G4+1 POSITION PAPER:
ACCOUNTING FOR SHARE-BASED PAYMENT
A Discussion Paper issued for comment by the Staff
of the International Accounting Standards
Committee
Comments to be submitted by 31 October 2000
This IASC Discussion Paper contains a Position Paper prepared by the G4+1
Group of standard setters reproduced here and issued by the Staff of the
International Accounting Standards Committee for comment only. The
Discussion Paper has not been considered by the Board of the International
Accounting Standards Committee and does not necessarily represent the views
of the Board.
Comments should be submitted in writing so as to be received by 31 October
2000. All replies will be shared with G4+1 member organisations and placed
on the public record unless confidentiality is requested by the commentator.
Comments should preferably be sent by E-mail to:
CommentLetters@iasc.org.uk or addressed to:
The Secretary-General
International Accounting Standards Committee
166 Fleet Street, London EC4A 2DY
United Kingdom
Fax: +44 (20) 7353-0562
CONTENTS
Page
FOREWORD BY THE IASC
G4+1 DISCUSSION PAPER
1
Preface
2
G4+1 Memorandum of Understanding on Objectives
3
Summary
5
Invitation to comment and questions for respondents
7
Chapter 1
Introduction and scope
13
Chapter 2
Background
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ISBN 0 905625 83 8
Chapter 3
Accounting principles
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Copyright © 2000 International Accounting Standards Committee
Chapter 4
Possible measurement methods
25
All rights reserved. Copies of this Discussion Paper may be made for the
purpose of preparing comments to be submitted to IASC, provided such
copies are for personal or intra-organisational use only and are not sold
or disseminated and provided each copy acknowledges the International
Accounting Standards Committee's copyright and sets out IASC’s
address in full. Otherwise, no part of this Discussion Paper may be
reprinted or reproduced or utilised in any form either in whole or in part
or by any electronic, mechanical or other means, now known or hereafter
invented, including photocopying and recording, or in any information
storage and retrieval system, without permission in writing from the
International Accounting Standards Committee.
Chapter 5
Possible measurement dates
37
Chapter 6
Allocation over the service period
49
Chapter 7
Other issues under vesting date measurement
53
Chapter 8
Summary and conclusion
69
The [logo]"Hexagon Device", "IAS", "IASC" and "International
Accounting Standards" are Trade Marks of the International Accounting
Standards Committee and should not be used without the approval of the
International Accounting Standards Committee.
International Accounting Standards Committee, 166 Fleet Street, London
EC4A 2DY, United Kingdom. Tel: +44 (020) 7353-0565, Publications
Department Tel: +44 (020) 7427-5927, Fax: +44 (020) 7353-0562, E-mail:
publications@iasc.org.uk Internet: http://www.iasc.org.uk
Appendix A
Example with falling share price
72
Appendix B
Example where options vest in instalments
74
Appendix C
Example of accounting for non-employee
share-based payment
78
Appendix D
Types of share-based payment currently in use
79
Appendix E
Accounting treatment of employee
share plans in various jurisdictions
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FOREWORD BY THE IASC
This Discussion Paper has been developed by the G4+1 group of accounting
standard-setters. It reflects an agreed approach to the accounting treatment of
share-based payment. The extent to which each body represented in the G4+1
group intends considering whether, and if so how, the Paper’s proposals
should be developed into new or modified accounting standards will be a
matter for each individual jurisdiction. G4+1 members will continue to cooperate over the future development of new or modified accounting standards
so as to ensure that the resulting standards in each jurisdiction are as similar as
possible.
The accounting issues relating to share-based payment, particularly in the case
of employee share plans, are complex. It has therefore taken some time to
agree upon the appropriate accounting treatment of share-based payment. In
some jurisdictions, the absence of clear accounting guidance has allowed a
number of questionable approaches to flourish, in particular the idea that
transactions involving the purchase of employee services with share options
have no cost and therefore should not be recognised in the financial
statements. The Paper deals with this and other arguments made against
financial statement recognition.
The main proposals in this Paper are:
•
a transaction whereby an entity obtains goods or services from other
parties, including employees and suppliers, with payment taking the form
of shares or share options issued by the entity to those other parties,
should be recognised in the financial statements, with a corresponding
charge to the income statement when those goods or services are
consumed (Chapter 3);
•
such a transaction should be measured at the fair value of the shares or
options issued. In most cases, an option-pricing model should be applied
to establish the fair value of an option (Chapter 4);
•
vesting date is the appropriate measurement date, i.e., the date at which
the fair value of the shares or options issued should be established, for the
purposes of measuring the transaction amount. Vesting date is the date
upon which the other party (the employee or supplier), having performed
all of the services or provided all of the goods necessary, becomes
unconditionally entitled to the options or shares. (Chapter 5); and
•
where performance by the other party occurs between grant date, being
the date upon which the contract between the entity and the other party
(the employee or supplier) is entered into, and vesting date, an estimate of
the transaction amount should be accrued over the performance period
(Chapter 6).
Other issues discussed include the treatment of lapsed options, options that are
repriced or otherwise modified, employee share plans with cash alternatives
and share appreciation rights (Chapter 7).
Standard setters that are members of the G4+1 are publishing this position
paper in their respective jurisdictions as a step toward improving, and
enhancing the worldwide comparability of, accounting for shared-based
payment.
The IASC Staff hopes that this Discussion Paper is useful in helping others
formulate their thoughts on the issues related to accounting for share-based
payments and on the appropriateness of the approach described in this
Position Paper. A series of questions is provided in the ‘‘Invitation to
Comment’’ section. We welcome comments both on the overall approach
outlined in this Discussion Paper and on the potential implications of adopting
such an approach. It would be helpful if comments were received by 31
October 2000. Comments should be addressed to:
Sir Bryan Carsberg
Secretary-General
International Accounting Standards Committee
166 Fleet Street
London EC4A 2DY
United Kingdom
E-mail: CommentLetters@iasc.org.uk
Fax: +44 (020) 7353-0562
G4+1 DISCUSSION PAPER
Accounting for Share-based Payment
Australian Accounting Standards Board
Canadian Accounting Standards Board
International Accounting Standards Committee
New Zealand Financial Reporting Standards Board
United Kingdom Accounting Standards Board
United States Financial Accounting Standards Board
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G4+1 MEMORANDUM OF UNDERSTANDING
ON OBJECTIVES (Revised March 1999)
PREFACE
This Discussion Paper results from the efforts of a Working Group consisting
of board members and senior staff of the standard-setting bodies of Australia,
Canada, New Zealand, the UK and the USA, and the International Accounting
Standards Committee. Whilst members of the Working Group represented the
standard-setting bodies to which they were affiliated, the views they expressed
were their own and had not necessarily been officially deliberated by the
bodies themselves.
The principal author is Kimberley Crook, a project director with the UK
Accounting
Standards
Board
(ASB)
on
secondment
from
PricewaterhouseCoopers in London. A significant contribution was made by
Kathryn Cearns, a project director with the ASB. Other ASB staff members
and staff members of the other G4+1 organisations also assisted in the
preparation of the Discussion Paper.
Shared Objectives of Member Organisations
G4+1 organisations share an objective of providing quality financial reporting
standards for the primary purpose of providing information useful to capital
market participants.
G4+1 organisations share an objective of seeking common solutions to
financial reporting issues. A single, quality financial reporting approach is
more useful to capital market participants than multiple approaches.
G4+1 organisations share the view that financial reporting standards should be
based on a conceptual framework. It follows that membership of the Group
requires acceptance of a conceptual framework similar to that of other
members.
G4+1 organisations share the view that seeking common solutions to financial
reporting issues requires members to have the willingness and ability to
commit resources to the resolution of those issues within the context of a
conceptual framework.
G4+1 Objectives
G4+1 organisations seek to further their shared objectives through analyses
and discussions of financial reporting issues. Those analyses and discussions
help participants from member organisations develop a common
understanding of the issues, a common language and tools for discussing and
analysing the issues, and an understanding of the views and constraints in each
others’ jurisdictions.
G4+1 organisations seek to learn about the timing and approach of standardsetting agenda projects in other jurisdictions. That knowledge can help them
identify and take advantage of opportunities to coordinate their efforts and
thereby further their shared objectives.
G4+1 organisations seek to further their shared objectives by exchanging new
ideas and approaches to financial reporting issues and standard-setting
processes that can be applied in their own jurisdictions.
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G4+1 organisations seek to further their shared objectives by pursuing projects
that have the potential to bring about convergence of financial reporting
standards across member jurisdictions at a high level of quality.
SUMMARY
This Discussion Paper has been developed by the G4+11 group of accounting
standard-setters. It reflects an agreed approach to the accounting treatment of
share-based payment. The extent to which each body represented in the G4+1
intends to consider whether, and if so how, the Paper’s proposals should be
developed into new or modified accounting standards will be a matter for each
individual jurisdiction. G4+1 members will continue to co-operate over the
future development of new or modified accounting standards so as to ensure
that the resulting standards in each jurisdiction are as similar as possible.
The accounting issues relating to share-based payment, particularly for
employee share plans, are complex and controversial. It has therefore taken
some time to agree upon the appropriate accounting treatment of share-based
payment. In some jurisdictions, the absence of clear accounting guidance has
allowed a number of misconceptions to flourish, in particular the idea that
transactions involving the purchase of employee services with shares or share
options have no cost and therefore should not be recognised in the financial
statements. The Paper deals with this and other arguments made for and
against recognition in financial statements and it concludes that these
transactions should be recognised.
The main proposals in this Paper are:
•
a transaction whereby an entity obtains goods and services from other
parties, including suppliers and employees, with payment taking the form
of shares or share options issued by the entity to those other parties,
should be recognised in the financial statements, with a corresponding
charge to the income statement when those goods or services are
consumed (Chapter 3)
•
such a transaction should be measured at the fair value of the shares or
options issued. In most cases, an option pricing model should be applied
to establish the fair value of an option (Chapter 4)
•
the transaction should be measured at vesting date, i.e. vesting date is the
date at which the fair value of the shares or options issued should be
1 The G4+1 comprises members of the standard-setting bodies from Australia, Canada, New
Zealand, the UK and the USA. Representatives of IASC attend as observers.
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established, for the purposes of measuring the transaction amount.
