense is adjusted. If the conditions are not met, the charge is reversed.
• Non-Vesting Conditions: Other conditions affecting receipt of the share-based payment. These are reflected in the fair value of the award at the measurement date. If a non-vesting condition is not met, there is generally no accounting impact.
• “a condition based on a commodity index is a non-vesting condition, for which neither the entity nor the counterparty can choose whether the condition is met.” [IFRS 2 Guidance] Such conditions are considered in fair value estimation, and if not met, “there is no accounting impact.”
• Impact on CSBP Measurement: Recent amendments clarify that “market conditions, such as a target share price… as well as non-vesting conditions, shall be taken into account when estimating the fair value of the cash-settled share-based payment granted and when remeasuring the fair value at the end of each reporting period and at the date of settlement.” [IFRS 2.33A] Service and non-market performance conditions affect the measurement by adjusting the number of rights expected to vest, consistent with equity-settled awards.

5. Modifications, Cancellations, and Settlements

IFRS 2 provides specific guidance for changes to share-based payment arrangements.

• Modifications: Beneficial modifications (e.g., repricing, changes to service or non-market conditions) affect the share-based payment cost.
• “The incremental fair value granted is the difference between the fair value of the replacement equity instruments and the net fair value of the cancelled equity instruments… at the date the replacement equity instruments are granted.” [IFRS 2.28(c)]
• Modifications that are not beneficial for the employee do not affect the total share-based payment cost.
• Cancellations and Settlements: “The cancellation or settlement of an equity instrument is accounted for as an acceleration of vesting. The amount that would otherwise have been recognised for services received over the reminder of the vesting period is therefore recognised immediately.” [IFRS 2.28(a)]
• Any payment to the employee is treated as a repurchase of an equity interest (deduction from equity), “except to the extent that the payment exceeds the fair value of the equity instrument granted, measured at the repurchase date. Any such excess is recognised as an expense.” [IFRS 2.28(b)]
• If a cash-settled award is cancelled and replaced with an equity-settled award, the liability is derecognized, and any difference between the derecognized liability and recognized equity is recognized in profit or loss.

6. Transactions with Settlement Alternatives

• Counterparty Choice: If the counterparty (e.g., employee) has the choice of settlement (cash or equity), the arrangement is accounted for as a compound financial instrument. The “entity shall first measure the fair value of the debt component, and then measure the fair value of the equity component—taking into account that the counterparty must forfeit the right to receive cash in order to receive the equity instrument.” [IFRS 2.37]
• If the fair values of alternatives are equal, the equity component is zero.
• Entity Choice: If the entity has the choice of settlement (cash or equity), “the entity shall determine whether it has a present obligation to settle in cash and account for the share-based payment transaction accordingly.” [IFRS 2.41]
• A present obligation to settle in cash exists if the equity settlement option has no commercial substance (e.g., legally prohibited from issuing shares), or the entity has a “past practice or a stated policy of settling in cash, or generally settles in cash whenever the counterparty asks for cash settlement.” [IFRS 2.41] In such cases, it’s accounted for as cash-settled. Otherwise, it’s equity-settled.
• Contingent Settlement Alternatives: If the settlement method is determined by events outside the control of the entity or counterparty, the classification (equity-settled or cash-settled) depends on whether the contingent event making cash settlement probable. This assessment is continuous.

7. Group Share-based Payment Arrangements

These involve two or more entities within the same group, such as a parent granting rights to its equity instruments to a subsidiary’s employees.

• Subsidiary Accounting (receiving services): “Where the subsidiary grants rights to equity instruments of its parent to employees, the subsidiary accounts for the transaction with its employees as cash-settled. This requirement applies irrespective of how the subsidiary obtains the equity instruments to satisfy the obligations to its employees.” [IFRIC 11.11] This is because the parent’s equity instruments are treated as assets of the subsidiary.
• However, recent amendments clarify that the receiving entity (e.g., subsidiary) should measure the goods or services received as an equity-settled share-based payment if “the awards granted are its own equity instruments, or…the entity has no obligation to settle the share-based payment transaction.” [IFRS 2.43B]
• Parent Accounting (settling entity): If the parent grants rights to its own equity instruments to a subsidiary’s employees, “the parent shall measure its obligation in accordance with the requirements applicable to equity-settled share-based payment transactions.” [IFRS 2.B54] The parent recognizes an increase in its investment in the subsidiary and a corresponding entry in equity.
• Employee Transfers: If an employee transfers between group entities during the vesting period, each subsidiary adjusts the previously recognized amount for services received if the vesting conditions (other than market conditions) are not met.

