2.3

Types of SBPT

(a)       Equity-settled share-based payment transactions (equity-settled SBPT) – in which the entity receives goods or services as consideration for equity instruments of the entity (including shares or share options).
(b)       Cash-settled share-based payment transactions (cash-settled SBPT) – in which the entity acquires goods or services by incurring liabilities to the supplier of those goods or services for amounts that are based on the price (or value) of the entity’s shares or other equity instruments of the entity.
(c)       SBPT with cash alternatives – in which the entity receives or acquires goods or services and the terms of the arrangement provide either the entity or the supplier of those goods or services with a choice of whether the entity settles the transaction in cash (or other assets) or by issuing equity instruments.

3.1

General recognition of SBPT

HKFRS 2 requires that an entity should:
(a)       recognize the goods or services received or acquired in a SBPT when it obtains the goods or as the services are received. When the goods or services received or acquired do not qualify for recognition as assets, they should be recognized as expense.
(b)       recognize a corresponding increase in equity if the goods or services were received in an equity-settled SBPT, or a liability if the goods or services were acquired in a cash-settled SBPT.

3.2

Example 1 – Equity settled SBPT

AC Ltd enters into a contract to buy 1,000 units of commodity at a price equal to 1,000 shares of its ordinary shares. AC Ltd’s ordinary share is $1 par value and worth $2 at the date of delivery. The entity settled the contract by issuing 1,000 ordinary shares at $2.

The following entry should be made at the date of delivery:

3.3

Example 2 – Goods or services received or acquired do not qualify for recognition as assets

On 5 May 2012, ABC Ltd acquires some sundry laboratory equipment with a market value of $120,000 from its associates for its ongoing research project by issuing 100,000 of its ordinary shares (par value of $1 each).

In this case, HKFRS 2 requires ABC Ltd to record the transaction on 5 May 2012 as follows:

4.1.2

Measurement of equity-settled SBPT with employees

(a)       HKFRS 2 takes the position that it is usually not possible to measure directly the services received for particular components of the employee’s remuneration package. Because of the difficulty of measuring directly the fair value of the services received, the entity should measure the fair value of the employee services received by reference to the fair value of the equity instruments granted measured at grant date.
(b)       The fair value of options is determined on grant date and not adjusted for subsequent changes in market conditions.
(c)       HKFRS 2 provides that the fair value of the equity instrument shall be based on the market price, if available, taking into account the terms and conditions upon which the equity instruments are granted.
(d)       If market prices are not available, HKFRS 2 provides that the entity shall estimate the fair value of the equity instrument granted using a valuation technique to determine what the price of those equity instrument would have been on the grant date in an arm’s length transaction between knowledgeable, willing parties.

4.1.3

Example 3

On1 October 2011, ABC Ltd (with 31 December accounting year-ends) approves a plan that grants the company’s top five executives options to purchase 200,000 shares each (a total of 1,000,000) of the company’s ordinary shares (par value $1.00) at $5.00 per share. The options are granted on 1 January 2012, and will vest on 1 January 2015 if the executives remain in the employment of the company until then. The options are exercisable from 1 January 2015 to 31 December 2018.

Assume that, using the Black-Scholes model, the fair value of each option on 1 January 2012 is $1.50.

In this case, the journal entries to record the share options are as follows:
1 October 2011 – No entry

If, on 10 January 2015, all the share options are exercised, the journal entry will be as follows:

If none of the share options are exercised and are eventually forfeited on 31 December 2018, the journal entry will be as follows:

4.2.3

Example 4

Scenario A
On 6 June 2012, A Ltd acquires a piece of land, which has been valued by professional valuer at $50,000,000, by issuing 10,000,000 of its ordinary shares (par value of $1 each).

In this case, HKFRS 2 requires A Ltd to measure the transaction based on the fair value of the land, and record the transaction on 6 June 2012 as follows:

Scenario B
On 6 June 2012, B Ltd acquires a building of historical significance which has been valued by various professional valuers ranging from $10,000,000 and $50,000,000, by issuing 1,000,000 of its ordinary shares (par value of $1 each).