Vesting date is the date upon which the other party (the employee or
supplier), having performed all of the services or provided all of the goods
necessary, becomes unconditionally entitled to the options or shares
(Chapter 5)
•
where performance by the other party occurs between grant date, being
the date upon which the contract between the entity and the other party
(the employee or supplier) is entered into, and vesting date, an estimate of
the transaction amount should be accrued over the performance period
(Chapter 6).
INVITATION TO COMMENT AND QUESTIONS FOR
RESPONDENTS
The G4+1 welcomes comments on any aspect of the Discussion Paper.
Respondents’ views are especially sought on the matters set out below. It
would be helpful if respondents could support their views with reasons and,
where applicable, preferred alternatives.
Recognition in the financial statements
Q1
Other issues discussed include the treatment of lapsed options, options that are
repriced or otherwise modified, employee share plans with cash alternatives
and share appreciation rights (Chapter 7).
Do you agree with the proposal that transactions whereby an entity
purchases goods and services by issuing shares or share options
should be recognised in the financial statements, thus resulting in a
charge to the income statement when those goods and services are
consumed (Chapter 3)?
Measurement basis
Q2
Do you agree with the conclusion that the appropriate measurement
basis for such transactions is the fair value of the shares or options
issued (paragraphs 4.13 and 4.14)? Please note that the related
question of the date at which fair value should be measured is
considered later.
Measuring the fair value of share options
Q3
Do you agree that, where an observable market price for an option
does not exist, an option pricing model should be used to estimate the
fair value of a share option (paragraphs 4.16-4.27)?
Q4
Assuming that the use of an option pricing model is required, do you
agree that:
(a)
for pragmatic reasons, it is acceptable to modify the assumptions
used in the option pricing model in the case of unlisted entities,
when not all of the relevant information is readily available, as
suggested in paragraph 4.28?
(b) in the case of employee share options, the assumptions used in
the option pricing model should be adjusted to take into account
the non-transferability of such options by using expected life
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rather than contracted life in the calculation (paragraphs 4.304.35)?
Q9
If you consider that service date is the appropriate measurement date:
(a)
Q5
Do you agree that, if an entity were to argue that it could not reliably
measure the fair value of its options at the required measurement date
(whatever that date is), it should instead be required to measure the
transaction at the fair value of the goods or services received, or, if
neither fair value can be reliably measured, at the fair value of the
share options at exercise date (paragraphs 4.38-4.41)?
(b) if it is your view that the credit to equity during the performance
period represents the issue of an equity instrument, should the
transaction amount be adjusted subsequently if the number of
options that actually vest is greater or less than expected? If so,
how would you reconcile this view with the conceptual
framework, whereby equity instruments are not remeasured
after issue (paragraphs 3.6-3.8)?
Measurement date
Q6
Do you agree with the conclusion that vesting date is the appropriate
measurement date, for the purposes of determining the fair value of
the shares or options issued (Chapter 5)?
Q7
If you do not agree that vesting date is the appropriate date, which of
the other dates discussedgrant date, service date, and exercise
datedo you regard as the appropriate measurement date (Chapter 5)?
Q10
Q8
is it your view that the credit to equity arising from recognition
of the transaction over the performance period represents the
issue of an equity instrument? If not, what is the nature of the
credit?
If you consider that exercise date is the appropriate measurement
date:
(a)
do you regard a share option as a liability or an equity
instrument (paragraph 5.16)?
If you consider that grant date is the appropriate measurement date:
(a)
(b)
(b) if you regard a share option as a liability, not an equity
instrument, how would you reconcile this with the conceptual
framework (paragraph 5.16)?
should the transaction amount be subsequently adjusted if the
number of options that actually vest is greater or less than
originally expected (paragraph 5.20) and, if so, how would you
reconcile this view with the conceptual framework2, whereby
equity instruments are not remeasured after issue (paragraphs
3.6-3.8)?
should the transaction amount be recognised as a charge to the
income statement in full on grant date or spread over the
performance period?
(c)
Vesting date measurement
Q11
(c)
if you consider that the transaction amount should be spread over
the performance period, how would you resolve the problem that
there appears to be no recognisable asset at grant date
(paragraphs 5.21 and 5.22)?
2 References to ‘the conceptual framework’ in this Paper encompass all of the conceptual
frameworks/statements issued by the G4+1 organisations, as explained in the footnote to
paragraph 1.7.
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if you regard a share option as an equity instrument, how would
you reconcile exercise date measurement with the conceptual
framework, whereby equity instruments are not remeasured
after issue (paragraphs 3.6-3.8)?
Assuming that vesting date is accepted as the appropriate
measurement date:
(a)
do you agree that the transaction should be recognised as an
accrual over the performance period? If so, is your conclusion
based upon pragmatic reasons only, or do you consider that it is
conceptually valid to do so under vesting date measurement
(Chapter 6)?
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(b)
assuming that the transaction is recognised as an accrual over
the performance period, do you consider that the credit entry
should be classified as a liability or part of equity (Chapter 6)?
(c)
do you agree that the transaction amount should be adjusted for
options that lapse, or are expected to lapse, during the
performance period, i.e. before vesting date (paragraphs 7.47.10)?
do you agree that the transaction amount should not be adjusted
for options that lapse, or are expected to lapse, after vesting date
(paragraphs 7.11-7.17)?
(d)
(e)
do you agree that the transaction amount should be adjusted if
the vested option is repriced or other modifications in terms are
made (paragraphs 7.18-7.26)?
(f)
where the other party (e.g. the employee or supplier) is able to
choose, on or before vesting date, to receive cash instead of
share options:
(g)
(i)
do you agree that the transaction amount should be
adjusted to reflect the form of consideration given, i.e.
cash or share options (paragraph 7.29)?
(ii)
with regard to the accrual during the performance period,
do you agree with the approach outlined in paragraphs
7.32 and 7.33 or do you prefer the approach outlined in
paragraphs 7.35 and 7.36?
(iii)
do you have any other comments or suggestions
regarding the amount and presentation of the accrual
during the performance period?
Q12
Do you agree with the proposed treatment of share appreciation
rights, as outlined in paragraphs 7.45-7.49?
Q13
Do you have any comments on the discussion of the application of the
proposals in this Paper to employee share purchase plans (paragraphs
7.50 and 7.51)?
Q14
Do you have any comments on the discussion of the application of the
proposals in this Paper to transactions with parties other than
employees (paragraphs 7.52-7.54)?
Q15
What other issues would need to be addressed if the proposals in this
Paper were to be developed into an accounting standard?
where the other party (e.g. the employee or supplier) is able to
choose after vesting date to return the vested share option in
exchange for cash, do you agree with the proposed treatment
outlined in paragraphs 7.37-7.44?
Other issues
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Accounting for Share-based Payment
Chapter 1 Introduction and Scope
Scope
1.1 This Paper discusses the accounting treatment of transactions where an
entity obtains goods or services from other parties, such as suppliers or
employees, with payment taking the form of shares or options on the entity’s
shares (share options) issued by the entity to those other parties.
1.2 Transactions involving the issue of shares or share options in
connection with a business combination fall outside the scope of this Paper.
Each of the G4+1 organisations has issued accounting standards that apply to
such transactions. It is not envisaged that any accounting standards on sharebased payment developed from this Paper would change or supersede existing
accounting standards on business combinations.
1.3
The primary purpose of the Paper is to:
(a)
identify the elements of financial statements (assets, liabilities, equity,
revenues or expenses) that arise in respect of share-based payment
transactions;
(b)
determine how those elements should be measured; and
(c)
determine when those elements should be recognised.
1.4 The Paper focuses primarily on employee share plans, whereby
employees (including directors) provide services to an entity in exchange for
shares or share options. However, the accounting issues relating to employee
share plans are the same as those that arise where an entity obtains goods and
services under a share-based payment arrangement. For example, companies
whose shares or share options are regarded as a valuable ‘currency’ may grant
shares or share options to suppliers of professional services. Therefore, the
proposals apply also to non-employee share-based payment. However, the
Paper focuses on employee share plans because it is in connection with such
plans that most of the more difficult issues arise.
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1.5 Furthermore, the use of the terms ‘shares’ and ‘share options’ is not
intended to limit the scope of the proposals to companies. Other entity
structures are also included, for example, arrangements whereby employees or
suppliers provide goods or services to a partnership in return for an equity
interest in that partnership.
Overview of Paper
1.6 Chapter 2 sets out brief background information on the types of share
plans in use at present and the accounting treatment of such plans.
1.7 Chapter 3 discusses the applicable accounting principles, including a
summary of the distinction between liabilities and equity under the conceptual
framework3, why changes in the value of debt instruments are recognised but
changes in the value of equity instruments are not, and the rationale for
recognising a charge in the income statement for employee services received
under an employee share plan.
1.8 Chapter 4 considers three possible methods of measuring shares or
options issued under an employee share planhistorical cost, intrinsic value
and fair value. Historical cost and intrinsic value are rejected and fair value is
proposed as the only suitable basis for measurement. Option pricing models
are discussed, including features relevant to employee share options.
Suggestions are made for situations where it is argued that the fair value of the
entity’s shares or options cannot be reliably determined.
instrument. In order for the transaction to be remeasured at exercise date, a
share option would need to be classified as a liability. It is concluded that a
share option is an equity instrument, and that exercise date measurement is
therefore not appropriate.
1.10 Another major issue addressed in Chapter 5 is the point at which an
equity instrument is issued, i.e. comes into existence in economic terms, as
this determines whether grant date, service date or vesting date measurement
is appropriate.
The chapter concludes by supporting vesting date
measurement, on the basis that it is on vesting date that an equity instrument is
issued. It is only then that the other parties have provided to the entity the
goods and services due from them as consideration for the equity instrument,
and receipt of that consideration by the entity is a prerequisite to issuing the
equity instrument to those other parties.
1.11 Chapter 6 considers the allocation of the transaction amount over the
performance period under vesting date measurement.
1.12 Chapter 7 discusses other issues relating to vesting date measurement,
such as the treatment of lapsed options, accounting for modifications of option
terms (including repriced options) and options with cash alternatives, and the
application of the proposals to other forms of share-based payment.