8. Disclosure and Presentation

IFRS 2 requires extensive disclosures to enable users to understand the nature, extent, and effect of share-based payment transactions.

• Nature and Extent: Entities must disclose “a description of each type of share-based payment arrangement that existed at any time during the period, including the general terms and conditions of each arrangement.” [IFRS 2.45(a)] This includes details on vesting requirements, maximum option terms, and settlement methods.
• Fair Value Determination: Information on how fair value was measured, including weighted average fair value for options and other equity instruments granted, and details about the valuation technique, expected dividends, and other features incorporated into the fair value measurement.
• Effect on Profit or Loss and Financial Position: Disclosure of “the total expense recognised for the period arising from share-based payment transactions in which the goods or services received did not qualify for recognition as assets and hence were recognised immediately as an expense, including separate disclosure of that portion of the total expense that arises from transactions accounted for as equity-settled share-based payment transactions.” [IFRS 2.51]
• Movements in Reserves: While IFRS 2 does not mandate specific reserve accounts, the credit entry for equity-settled share-based payments typically goes to retained earnings or a separate reserve.
• Illustrative Disclosures: The standard includes illustrative examples for required disclosures, such as movements in outstanding and exercisable share options, and weighted average share prices at exercise date.

9. Tax Implications

• IAS 12 Income Taxes: The tax impact of share-based payments is governed by IAS 12.
• Deductible Temporary Differences: If a tax deduction related to share-based remuneration differs from the recognized expense or arises in a later period, this can result in a deductible temporary difference and a deferred tax asset under IAS 12.
• Measurement of Deferred Tax Asset: The deferred tax asset is “based on an estimate of the future tax deduction.” [IFRS 2 BC] If the tax deduction depends on the share price at exercise, the estimate of the future deduction should be based on the current share price.
• Net Settlement Features for Withholding Tax: If an entity is obliged by tax laws to withhold a portion of equity instruments to meet an employee’s tax obligation, the transaction is classified as equity-settled in its entirety, provided it would have been equity-settled otherwise. The amount transferred to the tax authority is accounted for as a repurchase of vested equity instruments.

10. Key Concepts and Debates

• Recognition vs. Disclosure: A fundamental concept in IFRS is that “disclosure of financial information is not an adequate substitute for recognition in the financial statements.” [IFRS 2 BC287] Proponents argue that omitting expenses for share-based payments would overstate profits and impair financial reporting quality.
• Fair Value Measurement Reliability: Concerns about the reliability of fair value estimates, particularly for non-traded employee share options, have been raised. However, IFRS 2 emphasizes that the objective is to measure the fair value of the rights granted, not to predict the ultimate outcome.
• Intrinsic Value vs. Fair Value: IFRS 2 rejects the intrinsic value method for measurement, arguing that it “understates the value of the option by 100 per cent” [IFRS 2 BC76] by ignoring time value, which fails to faithfully represent the transactions.
• Employee Share Purchase Plans (ESPPs): IFRS 2 generally does not exempt broad-based ESPPs from expense recognition, viewing benefits provided to employees as remuneration, even if governments encourage such plans.
• Consistency with IAS 32: Differences exist between IFRS 2 and IAS 32’s classification of certain instruments (e.g., contracts settled in a variable number of own equity instruments). The IASB decided to retain these differences pending a broader review of the Framework’s definitions of liabilities and equity.

This briefing provides a detailed summary of the main themes and important ideas within the provided sources related to IFRS 2 Share-based Payment.