This article explains and provides examples of the accounting treatment for modifications and cancellations of share-based payment arrangements with employees.
As we learned in our article, ‘Insights into IFRS 2 – What is IFRS 2?,’ the general principle under IFRS 2 is that an entity must recognize, at a minimum, the value of the services received – measured at the grant date fair value of the equity instruments granted – unless those equity instruments do not vest because of a failure to satisfy a service condition or non-market performance condition that was specified at the grant date. This principle applies regardless of whether there has been a modification or cancellation, meaning that an entity cannot reduce the cost that it recognizes under the original terms or conditions of an award by modifying or cancelling the award.
An entity may modify one or more of the terms and conditions of a share-based arrangement, such as the exercise price, number of instruments granted, or vesting conditions. A common modification is when an entity reduces the exercise price of share options in response to a declining share price, because without the reprice the effectiveness of the award as a motivator for employee retention and performance may be lost.
In addition to recognizing the grant date fair value in accordance with the general principle above, an entity must also recognize the effects of any modifications that increase the total fair value of a share-based payment arrangement or that are otherwise beneficial to the employee.
IFRS 2 describes the following types of modifications that are beneficial to the employee:
The below summarizes the accounting treatment for the types of beneficial modifications outlined in IFRS 2:
Where beneficial modifications give rise to additional amounts to be recognized (i.e., as a result of an increase in fair value or an increase in the number of equity instruments granted), those additional amounts shall be recognized as follows:
The below summarizes the accounting treatment for the types of modifications that are not beneficial outlined in IFRS 2:
Multiple modifications
An entity may make multiple modifications to the terms of a share-based payment award that result in the total fair value of the arrangement changing. Some of the changes may be favourable to the employee, while other changes are not (e.g., when an entity reduces the exercise price of a share option award, but also extends the vesting period).
When there are multiple modifications to a share-based payment award, the following are some of the approaches observed in practice for determining whether the modifications are beneficial to the employee:
A modification may also give rise to a change in the method of settlement. For example, an equity-settled award may become cash-settled (or vice versa).
IFRS 2 does not provide guidance on how to account for modifications that result in the classification of an award being changed from equity-settled to cash-settled. However, it does provide illustrative guidance on how to account for an equity-settled award that is subsequently modified to contain a cash alternative. This example can, by analogy, be applied in determining the treatment for a change from an equity-settled to a cash-settled award.
The change in the method of settlement (i.e., from equity-settled to cash-settled, or with a cash alternative added) constitutes a modification if the change was not specified as part of the agreement at the grant date, or if the entity triggers the change (e.g., by changing its past practice of settling in equity to settling in cash instead, when it has a choice of the settlement method).
The general principle of modification accounting continues to be applied, where the entity shall at a minimum, recognize the value of services received measured at the grant date fair value of the original instruments over the original vesting period irrespective of the modification, unless the instruments do not vest because of the failure to satisfy a vesting condition (other than a market condition that was specified at grant date).
At the date of modification, the entity recognizes a liability for the cash alternative at an amount equal to the fair value of the liability at the date of modification, to the extent the specified services have been received. The liability is then remeasured from the date of modification until the date of settlement, with any changes in fair value recognized in profit or loss.
When an entity modifies a share-based payment award such that a cash-settled award becomes classified as an equity-settled award, the entity:
This treatment shall also be applied where an equity instrument is identified as a replacement for a cancelled cash-settled award.
When a share-based payment arrangement is cancelled or settled during the vesting period, an entity accounts for it as an acceleration of any unvested portion of the share-based payment on cancellation – that is, any remaining amount that would have otherwise been recognized over the remainder of the vesting period shall be recognized immediately in profit or loss.
IFRS 2 is unclear on whether the amount that would have otherwise been recognized over the remainder of the vesting period should reflect:
In our view, it is appropriate for an entity to make an accounting policy choice to account for cancellations under either one of the two approaches listed above. However, this policy should be applied consistently across all share-based payment arrangements.
When an entity compensates employees for the cancellation of an award, it recognizes the unvested portion of the share-based payment immediately as described above. Additionally, the compensation payment is treated as the repurchase of an equity interest and is deducted from equity, except to the extent that the payment exceeds the fair value of the equity instruments granted, measured at the repurchase date. Any such excess is recognized as an expense.
However, if the share-based payment arrangement included liability components, the entity shall remeasure the fair value of the liability at the date of cancellation or settlement. Any payment made to settle the liability component shall be accounted for as an extinguishment of the liability.
An entity may, upon cancelling an existing award, grant new equity instruments to employees. If the entity has designated these new equity instruments – on their grant date – as a replacement award for the cancelled award, the replacement award is accounted for as a modification to the existing agreement as discussed above.
The entity continues to expense amounts relating to the original award over the original vesting period as well as any incremental fair value, calculated as the difference in fair value between the original and replacement awards both measured at the date of modification (i.e., the date the replacement awards are issued). The fair value of the original awards that have been cancelled is their fair value, immediately before cancellation, less the amount of any payment made to the employee on cancellation that is accounted for as a deduction from equity.
If the entity does not determine that the new equity instruments have been granted as a replacement for the cancelled instruments, the new equity instruments are accounted for as a new grant.
In a business combination, the acquirer often issues new share-based payment awards to the acquiree’s employees to replace their existing awards. The accounting for these replacement awards is covered in IFRS 3 ‘Business combinations’ and differs depending on whether the acquirer was obliged to replace the awards or voluntarily chooses to replace the awards.
An acquirer is obliged to replace the awards if the acquiree or its employees have the ability to enforce replacement. This is often as a result of the terms of the acquisition agreement, the terms of the acquiree’s awards, or due to applicable laws or regulations.
We hope you find the information in this article helpful in giving you some insight into IFRS 2. If you have a complex scenario or you would like to discuss any of the points raised, please speak to your usual Doane Grant Thornton contact or contact your local office.