1.13 Chapter 8 summarises the conclusions reached in the Paper.
1.9 Chapter 5 considers the various possible measurement dates upon
which shares or options might be valuedgrant date, service date, vesting
date and exercise date. An example of how to calculate the transaction
amount under each measurement date is given and the relative merits of the
various measurement dates are discussed. The first major issue addressed in
the discussion is whether a share option is a debt instrument or an equity
3 Each member of the G4+1 has issued a ‘framework’ or ‘statement’, or a series of ‘statements’,
that set out the concepts or principles for financial reporting. For example, IASC has issued a
Framework for the Preparation and Presentation of Financial Statements and the FASB has
issued a series of Statements of Financial Accounting Concepts. There are some differences in
the wording used in each framework/statement for the definitions of liabilities and equity, but
the concepts are essentially the same. Accordingly, references to ‘the conceptual framework’ in
this Paper encompass all of the conceptual frameworks/statements issued by the G4+1
organisations.
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Chapter 2 Background
Use of share-based payment
2.1
The use of share-based payment has increased in recent years. For
example, shares or options are commonly included in the remuneration of
directors and other executives. In the UK, the Government has recently
announced a tax-advantaged share plan, to encourage more companies to offer
shares to all employees. Companies whose shares or share options are
regarded as a valuable ‘currency’ increasingly use share-based payment to
obtain employee and professional services.
Types of share plans
2.2.
Share plans range from the simple to the complex. An example of a
simple plan is one where the entity’s employees become entitled to shares or
share options, provided they remain in the entity’s employment for a specified
period of time.
2.3
A more complex plan may include other conditions, typically related
to the performance of the entity. Under such a plan, the employee’s
entitlement to shares or share options may vary, depending on whether all or
any of the conditions are met. For example, there might be performance
conditions such that the entity must achieve a certain growth in earnings over a
certain period of time, or achieve a certain ranking in a league table of entities
in the same industry.
2.4
The various types of share-based payment are discussed further in
Appendix D.
Present accounting practice
2.5
Accounting for share plans varies, both in terms of the extent of
accounting guidance available in the jurisdictions of the G4+1 members and in
the treatment of different types of share plans. The USA is the only G4+1
jurisdiction where comprehensive accounting guidance is available and that
guidance is summarised below. A more detailed summary of the accounting
treatment prescribed at present by each G4+1 member is in Appendix E.
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2.6
In the USA, APB Opinion 25 ‘Accounting for Stock Issued to
Employees’ requires a distinction to be drawn between non-performancerelated (fixed) plans and performance-related and other variable plans. In
respect of non-performance-related (fixed) plans, a charge is measured at the
intrinsic value4, if any, at grant date. In the case of performance-related and
other variable plans, a charge is measured at the difference between the
market price and exercise price of the share at measurement date.
Measurement date is the date at which both the number of shares or options
that the employee is entitled to receive and the exercise price become fixed.
As this measurement date is likely to be much later than grant date, any charge
is subject to uncertainty and, assuming that the share price is increasing, would
be larger in the case of performance-related plans. This has had the perverse
effect of discouraging companies from setting up performance-related
employee share plans.
2.7
FAS 123 ‘Accounting for Stock-Based Compensation’ requires a
charge to be made for the fair value of shares or options granted for goods or
services to a party other than an employee. Companies are also encouraged to
apply FAS 123 instead of Opinion 25 for transactions with employees. If
applied, FAS 123 requires grants of shares or options to employees to be
measured at fair value at grant date, irrespective of the type of plan concerned,
thus establishing a level playing field. FAS 123 does not reach a conclusion
on the measurement date for transactions with non-employees. However,
EITF Issue No. 96-185 provides a ‘modified’ vesting date approach. The
FASB regards FAS 123 as superior to Opinion 25. However, few companies
have chosen to adopt FAS 123 for transactions with employees.
Chapter 3 Accounting Principles
3.1
This chapter discusses the accounting principles applicable to
accounting for share-based payment. It includes a summary of the distinction
between liabilities and equity under the conceptual framework6, why changes
in the value of debt instruments are recognised but changes in the value of
equity instruments are not, and the rationale for recognising a charge in the
income statement for employee services received under an employee share
plan.
Liabilities and equity
3.2
The distinction between liabilities and equity is at present under
review by a number of standard-setting bodies. The FASB, for example, is
developing an accounting standard on the classification of financial
instruments as liabilities or equity. The outcome of this review may lead to a
change in the conceptual framework, or the way in which that framework is
commonly interpreted. However, the G4+1 believes that any such changes
will not affect the conclusion that a share option is an equity instrument
(paragraph 5.16). In any event, for the purposes of this Paper, the discussion
of liabilities and equity will be based upon the present conceptual framework
and the way it is normally interpreted, as set out below (paragraphs 3.3-3.5).
3.3
In the conceptual framework, liabilities are defined as present
obligations to transfer economic benefits or assets to another party as a result
of past transactions or events.7 Equity, otherwise known as ownership
6 As described in the footnote to paragraph 1.7.
4 Intrinsic value is the excess of the market value of the share to which the holder would be
entitled on immediate exercise of the option over the exercise price.
5 EITF Issue No. 96-18 ‘Accounting for Equity Instruments That Are Issued to Other Than
Employees for Acquiring, or in Conjunction with Selling, Goods or Services'
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7 There are differences between the conceptual frameworks of individual G4+1 members, and
the words used to define liabilities (and other elements of financial statements) may differ.
However, all of those definitions of liabilities embody the notion of a present obligation to
transfer economic benefits or assets to another party as a result of past transactions or events.
Some argue that the term ‘economic benefits’ has a broader meaning than ‘assets’ and that an
obligation to transfer economic benefits may include an obligation to issue an equity
instrument. This suggests that a conceptual framework that defines liabilities in terms of an
obligation to transfer economic benefits has a broader concept of liabilities than a framework
that defines liabilities in terms of an obligation to transfer assets. Exploring this issue is beyond
the scope of this Paper and, in any event, it has little effect on the conclusions reached
(discussed further in the footnote to paragraph 6.5). Therefore, the Paper bases its discussion of
liabilities and equity on the premise that an obligation to transfer economic benefits is limited to
an obligation to transfer cash or other assets of the entity.
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interest, is defined as the residual interest in the assets of the entity that
remains after deduction of liabilities.
3.4
Therefore, the determining factor when considering whether any
particular financial interest is a liability or a part of equity is whether there is
an obligation to transfer to another party economic benefits, i.e. cash or other
assets of the entity. Ordinary shares, for example, are classified as equity
under the conceptual framework, on the basis that the entity is not compelled
to transfer cash or other assets to the shareholders until some formal act has
occurred, such as the declaration of a dividend.
3.5
Hence, a financial instrument that requires some type of performance
by the entity will be a liability if that performance takes the form of a transfer
of cash or other assets from the entity to another party. In other words, it is
not enough that the financial instrument obliges the entity to perform in some
way; the conceptual framework requires there to be an obligation to transfer
cash or other assets to another party as one of the criteria for that financial
instrument to be classified as a liability.
are denominated in a foreign currency or where a fair value measurement
system has been adopted), and indeed with all financial instruments held by
the reporting entity (i.e. debt and equity instruments issued by other parties),
which may be subsequently remeasured.
Recognising a charge for shares and options granted to
employees
The ‘no cost therefore no charge’ argument
3.9
Some argue that a charge for shares or options issued to employees
should not be recognised, because there is no cost to the entity. In other
words, the granting of shares or options does not require the entity to sacrifice
cash or other assets, hence there is no cost.
3.10
Others argue that where shares or options are issued to employees for
less than fair value, there is a sacrifice in the form of an opportunity cost: the
sacrifice is the cash forgone, i.e. the additional cash that the entity could have
received by issuing those shares or options to other parties.
Changes in the value of debt and equity instruments
3.6
Under the conceptual framework, gains or losses arising from
changes in the value of debt instruments issued by the entity may be
recognised, but not gains or losses arising from changes in the value of equity
instruments issued by the entity. This reflects the definition of equity as a
residual interest, i.e. the residual interest in the assets of the entity that remains
after deduction of its liabilities. Hence equity is not measured directly; it is
measured as the difference between assets and liabilities.
3.7
Accordingly, the total of recognised gains and losses, otherwise
known as comprehensive income, is measured by the change in net assets
recognised during the period, other than changes arising from transactions
with owners. Therefore, changes in the market value of equity instruments do
not generate a gain or loss to the entity, because there has been no change in
recognised net assets.
3.11
Whether or not one accepts the opportunity cost argument, the ‘no
cost therefore no charge’ argument is unsound, because it ignores the fact that
a transaction has occurred, i.e. the employees have provided valuable services
to the entity in return for valuable shares or options.
3.12
Irrespective, therefore, of whether one believes such transactions
have a cost to the entity, an accounting entry is required to recognise the
resources received by the entity in respect of the issue of shares or options, just
as it is on other occasions when shares or options are issued. For example,
where shares are issued for cash, an entry is required to recognise the cash
received. If a non-monetary asset, such as plant and machinery, is transferred
to the entity instead of cash for those shares, an entry is required to recognise
the asset received.
3.8
As a result, once an equity instrument has been issued (i.e. brought
into existence, in economic terms), it is not subsequently remeasured in the
financial statements of the issuer. This contrasts with debt instruments issued
by the entity, which may be remeasured after issue (for example, where they
3.13
Any charge to the income statement arising out of such a transaction
represents the consumption of economic benefits, i.e. the ‘using up’ of the
resources received for the shares or options. In the case of the plant and
machinery mentioned above, the asset would be depreciated its expected life,
thus generating a charge to the income statement each year. Eventually, the
entire amount recognised for the resources received when the shares were
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issued would be charged to the income statement, including any residual
value, which would form part of the gain or loss on disposal of the asset.
3.14
The only difference in the case of employee services received as
consideration for the issue of shares or options is that usually the resources
received are consumed immediately upon receipt. (An example of an
exception to this is where those services are used in the production of
inventories or fixed assets: in such a case the charge may be included in the
cost of the asset and not recognised until such time as the inventories or fixed
assets are sold or consumed.)
3.15
If the ‘no cost therefore no charge’ argument is followed to its natural
conclusion, it would mean that every time the entity obtains resources through
the issue of shares or options, no entry should be made where the subsequent
consumption of those resources would generate a charge to the income
statement. For example, where shares are issued in a business combination,
apparently no entry should be made to recognise assets such as inventories and
depreciable fixed assets.