B Ltd’s 1,000,000 ordinary shares are traded in the HKSE and are quoted at $22 per share on 6 June 2012.

In this case, HKFRS 2 requires B Ltd to measure the transaction by reference to the fair value of shares issued, and record the transaction on 6 June 2012 as follows:

4.4.5

Example 6 – Performance condition is a market condition

On 1 October 2011, STU Ltd (with 31 December accounting year-ends) approves a plan that grants the company’s chief executive officer (CEO) options to purchase 500,000 shares of the company’s ordinary shares (par value $1.00) at $5.00 per share. The options are granted on 1 January 2012, and vest on 31 December 2014. However, the share options cannot be exercised unless the market price of the company’s shares has increased to at least $8.00 on 31 December 2014.

The company uses the binomial option pricing model (which takes into account the probability that the share price may or may not exceed $8.00 on 31 December 2014) and estimates the fair value of the share option with this market condition to be $1.20 per option.

Assuming the company expects the CEO to stay until after 31 December 2014, and the CEO does so, the journal entries to record the share options are as follows:

(Whether the market condition is met will not affect the following entries.)

The relevant accounting entries are as follows:
1 October 2011 – No entry

4.5.2

General rule of modifications

The general rule is that, apart from dealing with reductions due to failure to satisfy vesting conditions, the entity must always recognize at least the amount that would have been recognized if the terms and conditions had not been modified, i.e. if the original terms had remained in force.
(a)       If the change reduces the amount that the employee will receive, there is no reduction in the expense recognized in profit or loss.
(b)       When the modifications increase the fair value of equity instruments granted (e.g. a reduction in the exercise price options granted or issuance of additional options), the entity shall recognize the incremental fair value at the date of the modification as an expense over the remaining vesting period.

The incremental amount is the difference between the fair value of the modified equity instruments and the original equity instruments, both measured at the date of modification.

4.5.3

Example 8 – A case of modification of the terms and conditions of employee share options where the exercise price of the option is changed (repricing)

On 1 October 2011, XYZ Ltd (with 31 December accounting year-ends) approves a plan that grants the company’s top five executives options to purchase 20,000 shares each (a total of 100,000) of the company’s ordinary shares (par value $1.00) at $5.00 per share. The options are granted on 1 January 2012, and will vest on 1 January 2015 if the executives remain in the employment of the company until then. The options are exercisable from 1 January 2015 to 31 December 2018.

Assume that, using the Black-Scholes model, the fair value of each option on 1 January 2012 is $3.00.

On 1 January 2013, the company reduces the exercise price of the share option to $4.00, in view of the expectation that the market price of the company’s share is not expected to exceed $5.00 in the next 3 – 4 years because of the world recession.

The company estimates that, on 1 January 2013 (date of repricing), the fair value of each option before taking into account the repricing is $1.60, and the fair value of each repriced option is $1.80.

In this case, the journal entries to record the share options are as follows:

1 October 2011 – No entry

4.6.1

Cancellations and settlements

(a)       If an entity cancels or settles a grant of equity instruments during the vesting period, HKFRS 2 provides that the entity shall account for the cancellation or settlement as an acceleration of vesting and therefore recongise immediately any settlement that otherwise would have been recognized in income statement.
(b)       HKFRS 2 also provides that any compensation payments made with the cancellation or settlement (up to the fair value of the equity instruments) shall be accounted for as the repurchase of an equity interest, and any amounts paid in excess of the fair value of the equity instruments granted is recognized as an expense. This means that entities are required to value equity instruments granted at the date of cancellation or settlement to determine whether there is a charge to the profit or loss.
(c)       New equity instruments granted may be identified as replacement equity instruments for the cancelled equity instruments. In those cases, the replacement equity instruments shall be accounted for in the same way as a modification of the original grant of equity instruments. The fair value of the replacement equity instruments is determined at grant date, while the net fair value of the cancelled instruments is determined at the date of cancellation, less the amount of any payment made on cancellation that is accounted for as a deduction from equity.
(d)       If an entity repurchases vested equity instruments, HKFRS 2 also requires the payment made that is accounted for as deduction from equity, except that any excess over the fair value of equity instruments at the repurchase date is recognized as an expense.

