Share Based Payment

Share-based payments are payments made for transactions that involve receiving goods and services for exchange from their equity instruments by a company. These also involve cash-settled share-based payment or payment cash about the price of the equity instruments. They are dealt with under International Financial Reporting Standards (IFRS) 2. The goods include property, inventory, intangible assets, plant and equipment and non-financial assets. 

There are, however, exemptions such as shares that are issued in a business combination and contracts for goods purchase that are treated under accounting standards or financial instruments IAS 32 presentation of financial instruments under IFRS 9. Additionally, purchases under this would not include purchases of treasury shares or rights issues (where employees are shareholders).

IFRS 2 necessitates disclosures on these payments under three criteria. The first is a recording of information that reveals the nature and extent of these transactions during a specific period. Secondly the information that reveals the method of deriving fair value of goods and services that are received. It also includes the fair value of equity instruments granted during a specific period. Thirdly, the information regarding the effects of expenses (share-based payment expense) that rise from these transactions on the business's profit and loss during the period. 

Share-based payments are made mostly to avoid conflicts between the employees and management. They are also made as a means of rewarding past services. In such cases they are granted without the condition of fulfilling future services. Similarly, there is another reason. It is to receive goods and services without affecting the liquidity of the business.

Given below are the two share-based payment methods:

#1 - Equity Instruments

Equity instruments are contractual evidence that possess an interest in the assets of the entity after deducing its liabilities. Some such instruments used for these payments are written call options and ordinary shares.  The payments can also involve the grant of preference shares or a class of ordinary shares in circumstances where there is more than one such class. The equity instruments could also be redeemable shares.  

#2 - Cash Payments

The company pays the payments on the basis of the price or value of the equity instruments it owns. It could also be on instruments of another entity that belongs to the same group. Payment through cash happens when the company does not settle through its equity instruments. Examples of cash-based share payments are stock appreciation rights (SARs) give the holder entitlement to receive cash payments. The payment is equivalent to the value increase in the shares of a specific level over a certain period.  The payment could also be based on an equity instrument on a specific date.

Equity settled transactions for employees and directors are recorded as expenses based on the fair value at the grant date. It is agreed between both parties. When transaction prices are unavailable, valuation techniques such as option pricing models are utilized, as IFRS 2 does not recommend any particular models. However, they suggest some key factors, including the calculation of intrinsic value when fair value cannot be determined.  

The IFRS 2 allocates and recognizes compensation costs over the service duration, and the fair value is determined throughout the vesting period. Hence, adjustments are made regularly to reflect the evaluated vested options. The shareholders' equity is increased due to correspondence to the expenses (share-based payment expense) recorded in the profit and loss.  

If in case employees choose to exercise their options due to unfavorable prices no adjustments are made to profit and loss. In cases of early settlement without replacements, the businesses are required to recognize the remaining expenses that would be charged during the vesting period.  

Cash-based equity settlements involve payments based on the equity price of the shares that reflect the cash disbursed.

Let us look at some examples to understand the concept better.

Example #1

Imagine, Company XYZ offers its stocks to its employees. This is part of the compensation package. The option allows the employees to purchase shares at a fixed price after a specific period. Over the years, employees become eligible to exercise these options when they continue to be employed. So, when the company prices rise, the employees can buy the shares at low prices and sell them later for a profit. The company introduced such a policy to reduce the employee turnover that it had experienced for the past few years. With this move they are expected to bring in more profit through employee retention.

Example #2

Imagine ABC Limited issued 1000 shares for $10 each and had a vesting period of 4 years. The grant date had shown a fair value of each option at $5. The value was assessed using the option pricing model, and after the vesting period of 4 years, the company recorded an expense of $5000 for each of the 100 shares in its profit and loss statement. If the employee who buys it is still an employee of the company, they will have a choice to exercise the option and buy it at $10 even if the price rises.

Share-based transactions in some jurisdictions may be granted tax allowance. However, it may not match the expense charged under profit and loss as per IFRS 2. Tax deduction for equity-settled schemes is based on the intrinsic value of the options. A temporary deductible difference will arise as a result of a mismatch between the employee services tax base and the share-based payment's carrying amount. The deferred tax asset would be recognized if the company has sufficient taxable profits.  

The estimated tax deduction will be based on the current share price for these payments. Therefore, the tax benefits received or that are expected to be received are recognized as profit or loss.