3.16
Clearly, such a result would be unacceptable. It demonstrates that the
‘no cost therefore no charge’ argument is unsound, because it fails to
appreciate that the debit entry made when shares or options are issued is to
recognise the resources received by the entity, i.e. the resources that another
party has contributed to the entity in exchange for shares or options. Any
charge to the income statement recognises the subsequent consumption of
those resources. If the ‘no cost therefore no charge’ argument were applied,
then not only would the financial statements fail to recognise the receipt of
resources by the entity, the financial statements would also fail to recognise
the use of those resources by the entity. Such a result would seriously impair
the quality of financial reporting because the financial statements would fail to
reflect economic transactions that had occurred.
The ‘earnings per share is hit twice’ argument
3.17
Another argument made against recognising a charge on the issue of
shares or options to employees is that earnings per share is ‘hit twice’, in that
the charge to the income statement for the employee services consumed
reduces the entity’s earnings, while at the same time there is an increase in the
number of shares issued or to be issued.
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3.18
It should be noted that if the entity issued shares for cash and used
that cash to pay employees for their services, it would have the same effect on
earnings per share as issuing those shares directly to the employees.
3.19
The impact on earnings per share reflects the fact that if earnings per
share is to be maintained, the dilutive (or potentially dilutive) effects of
providing consideration to employees by way of an issue of shares (or options)
must be compensated for by generating earnings sufficient to maintain the
entity’s existing earnings performance.
3.20
Basically, the dual impact on earnings per share simply reflects the
two economic events that have occurred: the entity has issued shares (or
options), thus increasing the denominator of the earnings per share calculation,
and it has also consumed the resources it received for those shares (or
options), thus reducing the numerator.
3.21
In contrast, if the entity had paid cash to the employees instead of
awarding them shares or options, the numerator of the earnings per share
calculation would be affected but not the denominator. In such a case, the
entity could maintain its earnings per share simply by generating sufficient
revenue to offset the charge to the income statement for the employee services
purchased and consumed.
3.22
Accordingly, issuing shares or options to employees, instead of
paying them in cash, requires a greater increase in the entity’s earnings in
order to maintain its earnings per share. Hence, recognising such a transaction
ensures that its economic consequences are reported.
The ‘adverse economic consequences’ argument
3.23
Some argue that to require recognition (or greater recognition) of
employee share-based payment would have adverse economic consequences,
in that it might discourage entities from introducing or continuing employee
share plans.
3.24
It is interesting to note that in the USA, the bias in Opinion 25,
whereby a charge (or greater charge) is more likely to arise under
performance-related and other variable plans, has apparently led to entities
favouring service-only (fixed) plans. In this case, accounting practice has
created an economic distortion.
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3.25
Some might argue that such a distortion could be corrected by simply
not recognising employee share plan arrangements, thus enabling entities to
set up whatever type of plan they wish, without any accounting implications.
However, such an approach does not eliminate the economic distortion, it
simply adds to it, because the failure to recognise employee share plans results
in a failure to recognise the transfer and consumption of economic resources.
As a result, the quality of financial reporting is impaired. For example,
comparability is impaired between entities that pay for employee services with
cash and those that pay by issuing shares or share options.
3.26
If the introduction of proposals such as those in this Paper did indeed
lead to a reduction in the use of employee share plans, that might be because
the requirement for entities to account properly for employee share plans had
revealed the economic consequences of such plans. In effect, this would
correct the present economic distortion, whereby entities are able to obtain and
consume resources by issuing valuable shares or options without having to
account for such transactions.
Summary
3.27
Transactions between the entity and its employees (including
directors), whereby the employees provide services in return for valuable
shares or share options issued to them by the entity, should be recognised in
the entity’s financial statements, to reflect the receipt and consumption of
employee services and the issue of equity instruments.
Chapter 4 Possible Measurement Methods
4.1
This chapter discusses the possible methods of measuring awards of
an entity’s shares or share options: historical cost, intrinsic value and fair
value. The next chapter, Chapter 5, outlines the various possible dates at
which the elements of the transaction could be measured and discusses the
merits of each. Once the appropriate measurement method and measurement
date have been established, the transaction amount may be calculated.
Therefore, this and the following chapter focus on measurement of the
transaction amount, not the timing of recognition in the financial statements.
The allocation of the transaction amount to various financial reporting periods
is not considered until Chapter 6.
4.2
The principles prescribed for accounting for share options are equally
applicable to awards of shares. For example, under the fair value method, the
same issues concerning the appropriate measurement date apply irrespective
of whether it is the fair value of an option or the fair value of a share that is to
be measured on that date.
4.3
The following measurement methods are considered:
•
historical cost
•
intrinsic value
•
fair value.
Historical cost
4.4 In jurisdictions where legislation permits, companies commonly
repurchase their own shares, either directly or through a vehicle such as a
trust, as a means of ensuring that they can easily fulfil promised awards of
shares to employees or the exercise of employee options. A possible basis for
quantifying an award of shares (or options) would be the historical cost of the
shares (if any) that were so held, even if they were acquired before the award
was made.
4.5 This would entail comparing the historical cost of such shares held and
the funds received when those shares were subsequently transferred to other
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parties, such as employees8. Any shortfall would be regarded as a cost to the
entity.
transfer of such an asset in order to acquire resources at the fair value of the
asset given up, not its historical cost.
4.6 However, the historical cost basis does not reflect either the value of the
shares (or options) issued or the value of the employee services received.
Intrinsic value
4.7
Furthermore, the historical cost basis is unsound because it treats the
entity’s purchase of its own shares as being the purchase of an asset, which is
not the case. 9 The repurchase of shares and their subsequent reissue or
transfer to other parties are transactions with owners that should be reported as
movements within equity. It follows that no gain or loss should be recognised
in the income statement. Under the conceptual framework, gains and losses
are measured by changes in the net assets of the entity, other than changes
arising from transactions with owners. (Note that this principle should not be
confused with the need to charge the income statement when resources
contributed to the entity, as consideration for the issue of an equity instrument,
are subsequently consumed by the entity, as discussed earlier (paragraph
3.13).)
4.8
In any event, even if the entity’s own shares were an asset of the
entity, it would not necessarily follow that their transfer to other parties, such
as employees, ought to be recorded at historical cost. The historical cost
system measures the acquisition of resources at the amount sacrificed by the
entity to acquire those resources. Accordingly, where goods and services, such
as employee services, are purchased, the amount sacrificed is the value of the
resources given up by the entity. Therefore, even if the entity’s own shares
were an asset of the entity, it would seem more appropriate to record the
4.9
Another method for valuing an equity instrument is its intrinsic value.
The intrinsic value of an option at any point in time is the excess of the value
of the shares to which the holder would be entitled on immediate exercise over
the exercise price. Like fair value (discussed below), an intrinsic value
measurement basis could be applied at any measurement date.
4.10
Often, options granted to employees do not have any intrinsic value at
the date of grant—commonly the exercise price is at or above the market value
of the shares at grant date. In many cases, therefore, valuing options at their
intrinsic value at grant date is equivalent to attributing no value to options at
all.
4.11
It is clear, however, that the intrinsic value of an option does not fully
reflect its value. This is evidenced by the fact that options sell in the
marketplace for more than their intrinsic value. The holder of an option need
not exercise it immediately and stands to benefit from any increase in the
value of the underlying shares. The possibility of such a future gain is
undeniably part of the value of an option: it is commonly referred to as the
option’s ‘time value’. (It should be noted that the value of an option is clearly
more than its intrinsic value because the option conveys the valuable right to
participate in future gains. The future gain itself is not measured in the
valuation, only the amount that a buyer would pay at the valuation date to
obtain the right in question.)
8 See, for example, UITF Abstracts 13 and 17 in the UK.
9 Accounting practice in some jurisdictions may present own shares acquired as an asset, but
they lack the essential feature of an assetthe ability to provide future economic benefits. The
future economic benefits usually provided by an interest in shares are the right to receive
dividends and the right to gain from an increase in value of the shares. When a company has an
interest in its own shares, it will receive dividends on those shares only if it elects to pay them,
and such dividends do not represent a gain to the company, as there is no change in net assets:
the flow of funds is simply circular. Whilst it is true that a company that holds its own shares in
treasury may sell them and receive a higher amount if their value has increased, a company is
generally able to issue shares to third parties at (or near) the current market price. Although
there may be legal, regulatory or administrative reasons why it is easier to sell shares that are
held as treasury shares than it would be to issue new shares, such considerations do not seem to
amount to a fundamental contrast between the two cases.
4.12
To illustrate this, consider two options, each of which gives the
holder the right to purchase for $9 a share worth $10. The intrinsic value of
the awards is the same. However, if one option has a longer exercise period
than the other, or if the price of the underlying shares is more volatile, then it
is clearly more valuable. Use of intrinsic values would portray these
dissimilar options as similar, rather than capture their differences.
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Fair value
4.13
If it is agreed that neither historical cost nor intrinsic value provides a
suitable basis for measurement, the only alternative would seem to be fair
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value. Fair value is already used in other areas of accounting, including other
situations where non-cash resources are acquired through the issue of equity
instruments. For example, a business acquisition is measured at the fair value
of the consideration given, including the fair value of any equity instruments
issued by the entity. Similarly, where an entity purchases goods, services or
other assets by transferring a non-cash asset to the supplier, the cost of the
resources purchased is measured at the fair value of the consideration given by
the entity in exchange.
4.14
In summary, fair value is already commonly used to measure the
purchase of resources where non-cash consideration is given by the entity in
exchange. Therefore, the quality of financial statements, particularly
consistency and comparability, would be enhanced by adopting fair value as
the basis for measuring options or shares issued by the entity as consideration
for the purchase of goods and services from other parties, including
employees.
4.15
There are, however, various ways in which the fair value of an option
might be measured, and these are considered below.