4.6.2

Example 9

XYZ Ltd is incorporated on 2 January 2011 to undertake research and development in a new field of science. In February 2011, the company approves a plan to grant its chief executive officer (CEO) options to purchase 1,000,000 of the company’s ordinary shares (par value $0.20) at $0.30 per share. The options are granted on 1 March 2011, and will vest on 1 January 2014 if the CEO remains in the employment of the company until then. The options are exercisable from 1 January 2014 to 31 December 2015.

Given that the company is a new start-up in a new industry, it may be argued that the fair value of its equity instrument cannot be estimated reliably. The company thus measures the share option at their intrinsic value, as provided for under HKFRS 2.

Assuming the company has a 31 December accounting year-end.

Assume further that, based on net tangible asset backing per share, the fair value of the shares are estimated as follows:

As at 1 March 2011: $0.30 per share
As at 31 December 2011: $0.42 per share
As at 31 December 2012: $0.45 per share
As at 31 December 2013: $0.50 per share

The company’s share is quoted on the HKSE on 2 January 2014. The CEO exercised 200,000 of the options on 31 December 2014 when the market price is $0.60 per share and exercised the remaining 800,000 of the options on 31 December 2015 when the market price is $0.80 per share.

In this case, the journal entries to record the share options are as follows:

1 February 2011 – No entry

Note that the total staff cost is $460,000 [($0.60 – $0.30) x 200,000 + ($0.80 – $0.30) x 800,000].

4.7.3

Vesting conditions

HKFRS 2 defines vesting conditions as:

• The conditions that must be satisfied for the counterparty to become entitled to receive cash, other assets or equity instruments of the entity under a share-based payment arrangement.
• Vesting conditions include service conditions, which require the other party to complete a specified period of service, and performance conditions, which require specific performance conditions are met.

• Non-vesting conditions are conditions other than vesting conditions defined above. An example of a non-vesting condition is the contribution of fund for the purchase of shares under a share option scheme.

4.7.5

Accounting treatment of cancellations by a party other than the entity

Previous HKFRS 2 did not state how cancellations by a party other than the entity should be accounted for.

The Amendment provides that if a share-based payment has a non-vesting condition and an entity or counterparty can choose whether to meet the non-vesting condition. Failure of the entity or counterparty to meet the non-vesting condition during the vesting period, should be treated as a cancellation.

Upon cancellation, the entity should recognize immediately the amount of expense that would otherwise have been recognized over the remainder of the vesting period.

4.7.6

Example 10

On 1 January 2011, ABC Ltd grants its chief executive office (CEO) the opportunity to participate in a plan in which the CEO obtains share options if he agrees to save 10% of his monthly salary of $100,000 for a three-year period. The monthly payments are made by deducting from the CEO’s salary. The CEO may use the accumulated savings to exercise his options at the end of the three years, or take a refund of his savings at any point during the three-year period.

The estimated expense of the share-based payment arrangement is $36,000.

In April 2012, the CEO stops paying contribution to the plan and takes a refund of contribution of $150,000 paid over the last 15 months.

In this case, the requirement to pay contribution to the plan is a non-vesting condition. When the CEO chooses not to continue to make the contribution in April 2012, this event is treated as a cancellation.

The journal entries will be as follows:

5.2

Measurement of cash-settled SBPT

(a)       For cash-settled share-based payment transactions, HKFRS 2 requires an entity to measure the goods or services acquired and the liability incurred at the fair value of the liability.
(b)       Further, HKFRS 2 requires the liability to be re-measured at its fair value at each reporting period and at the date of settlement, with any changes in fair value recognized in income statement for the period.