Observable market value
4.16
There may be instances where shares or share options are issued to
employees or suppliers on terms and conditions that are substantially similar to
those for other shares or options issued by the entity that are actively traded in
the market. In this situation, the observable market value of the traded shares
or options would establish the fair value of the shares or options issued to
employees or suppliers. For most options, however, it is likely that no such
market value will exist, either because the entity has not issued any options
that are traded in the market or because the traded options were issued on
terms and conditions significantly different from those applying to options
issued to employees or suppliers. Accordingly, in most cases it will be
necessary to consider another means of establishing the fair value of shares or
options issued to employees or suppliers.
Consideration received
4.17
Where an option is issued on arm’s length terms for consideration
(often cash), in the absence of any indication that the transaction did not take
place at fair value, it seems reasonable to suppose that the value of the
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consideration received represents the fair value of the option. Where non-cash
consideration is received, such as in the case of employee share plans, valuing
the consideration received can be more difficult.
Cash alternative
4.18
In some instances employees are offered the choice of taking share
options or cash. However, the value of the cash alternative may not represent
the fair value of the option. This is because the cash alternative is part of the
offer by the employer, rather than an independently negotiated price, i.e. the
cash alternative does not represent the amount a third party would pay for the
option, but rather the amount the employees may receive instead of the option.
4.19
Therefore, even if it were demonstrated in a particular case that a
large number of employees chose the cash alternative, it should not be
assumed that the value of the options was no more than that of the cash. This
is because the economic nature of the cash and the options differ, notably in
terms of liquidity and certainty of value. This may give employees an
incentive to take the cash alternative, even if its value is lower than the value
of the options. Employees may also lack the expertise to value the options. 10
4.20
In other situations, the entity may wish to conserve its cash resources
and therefore offer an inducement, in the form of a low cash alternative or
additional options, to encourage employees to choose to receive options rather
than cash. If the options issued were measured by the amount of the cash
alternative, this would not capture the additional value given to the employees.
4.21
It is sometimes argued that the measurement objective for employee
share awards should be to determine the fair value of an award to the
employees in question. Advocates of such an approach suggest that employee
share awards create a community of interest between the employer and the
employee: as a result the employer may be willing to make share awards to the
employee for a lower consideration than it would willingly accept for issuing
an identical instrument to a third party. It is suggested that employees may be
unwilling to pay as much as a third party because, given their individual
financial circumstances, an investment in their employer’s equity instruments
(or, perhaps, in equity instruments at all) might not be a sensible investment,
10 The question remains as to whether, if employees choose to receive the cash alternative, this
impacts upon the measurement of the transaction amount. This question is addressed in Chapter
7 (paragraphs 7.27-7.44).
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unless it could be acquired at a significant discount. This argument, however,
would be difficult to sustain in the case of directors and other executives, who
may have the financial resources, and the inclination, to invest in the entity’s
equity instruments even without any discount.
4.22
Even if the objective suggested (i.e. an employee-specific value)
were accepted, it is not clear how it could be implemented in practice. In
particular, there would seem to be no strong reason to suppose that the amount
of a cash alternative would necessarily equate to such a value.
4.23
More fundamentally, the financial statements are intended to reflect
the financial performance, financial position and cash flows of the entity, not
its employees. Thus, it is difficult to see how the value to the employee is
relevant.
Option pricing models
4.24
Option pricing models are widely used in the financial markets, and
seem to provide the only practicable means of determining a fair value in the
absence of an observable market price.
4.25
The mathematical basis of option pricing theories is complex, and
estimating some of the inputs necessary to use an option pricing model, such
as the expected volatility of the price of the underlying shares, may be
difficult. However, their application is (reasonably) straightforward and has
been facilitated by developments in technology. Once the relevant inputs have
been determined, the necessary calculations can be performed on a standard
spreadsheet package, or even on a pocket calculator.
4.26
It may not be appropriate for an accounting standard to prescribe the
precise formula or model to be used for option valuation (although examples
of acceptable models might be given). Choosing between the various models
that exist could be done only on the basis of resolving controversies with
which the academic communities are struggling at present. There would also
be a risk that the model specified might be superseded by improved
methodologies in the future.
4.27
It would, however, be reasonable to specify that the model used must
take into account a number of specific features of an option currently accepted
as relevant to its value. These features are:
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(a)
the exercise price of the option
(b)
the current market price of the share
(c)
the expected volatility of the share price
(d)
the dividends expected to be paid on the shares
(e)
the rate of interest available in the market
(f)
the term of the option.
The first two of these items define the intrinsic value of an option; the
remaining four are relevant to the option’s time value.
4.28
The market price of the shares and the volatility of that price may be
particularly difficult to estimate where those shares are unlisted. This may
justify or require a modification of the application of the model in the case of
unlisted companies. Such a modification may deviate from a fair value
approach, but might be regarded as a pragmatic solution to measurement
difficulties associated with options on the shares of unlisted companies.
(FAS 123 permits unlisted companies to use a ‘minimum value’ approach11.)
Features relevant to employee share options
4.29
Option pricing models generally have been developed to deal with
options that are traded in the capital markets (either individually or embedded
in other instruments). Employee share options differ from such instruments in
some important respects, and this may require modifications to the standard
models. The most important such difference is that employee share options
are generally non-transferable.
Non-transferability of employee share options
11 Minimum value can be determined by a present value (PV) calculation (i.e. current share
price less PV of expected dividends during the option’s term less PV of exercise price, based on
the risk-free rate of return) or using an option pricing model with zero volatility.
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4.30
The inability to transfer an option affects its time value because nontransferability limits the opportunities available to a holder where the option
has some time yet to run and the holder wishes to terminate the exposure to
future price changes (for example, because the holder believes that over the
remaining term of the option the share price is more likely to decline than to
increase).
the absence of a superior solution, the use of expected life is a pragmatic way
of dealing with this issue. However, to estimate expected life reliably,
sufficient historical data upon which to base such an estimate would be
required13. If sufficient historical data are not available, contracted life rather
than expected life should be used in the valuation of the entity’s options.
Other features of employee share options
4.31
In the case of a conventional option, such a holder would sell the
option rather than exercise it and then sell the shares. Selling the option
enables the holder to receive the option’s remaining time value, whilst
exercise enables the holder to receive only the option’s intrinsic value.
4.32
However, the option holder is not able to sell a non-transferable
option. The only possibility open to the holder of such an option is to exercise
it, which entails forgoing the remaining time value (although, depending on
the terms of the arrangement, it may be possible to transfer the remaining time
value to another party by means of a derivative).
4.33
FAS 123 addresses this by requiring the expected life12 of a nontransferable option to be used in valuing it, rather than the contracted term.
Some support such an approach, arguing that the use of expected life provides
a means of addressing the issue of non-transferability, that this is an important
issue that must be addressed in some way, and that a superior solution is not
readily apparent.
4.34
Others argue that the use of expected life is not an appropriate means
of dealing with non-transferability. For example, it is not clear that the value
of an option with a contractual term of ten years should be valued at the same
amount as an option with a contractual term of six years, just because both
options may have an expected life of five years. There is also concern that
using expected life adds subjectivity to the valuation process and might tend to
bias estimates towards unrealistically short expected lives because the shorter
the expected life, the lower the option value, hence the lower the charge to the
income statement.
4.35
On balance, because the term of an option is an important factor in
determining the option’s time value, the potential loss of that time value due to
non-transferability should be taken into account when valuing the option. In
12 Based on the vesting period of the grant, the average length of time similar grants have
remained outstanding in the past and the expected volatility of the underlying shares.
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4.36
Other features of employee share options that may require
modification to standard option pricing models include the possibility that
options are forfeited before vesting, or are never issued because performance
conditions are not met. Whether these issues need to be addressed in the
context of measurement principles will depend upon the measurement date
selected: for example, these features need to be addressed if grant date
accounting is selected but not if a vesting date method is prescribed (except in
the context of a change in estimate)14. This matter is discussed further later
(paragraphs 5.20 and 7.4-7.10).
4.37
Similarly, after vesting, in some jurisdictions it is common for some
employees to fail to exercise their options for a variety of reasons other than
whether or not the options are ‘in the money’ at the end of the exercise period.
For example, an employee may lack the expertise to assess whether to take up
the options or may have difficulty in raising the funds required to exercise the
options. This issue, which will need to be addressed if a measurement date
earlier than exercise date is selected, is also considered further later
(paragraphs 7.11-7.17).
13 Ideally, this data should be based upon the entity’s previous experience of issuing options on
similar terms and conditions to similar groups of employees. Alternatively, it may be acceptable
in certain circumstances to consider data based upon the previous experience of other similar
entities that have issued options on similar terms and conditions to similar groups of employees,
if such data are readily available.
14 Definitions of grant date, service date, vesting date and exercise date are given in paragraph
5.2.
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Options that are difficult to value
4.38
One criticism of any proposal to fair value options is that features of
certain kinds of options make them very difficult to value. However, only in
extremely rare circumstances will it not be possible to establish a value.
Indeed, there seem to be strong grounds for arguing that the fiduciary duties of
directors should prevent them from issuing instruments whose value cannot be
established within reasonable parameters. For example, it has been held in a
US case that the directors should be satisfied that the value of the benefits to
be received by the corporation from granting the options bears some
reasonable relationship to the value of the options granted.15
4.39
However, plans may exist where valuation would be very difficult.
This difficulty is more likely to arise if an earlier measurement date is
selected. In other words, in some cases it may be very difficult to measure the
fair value of the option at grant date but less difficult at vesting date.
Certainly it will be possible to establish the fair value of the option at exercise
date. One alternative, therefore, is to require exercise date measurement to be
applied if an entity were to argue that it could not reliably measure the value
of its options at an earlier date.
4.40
Another approach would be to use an alternative measure. An
appropriate alternative measure is the value of the employee services received.
As noted earlier, the value of the consideration received for an option seems a
reasonable measure of the value of that option. Whilst valuing employee
services is usually more difficult than valuing the option, this will not
necessarily be the case if the entity cannot estimate the fair value of its options
at the required measurement date. For example, an unlisted start-up company
may argue that fair valuing its options is very difficult. The fair value of the
employee services received, however, may be more readily measurable, by
comparing the employee’s remuneration, excluding the options, with the
current remuneration of similarly qualified employees of other entities who do
not receive options.
4.42
Where the entity obtains services from employees by issuing shares
or share options, these transactions should be measured at the fair value of the
options or shares issued. Fair value is commonly used to measure other
transactions where non-cash consideration is given by the entity to acquire
resources, including other situations where that consideration takes the form of
shares or share options issued by the entity. Hence, the consistency and
comparability of financial statements will be enhanced by requiring a similar
treatment for employee share plans and other situations where the entity has
acquired goods and services by issuing shares or options to the supplier.
4.43
Furthermore, other measurement bases, such as historical cost and
intrinsic value, do not provide a suitable basis for measuring either the value
of the employee services received or the value of the shares or options issued.
4.44
Where an observable market price does not exist, the fair value of
share options should be calculated using an option pricing model. The model
should take into account the relevant features of the option, i.e. the exercise
price, term of the option, the current market price and expected volatility of
the share price, dividends expected to be paid on the shares and the rate of
interest available in the market. Where the share option is non-transferable
and sufficient historical data are available, the calculation of the fair value of
the option should be based upon the expected life of the option rather than its
contracted life, in order to take into account the potential loss of the option’s
time value.
4.45
In extremely rare cases, where an entity is unable to estimate reliably
the fair value of its options at the required measurement date, an alternative
measure is the fair value of the goods or services received. If the entity is
unable to estimate reliably the fair value of either side of the transaction, it
should be required to apply exercise date measurement.
4.41
It seems reasonable to conclude that if an entity cannot reliably
measure the fair value of either side of the transaction at the required
measurement date, then it should be required to adopt exercise date
measurement.
Summary and conclusion
15 Olsen Brothers, Inc. v. Englehart, 211 A.2d 610
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Chapter 5 Possible Measurement Dates
5.1
This chapter considers a range of possible measurement dates, any
one of which could be used for calculating the fair value of the shares or
options issued. An example is given to illustrate the calculation of the fair
value of an option at each of the dates16. It should be noted that this chapter
focuses on measurement, not on the timing of recognition in the financial
statements. The allocation of the transaction amount to particular accounting
periods is discussed in Chapter 6.
5.2
The fair value of an employee share option might be assessed for
accounting purposes at one of several dates:
(a)
Grant date—the date at which the employee and employer enter into
a contract that will entitle the employee to receive an option on a
future date, provided certain conditions are met.
(b)
Service date—the date upon which the employee performs the
services necessary to become unconditionally entitled to the option.
However, the relevant services are usually performed over a period
rather than on a single date: conceptually, service date measurement
entails measuring the fair value of the option at each date when
services are performed. For pragmatic reasons, an approximation
may be used to calculate the charge in respect of services received
during a particular accounting period. For example, the fair value of
the option at the end of the accounting period may be used, where
that is regarded as a reasonable approximation, or the fair value of
the option may be based upon the average share price during the
period.
(c)
Vesting date—the date at which the employee, having satisfied all the
conditions necessary, becomes unconditionally entitled to the option.
In many cases, once an option has vested it may be exercised
immediately.
(d)
Exercise date—the date at which the option is exercised.
16 For simplicity, this chapter considers the fair value of options rather than both shares and
options. However, the same measurement principles apply to awards of shares.
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Illustration of fair value calculation at each measurement
date
5.3
To illustrate the calculation of fair value for each measurement date,
a single example is used throughout. It should be noted that this example is a
simple ‘cliff vesting’ plan, whereby all of the options vest on one date at the
end of the performance period (provided that the performance criteria have
been satisfied). A more complex plan may stipulate a range of vesting dates,
upon which specified numbers of options vest. For example, a plan might
specify that one-third of the options will vest at the end of each year of a threeyear period. Other plans may not stipulate a particular calendar date for
vesting; instead vesting might occur when a specified performance target has
been achieved (e.g. earnings per share exceeds 25 cents). The example given
is purposely a simple one, to aid discussion of the various possible
measurement dates.
On 1 January 2000 a company grants an employee rights to subscribe, between
the dates 31 December 2002 and 31 December 2004, for 120 shares at $17
each. The market value of the shares on 1 January 2000 was $16 each and the
fair value of the options at that date was estimated to be $3.50 each.
There are no performance conditions, except that the employee must remain
employed by the company until 31 December 2002: if the employee leaves the
company’s employment at any time before that date all the options will be
forfeited. The options vest on 31 December 2002.
The following table gives the share prices on the last day of the year, as well
as the fair value of the option at those dates:
Year
Share price
Fair value of option
2000
$16
$3
2001
$18
$4.50
2002
$20
$5
2003
$23
$6.50
The employee remains employed throughout the three-year period and chooses
to subscribe for the shares (i.e. exercise the options) on 31 December 2004,
when the share price is $24.
Note: The determination of the option’s fair value would not include the effects of any
performance conditions (being the service of the employee in this case) and, in any event, the
fair values given above have been assumed for this example, rather than calculated from further
assumptions.
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Grant date measurement
Vesting date measurement
5.4
Under grant date measurement, the transaction, being the receipt of
employee services and the issue of share options, will be measured as follows:
5.6
Under vesting date measurement, the transaction amount would be
calculated as follows:
The transaction is measured and fixed at the date of grant when the fair value
of the option was $3.50. As 120 options were granted, the amount to be
recognised is $420.
The transaction is measured at the fair value of the option at vesting date, i.e.
$5. As 120 options vested, the amount to be recognised is $600.
Exercise date measurement
Service date measurement
5.5
Under service date measurement, the transaction would be measured
as follows:
The transaction is measured by reference to the fair value of the option during
each of the three years of the service period. Assuming that the fair value of
the option at the end of each year represents a reasonable approximation of the
fair value of the option during the year, the transaction amount would be
calculated as follows:
$
5.7
Under exercise date measurement, the transaction amount would be
calculated as follows:
The transaction is measured at the fair value of the option at exercise date, i.e.
$7. As 120 options were exercised, the amount to be recognised is $840.
Summary of methods
5.8
The outcome of calculations under the different methods can be
summarised as follows:
Year
Calculation
2000
120 options × 1/3 × $3
=
120
Total calculated ($)
2001
120 options × 1/3 × $4.50
=
180
2002
120 options × 1/3 × $5
=
200
Method
Transaction
amount
Total
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500
40
Grant
420
Service date
500
Vesting
Exercise
600
840
5.9
An important point to note is that this example deals with a scenario
in which the share price is rising over the period in question. If the share price
fell instead, then grant date measurement would almost certainly produce the
greatest expense. Using service date, vesting date and exercise date methods
would lead to a credit in later years that could replace or in extreme cases
wipe out any earlier charges (see the example in Appendix A).
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Consideration of the measurement date: at what date has a
financial instrument been issued?
5.10
To consider, at each of the possible measurement dates, what type of
financial instrument, if any, has been issued (i.e. come into existence, in
economic terms), two interrelated questions are addressed:
(a)
has a financial instrument been issued at the proposed measurement
date?
(b)
if a financial instrument has been issued, is it debt or equity?
5.11
As a working model, the IAS 32/3917 definition of a financial
instrument (and related definitions) is used here:
“A financial instrument is any contract that gives rise to both a
financial asset of one enterprise and a financial liability or equity
instrument of another enterprise.”
5.12
This discussion begins by considering whether the financial
instrument is debt or equity, as this determines whether exercise date
measurement is acceptable under the conceptual framework, as explained
below.
5.13
Irrespective of whether the share option is regarded as issued (i.e.
comes into existence, in economic terms) on grant date, over the service
period or on vesting date, it is certainly in existence by vesting date because at
that date the employee has the unconditional right to subscribe to the entity’s
shares at the exercise price. As discussed earlier (paragraphs 3.6-3.8), once an
equity instrument has been issued, it should not subsequently be remeasured
for later changes in value. Therefore, if that share option is an equity
instrument, it should not subsequently be remeasured. Accordingly, exercise
date measurement is possible only if the share option is regarded as a liability.
If the share option is a liability, then the transaction may be remeasured at any
time until the liability (the share option) is extinguished, either by being
exercised or by lapsing at the end of the exercise period.
Exercise date measurement: is a share option debt or equity?
“A financial asset is any asset that is:
(a)
cash;
(b)
a contractual right to receive cash or another financial asset
from another enterprise;
(c)
a contractual right to exchange financial instruments with
another enterprise under conditions that are potentially
favourable; or
(d)
an equity instrument of another enterprise.”
“A financial liability is any liability that is a contractual obligation:
(a)
(b)
to deliver cash or another financial asset to another
enterprise; or
to exchange financial instruments with another enterprise
under conditions that may be potentially unfavourable.”
“An equity instrument is any contract that evidences a residual
interest in the assets of an enterprise after deducting all of its
liabilities…”
17 International Accounting Standards IAS 32 ‘Financial Instruments: Disclosure and
Presentation’, IAS 39 ‘Financial Instruments: Recognition and Measurement’
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5.14
Those who believe that employee share options remain liabilities
until they are exercised claim that assets, liabilities, gains and losses should be
recognised by reference to the effects of transactions on the entity, or its
equivalent, the existing body of owners of the entity. Option holders, it is
argued, are only potential owners of the entity. The entity’s promise to issue
shares is therefore seen as a liability, as it exposes the existing shareholders to
the opportunity cost of forgoing the potential proceeds from issuing shares at
full value. Many who support exercise date accounting do so because they
believe that an obligation to issue shares at a fixed price should qualify as a
liability (i.e. they consider that the definition of a liability should be revised so
as to include such obligations). An additional argument is that many people
regard the benefit of share options to an employee as being the difference
between the market value of the shares on exercise of the options and the
exercise price paid by the employee to obtain the shares; only exercise date
measurement will ensure that the amount recognised by the entity is the same
amount as the perceived value of the benefit to the employee.
5.15
Exercise date measurement also results in recognition of the same
amount for employee options as a contract that is similar to an option except
that it is settled by a cash payment from the company for the difference
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between the share price and a fixed amount (this is sometimes described as a
‘stock appreciation right’).
5.16
Against this, it is argued that the only rights of holders of options for
ordinary shares are rights to become owners, i.e. they are in the nature of
ownership interests. Options do not, at present, meet the definitions of
liabilities contained in the conceptual framework. This is because share
options do not give rise to an obligation to transfer to another party economic
benefits, i.e. cash or other assets of the entity. Accordingly, share options are
equity instruments under the conceptual framework; hence exercise date
measurement is not consistent with the conceptual framework.