5.7

Example 11

On 1 January 2011, JKL Ltd grants its chief executive officer (CEO) 1,000,000 share appreciation rights on the condition that she remains in its employment for the next three years.

The market price of JKL Ltd’s share is $5.00 on 1 January 2011. Subsequently, the market prices are as follows:

31 December 2011: $5.50
31 December 2012: $5.80
31 December 2013: $6.00
31 December 2014: $7.00
31 December 2015: $8.00

Based on an option pricing model, the fair value of the share appreciation rights is estimated as follows:

31 December 2011: $0.90
31 December 2012: $1.50
31 December 2013: $2.10
31 December 2014: $2.50

The CEO exercises 400,000 of her rights on 31 December 2014 and the remaining 600,000 on 31 December 2015.

The journal entries will be as follows:

Note that the total staff cost over the years is $2,600,000 ($800,000 + $1,800,000).

Question 1
Ryder Group granted share appreciation rights (SARs) to its employees on 1 November 2003 based on ten million shares. The SARs provide employees at the date the rights are exercised with the right to receive cash equal to the appreciation in the company’s share price since the grant date. The rights vested on 31 October 2005 and payment was made on schedule on 1 December 2005. The fair value of the SARs per share at 31 October 2004 was $6, at 31 October 2005 was $8 and at 1 December 2005 was $9. The company has recognised a liability for the SARs as at 31 October 2004 based upon HKFRS 2 ‘Share-based Payment’ but the liability was stated at the same amount at 31 October 2005.

Required:

Discuss the accounting treatment of the above event in the financial statements of the Ryder Group for the year ended 31 October 2005.                                                                 (5 marks)
(Adapted ACCA 3.6 Advanced Corporate Reporting December 2005 Q4(v))

6.4.4

Example 12

On 1 January 2011, LMN Ltd grants its CEO, as part of her remuneration package, the right to choose either 1,200,000 shares (par value $1.00 each) or 1,000,000 phantom shares under which she has the right to receive a cash payment equal to the value of 1,000,000 shares. The grant is conditional upon her completion of two years’ of service with the company. Further, if the CEO chooses the share alternative, the shares must be held for another two years after vesting date.

The market price of the company’s shares are as follows:

On 1 January 2011: $5.00 per share
On 31 December 2011: $5.40 per share
On 31 December 2012: $6.00 per share

Based on an option pricing model, and having taken into account the post-vesting transfer restriction, the fair value of the share alternative is estimated to be $4.50 per share on grant date.

In this case, the fair value of the compound instrument is $5,400,000 (1,200,000 × $4.50), the debt component (i.e. cash settlement) is $5,000,000 (1,000,000 × $5), and therefore the fair value of the equity component is $400,000 ($5,400,000 – $5,000,000).

The journal entries will be as follows:

Assuming the CEO chooses cash settlement on 1 January 2013, the journal entry will be as follows:

However, if the CEO chooses for equity settlement on 1 January 2013, the journal entry will be as follows:

7.3

Accounting treatment

(a)        The entity receiving the goods or services shall measure the goods or services received as an equity-settled SBPT when:
(i)         the awards granted are its own equity instruments; or
(ii)        the entity has no obligation to settle the share-based payment transaction.
In all other circumstances, the entity will measure the transaction as a cash-settled share-based payment.
(b)       Subsequent remeasurement of such equity-settled transactions will only be carried out for changes in non-market vesting conditions.

Classification

Entity receiving goods or services

Obligation to settle SBPT

How is it settled?