Has a financial instrument been issued on grant date?
5.17
On the date that a grant is made, the employer commits itself to issue
shares in the future, provided that the employee fulfils the conditions of the
plan and pays the exercise price. Some would argue that this promise to issue
shares is a financial instrument.
5.18
Grant date measurement, therefore, is based on the argument that an
equity instrument has been issued by the company at the moment the promise
is made and the transaction should therefore be measured at that date. It is
argued that the employee has an equity interest in the entity at grant date and
any subsequent changes in the value of the option are borne by the option
holder in the capacity of an owner, not an employee.
5.19
It is also argued that, when determining the terms of an option plan,
the parties presumably have in mind the option value at that time rather than
its possible value at a future date and the amounts recognised represent the fair
value of the services the entity calculates it will receive in return for granting
the share options.
5.20
An argument against treating these instruments as having been
created at the grant date is that the estimate of the value should reflect the
possibility that, if the related conditions are not met, e.g. because an employee
leaves, the options will never vest. Under strict grant date measurement, that
estimate would not be revised to reflect any changes: thus a charge to the
income statement and a contribution to equity could be recognised based on
the number of options expected to vest (as estimated at grant date), even if the
actual outcome is that a smaller or greater number of options vest. (For
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options granted to employees, FAS 123 uses a version of grant date
measurement18 under which the fair value of options recognised is that
prevailing at the date of grant, but the charge is adjusted to reflect the extent to
which options vest.)
5.21
Grant date measurement might be more appealing if the option were
valued at grant date and a corresponding asset—prepaid staff costs—could be
recognised (this was suggested in the exposure draft to FAS 123 but not taken
forward to the final standard). The resulting charges to the income statement,
representing amortisation (and perhaps impairment) of that asset, would then
be understandable. However, there seems to be no basis for recognising such
an asset, because the entity has not received an enforceable right to the
employee services at the grant date. The employee is free to leave at any time
(subject to the terms of the employment contract).
5.22
Furthermore, the employee’s share subscription rights are dependent
upon the employee first providing services to the entity, so the employee has
no enforceable rights at grant date. Therefore, neither party to the contract has
any enforceable rights at grant datethe entity has no enforceable right to the
employee’s services and the employee has no enforceable right to subscribe to
the entity’s shares. That being so, it appears that the definition of a financial
instrument is not satisfied. This contrasts with the situation at vesting date, by
which time the employee will have completely satisfied the performance
criteria and therefore will have an enforceable right to subscribe to the entity’s
shares during the exercise period while the entity will have an enforceable
obligation to issue the shares upon exercise of the option by the employee.19
If the contract did not create a financial instrument at the
grant date, what happens during the service period?
5.23
While proponents of grant date measurement argue that a financial
instrument has been issued on grant date, others argue that at grant date the
contract is completely unperformed by each party. Furthermore, neither party
has an enforceable right to require performance by the other party. It is argued
18 Two FASB board members dissented from FAS 123, partly because they believed that vesting
date measurement would provide a superior measure of compensation cost to the grant date
method.
19 As noted above (paragraph 5.16), a share option is an equity instrument. An obligation to
issue shares upon exercise of the option by the employee is not a liability because the entity is
not obliged to transfer cash or other assets of the entity to the option holder.
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that, on grant date, the employee has not fulfilled any of the performance
criteria and therefore has no right to receive, and the entity has no obligation to
issue, the equity instrument. Similarly, the entity has no right to receive, and
the employee has no obligation to provide, services. It will remain so until
some later date, e.g. vesting date.
5.24
If this is the case, it is necessary to look at what might have happened
at dates later than the grant date. Some would argue that the equity instrument
is issued at the same time as performance occurs, i.e. when the employee
performs the services required to ‘earn’ the options. Once some employee
services have been received, the contract is partially performed. If this
approach is taken, then the most suitable measurement date(s) is(are) over the
service period.
Vesting date measurement
5.28
Vesting date measurement is based on the view that a financial
instrument can be deemed to have been created only once performance by the
employeethe provision of the services to the entity as consideration for the
equity instrumentis complete. The option is seen as an absolute right to
subscribe for shares, which can be obtained only when certain prior conditions
are met by the employee. (By contrast, supporters of grant date measurement
see the option as a conditional right that is obtained immediately.)
Summary and conclusions on measurement date
5.29
Exercise date measurement would require share options to be treated
as liabilities, which would be inconsistent with the conceptual framework.
Service date measurement
5.25
The use of service date measurement, it is argued, reflects the nature
of an employee share plan, i.e. the plan provides remuneration to employees in
return for their services over a period and it is therefore appropriate to
measure the transaction based on the value accruing during that period. The
terms are agreed at grant date but it is only in line with performance by the
employees of their part of the contract that the consideration from the
employer in the form of share options becomes due.
5.26
Others argue that service date measurement is inappropriate, because
a financial instrument is issued on a particular date; it cannot be issued
progressively over a period of time.
Is the equity instrument created at vesting date?
5.27
Some believe that, both at grant date and throughout the service
period, the contract is completely unperformed by the entity and that the
entity’s performancethe issue of the equity instrumentoccurs on vesting
date.
5.30
Also, the proposals in this Paper are intended to be appropriate for all
kinds of options, not just employee share options. Exercise date measurement
would have implications for other kinds of options, unlike the other
approaches considered above. Grant date, service date and vesting date
measurement are all based on the view that the option issued by the entity is an
equity instrument that would be accounted for by crediting to equity the
consideration received on issue (cash or, in the case of employee share plans,
employee services) and the consideration received on exercise (usually cash).
But if exercise date measurement is to be used for employee share options, it
is on the basis that it should be used for all share options. This would mean
remeasuring all other forms of share subscription rights on exercise date. For
example, where a share option is issued for cash, the application of exercise
date measurement would result in the recognition of a gain or loss in the
income statement for the difference between the cash received on issue of the
option and the fair value of the option at exercise date.
5.31
Thereafter, the essential question on which the choice of methods
depends is the point when an equity instrument is regarded as having been
issued. Once an equity instrument is issued, it is not subsequently remeasured.
5.32
The decision between grant date measurement, on the one hand, and
service date or vesting date measurement, on the other, turns on the nature of
the conditions that the employee has to meet. It is true that options bought and
sold on the markets (or over the counter) are contingent, in the sense that the
value of the rights that they convey depends on the outcome of some future
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event. But such options involve transfer of consideration from the holder to
the issuer at the outset. Even if the option is not paid for immediately, the
holder has an obligation to pay for it. For employee share options, however,
the employee has no such obligation, because he or she is free to leave the
enterprise (subject to the terms of the employment contract) or to fail to meet
performance conditions in other respects. The performance condition,
therefore, is not a term of the option, but rather the consideration for obtaining
the option. The promise to give the employee subscription rights to the
entity’s shares does not need to be fulfilled until performance by the employee
occurs. If this argument is accepted, then the treatment of such options is
consistent with the accounting principles governing the normal recognition of
options and other equity instruments.
5.33
There remains the choice between service date and vesting date
measurement. Service date measurement has the effect that the employee’s
remuneration is measured by reference to the value of the subscription rights
over the period when service is rendered. Provided performance by the entity
(i.e. the issue of the equity instrument) can be deemed to be fulfilled
incrementally over that period, service date measurement would be
appropriate. However, the employee’s performance may involve remaining in
the entity’s employ until vesting and sometimes meeting other criteria of
varying degrees of challenge. The employee’s performance is not regarded as
complete until the date that all the performance criteria are met, i.e. the
vesting date.
Completion of that performance, which represents the
consideration due from the employees for the equity instrument, is necessary
for the employees to become entitled to receive, and hence the entity to
become obliged to give, the equity instrument. Therefore, the entity’s
performancethe issue of the equity instrumenttakes place on vesting date.
Hence vesting date seems to be the most appropriate measurement date.
5.34
Furthermore, an advantage of vesting date measurement is that the
employee’s services are valued at a price that reflects the performance in the
share price achieved at the end of the contract. The promise of shares or share
options to employees is seen as a means of giving them a benefit directly
related to the performance of the share price that results fromor at least
coincides withtheir effort. Their slice of that performance is therefore
appropriately measured at vesting date.
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Chapter 6 Allocation over the service period
6.1
The discussion of vesting date measurement has thus far focused on
the point when an equity instrument is issued. Employee share options are a
form of compensation for service that is received over a period of time. Thus
it is appropriate that a charge should be recognised over the period of service,
whether that is defined as the period within which specified performance
criteria have to be met or the period up to vesting date during which the
employee has to remain with the entity.
6.2
However, if the equity instrument is issued only on vesting date, what
is the nature of the credit that would be generated by recognising an expense
over the service period? Is it a liability or a part of equity?
6.3
The service performance, which is consideration for obtaining share
options at vesting date, is only partially completed, yet even that partial
completion makes the contract something less than wholly unperformed. One
approach is to regard the employees’ performance of their side of the contract
as creating an obligation for the entity to fulfil its part of the contract at a later
date. Even though the obligation does not become unconditional until
performance is complete, the amount and likelihood would be assessed in
advance and a provision recognised. If the entity were to cancel the contract
at any time, presumably some sort of compensation would be required to be
paid to the employees (assuming that the cancellation of the contract was not
due to the employees failing to perform their side of the contract).
6.4
This suggests that some form of obligation to the employees is
created during the period of service performance, hence it could be argued that
a liability exists. That obligation would be settled on vesting date, when the
entity gives the share subscription rights to the employees. The liability would
be measured at the estimated amount at which it was to be settled, being the
value of the option at vesting date. In this manner, the amount of the liability
would be re-estimated over time and ‘trued up’ on vesting date.
6.5
The problem with this approach is that, unless the entity is
demonstrably committed to cancelling the contract, the ultimate settlement of
that obligation to the employees will be by the issue of an equity instrument,
hence there is no obligation to transfer future economic benefits, i.e. cash or
other assets of the entity. Therefore, even if it is accepted that the entity has
some form of obligation to the employees during the performance period, the
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nature of that obligation does not meet the definition of a liability under the
conceptual framework.20
framework, as discussed above, this still leaves open the question of whether
recognition within equity before vesting date is appropriate.