Subsidiary’s financial statement

Consolidated financial statements

Subsidiary

Subsidiary

Equity of the subsidiary

Equity

Equity

Subsidiary

Subsidiary

Cash

Cash

Cash

Subsidiary

Subsidiary

Equity of parent

Cash

Equity

Subsidiary

Parent *

Equity of parent

Equity

Equity

Subsidiary

Parent *

Cash

Equity

Cash

7.5

Example 13

On 1 October 2010, P Ltd approves a plan that grants the top five executives of its subsidiary, S Ltd, options to purchase 200,000 shares each (a total of 1,000,000) of P Ltd’s ordinary shares at $5.00 per share. The options are granted on 1 January 2011, vest on 31 December 2013, and may be exercised from 1 January 2014 to 31 December 2015. The group adopts 31 December accounting year-ends.

Assume that using the Black-Scholes model, the fair value of each option is $1.50.

In this case, HKFRS 2, requires the employees share ownership plan (ESOP) to be accounted for as an equity settled share-based payment transaction for S Ltd, P Ltd and the Group.

The journal entries required to record the ESOP as at 31 December 2011 (as well as 31 December 2012 and 2013) are as follows:

As a result, in the Group financial statements:
(a)       The staff cost will increase by $500,000; and
(b)       Capital reserve – ESOP will increase by $500,000.

The effect is similar to the case where an entity issues its own equity instruments to its own employees under HKFRS 2.

4.4.8

Example 7 – Performance condition is not a market condition

On 1 October 2011, LMN Ltd (with a 31 December accounting year-end) approves a plan that grants the company’s ten marketing executives options to purchase 10,000 shares each (a total of 100,000) of the company’s ordinary shares (par value $1.00) at $5.00 per share. The options are granted on 1 January 2012, and will be vested on either of the following dates:
(i)        31 December 2012, if the company’s sales increases by more than 20%;
(ii)       31 December 2013, if the average increase over the two-year period exceeds 15%; or
(iii)      31 December 2014, if the average increase over the three-year period exceeds 10%.
Assume that using the Black-Scholes model, the fair value of the option on 1 January 2012 is $3 each.

On 31 December 2012, sales increased by only 16%, but the company is confident that sales for 2013 will increase by at least 15% and therefore meet the vesting condition of a cumulative increase of 15%. During 2012, one of the marketing executives left the company, and the company expects another executive to leave during 2013.

On 31 December 2013, sales only increased by 13%, but the company is confident that sales for 2014 will increase by at least 8%, and therefore meet the vesting condition of a cumulative increase of 10%. During 2013, one of the marketing executives left the company, and the company expects another executive to leave during 2014.

On 31 December 2014, sales increased by 10%, and the vesting condition is met. None of the marketing executives left the company during 2014, and therefore a total of eight executives receive 10,000 shares each.

In this case, the journal entries to record the share options are as follows:

Note that the total staff cost charged over the three years is $240,000 ($3 × 10,000 × 8).

4.3.3

Example 5

IK Ltd grants share options to each of its 100 employees working in the sales department. The share options will vest at the end of year 3, provided that the employees remain in the entity’s employment and that the volume of sales of a particular product increases by at least an average of 5% per year. If the volume of sales of the product increases by an average of between 5% and 10% per year, each employee will receive 100 share options. If the volume of sales increases by an average of between 10% and 15% each year, each employee will receive 200 share options. If the volume of sales increases by an average of 15% or more, each employee will receive 300 share options.

On grant date, IK Ltd estimates that the share options have a fair value of $21 per option. It also estimates that the volume of sales of the product will increase by an average of between 10% and 15% per year, and therefore expects that, for each employee who remains in service until the end of year 3, 200 share options will vest. No employees will be expected to leave before the end of year 3.

The relevant accounting entries are as follows:

Year 2
Product sales increased to 18% and the entity expects each sales employee will receive 300 share options

Year 3
Two employees left during the year.

Generally, vesting conditions are not taken into account when estimating the fair value of the shares or options at grant date. Vesting conditions are taken into account by adjusting the number of equity instruments included in the measurement of the transaction amount so that, ultimately, the amount recognized for goods or services received as consideration for the equity instruments granted is based on the number of equity instruments that eventually vest [e.g. 98 x (300 x $21) = $617,400] and this amount has been expensed over 3 years.