6.6
Another approach is that the credit to equity during the performance
period recognises the employee services received as being payment on account
of the equity instrument to be issued on vesting date. In other words, the
employees are required to provide services as consideration for the issue of the
equity instrument. Because that consideration is received before the issue of
the equity instrument, it is necessary to recognise the consideration as and
when it is received.
6.10
During the performance period, the entity has what might be
described as a contingent or conditional obligation to issue an equity
instrument. This ‘obligation’ is contingent or conditional, as it is dependent
upon the employee first completing the performance criteria for the obligation
to issue the equity instrument to crystallise. In the case of liabilities, it is
common practice to accrue for contingent or conditional obligations, if it is
considered probable that a future outflow of resources will occur, to the extent
that performance by the other party has already occurred. For example, in the
case of employee pensions and other long-term benefits, an accrual is made
over the period of service.
6.7
This is similar to a situation where the cash for a share issue is
received before the shares are issued. If the cash were received before
balance sheet date and the shares were issued after balance sheet date, the
credit side of the entry to recognise the cash received would be shown in
equity, on the basis that, since the cash is not going to be repaid, it does not
represent a liability. In some jurisdictions, where the payment for shares is
made in instalments, the shares may not legally be issued until such time as
the full amount due for those shares has been paid to the entity. In such cases,
any money received before the issue of the shares is reported as part of equity.
6.8
Similarly, during the performance period, the employees will have
partly provided the consideration due from them for the share options. Given
that the entity will not transfer cash or other assets to the employees to pay for
those services, but will instead issue an equity instrument in the future, there is
no obligation to transfer economic benefits, hence no liability. The credit to
equity therefore recognises the consideration received from the employees, on
account of the equity instrument to be issued to them at a later date.
6.9
Furthermore, as noted above, the performance by the employees
during the performance period means that the contract between the entity and
the employees is no longer wholly unperformed, as the employees have partly
provided the consideration due from them for the equity instrument, which
suggests that some form of obligation to the employees exists. While this
‘obligation’ may not meet the definition of a liability under the conceptual
6.11
Accordingly, the employee services received are recognised based
upon an estimate of the value of the equity instrument to be issued. On
vesting date, this estimate is ‘trued up’, to recognise the value of the equity
instrument at that date.
6.12
It should be noted, however, that the recognition of a credit to equity
and the subsequent adjustment of that credit during the performance period
does not represent the remeasurement of an equity instrument. The equity
instrumentthe share optionis not issued until vesting date. Because the
transaction is measured at the fair value of the equity instrument issued when
the transaction is completed on vesting date, but part of the transaction (the
receipt of employee services) occurs over a period of time before vesting date,
the credit to equity during the performance period is merely an interim
measure that is used to recognise the partially completed transaction. When
the transaction is completed on vesting date, the amount previously credited to
equity is finalised, by being adjusted to equal the fair value of the equity
instrument issued on that date.
20 As noted in the footnote to paragraph 3.3, some argue that an obligation to issue an equity
instrument is an obligation to transfer economic benefits, i.e. a liability. However, the G4+1 has
agreed that a share option, once issued, is an equity instrument. Therefore, even if one
considers that there is an obligation that meets the definition of a liability during the
performance period, this merely affects the classification of the accrual.
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6.13
be:
Using the earlier example, the amount recognised each year would
Year
Calculation
$
2000
120 options × /3 × $3
2001
120 options × 1/3 × $4.50
1
120
120 × /3 × $(4.50 − 3)
= $60
2002
120 options × /3 × $5
= $200
1
7.1
This chapter discusses various other issues relating to the application
of vesting date measurement, including:
•
Lapsed options
•
Repricing of options and other modifications to the terms of options
•
Options with cash alternatives
•
Share appreciation rights
240
•
Application to other forms of share-based payments.
600
Lapsed options
= $180
+ Backlog for 2000
1
Chapter 7 Other issues under vesting date
measurement
240
+ Backlog for 2000 and 2001
120 × 2/3 × $(5 − 4.50)
Total
120 options × $5
= $40
7.2
There are two circumstances in which an employee share option, or
the promise of an option, will lapse:
6.14
If neither of these approaches to the allocation of the charge over the
performance period were accepted, the alternative would be to recognise the
charge, in its entirety, on vesting date. However, this would not reflect the
receipt and consumption of resources (the employee services) over the
performance period. Instead, it would give the impression that those resources
had been received and consumed on vesting date, which would not accord
with economic reality.
6.15
It is therefore appropriate that a charge is recognised over the
performance period, with the credit shown as part of equity.
•
the employee fails to meet the required performance criteria (i.e. lapse
occurs before vesting date)21
•
the employee fails to exercise the option rights, normally because the final
exercise date is reached and the share price is below the exercise price
(i.e. lapse occurs after vesting date)
7.3
The second of these circumstances can occur for a normal share
option (but for an employee share option may be accompanied by a repricing
or other modification of the option); the first will be unique to the specific
terms under which the share option has been promised to the employee.
21 It should be noted that while this is described as a ‘lapsed option’ for the purposes of this
discussion, in fact, because the option is regarded as not issued until vesting date, it is
technically not an ‘option’ where the lapse occurs before vesting date.
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Employee fails to meet performance criteria (lapse occurs before vesting
date)
7.4
The accounting for lapsed options is dealt with under the modified
grant date method in FAS 123 by adjusting the estimated compensation cost
for subsequent changes in the expected or actual outcome of service- and
performance-related conditions until the vesting date. The effect of a change
in the estimated number of shares or options expected to vest is treated as a
change in estimate, and the cumulative effect of the change on current and
prior periods is recognised in the period of change.
7.5
FAS 123 describes the adjustments made for actual lapses (and
changes in expectations about the future number of lapses, where recognised)
as a change of estimate rather than a revaluation to a new fair value. This
would also be the case under vesting date measurement, as the equity
instrument is regarded as not being issued until vesting date. Therefore, any
reduction in the number of options to be issued will result in an adjustment
being made to the credit to equity, with a gain being recognised in the income
statement.
7.6
Using the earlier example (paragraph 5.3), suppose that the
employee’s options to subscribe to 120 shares were partially dependent on
certain performance criteria, so that the employee could subscribe to only 100
shares if the performance criteria were not met. Assume that a performance
failure occurred in 2002. The amount recognised each year would then be as
follows:
Year
Calculation
$
2000
120 options × 1/3 × $3
2001
120 options × 1/3 × $4.50
120
=
$180
120 × 1/3 × $(4.50 − 3)
=
$60
100 options × 1/3 × $5
=
$167
100 × 2/3 × $(5 − 4.50)
=
$33
− Lapse 20 options × /3 × $4.50
=
($60)
+ Backlog for 2000
2002
240
+ Backlog for 2000 and 2001
2
Total
100 options × $5
140
500
7.7
The above calculation assumes that the adjustment for lapsed options
is made at the time of lapsing. A further refinement would be to base the
calculation for 2000 and 2001 on estimates of the probable outcome of the
performance criteria. For example, if it were estimated in 2001 that the
performance criteria would probably not be met, then it would seem
reasonable to recognise an adjustment for options likely to lapse at that time.
Appendix B contains an example that illustrates the calculation of the charge
for a plan where there are changes in expectations of whether the employees
will meet the performance criteria and where the options vest in instalments
over the performance period.
7.8
This produces what is probably a desirable practical result in that it
expunges all unvested options that no longer exist. However, it also means
that, in the case of options that lapse during the performance period, any
charge for service received up to the date of lapsing will be reversed at that
time, even though it may be argued that service of value has been received
from the employee up to that date.
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7.9
Given that vesting date measurement is based on the view that no
performance by the entity (i.e. the issue of the equity instrument) occurs or is
required until vesting date, it seems appropriate to reverse the charge
previously made to the income statement for employee services received if
options lapse before vesting date, as the final result was that the entity made
no payment for those services.
7.10
By definition, options cannot lapse after vesting date for failure to
meet performance criteria.
Employee fails to exercise the option (lapse occurs after vesting date)
7.11
An option may not be exercised. For example, the employee would
probably not exercise the option if the share price is below the exercise price
throughout the exercise period. Also, as noted earlier (paragraph 4.37), it is
possible that some employee share options may lapse unexercised, irrespective
of whether the option is ‘in the money’ during the exercise period. Once the
latest date for exercise is passed, the option will lapse. However, in this case,
the options will have lapsed after vesting date. Therefore, the matter to be
addressed is whether any adjustment should be made for options lapsing after
vesting date.
7.12
To illustrate this, consider the earlier example where the employee
received options to subscribe for 120 shares at $17 each (paragraph 5.3).
Under vesting date measurement, the amount recorded for this transaction
would be $600, based upon the value of the option ($5) at vesting date.
Suppose that the market value of the entity’s shares was less than $17
throughout the exercise period, so that the employee does not exercise the
options.
7.13
There remains an amount in equity that, at the point the options have
lapsed at the end of the exercise period, is no longer represented by any
ownership interest ($600 in the example). It may initially seem unattractive to
leave such an amount recorded in equity, but it is consistent with the view that
the transaction whereby consideration was received (the employee services)
and an equity instrument was issued (the share option) was completed on
vesting date, hence the subsequent lapse of that option does not change the
fact that the original transaction occurred.
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7.14
Furthermore, as noted earlier, once an equity instrument has been
issued, gains and losses arising from changes in value in that equity instrument
should not be recognised. For example, if the share price has fallen to below
the value for which the shares were originally subscribed, the entity would not
recognise a gain or loss.
7.15
Even though the lapsing of an option is more than simply a decline in
value of an equity instrument, in that it represents the cessation of the
existence of that equity instrument, it still follows that no gain or loss should
be recognised by the entity, because the lapsing of the option does not change
the entity’s net assets. Some may see such an event as being a benefit to the
remaining shareholders, but that has no impact on the entity’s financial
position.
7.16
Furthermore, this is consistent with the usual treatment of other
equity instruments, such as warrants issued for cash. Where warrants
subsequently lapse unexercised, this is usually not treated as a gain; instead
the amount previously recognised when the warrants were issued remains
within equity.22
7.17
It may be, however, that an adjustment is made within equity, to
reflect that the options are no longer outstanding. Such an adjustment would
be for presentation purposes only, where options have been presented as a
separate component of equity.
Repricing and other modifications of option terms
7.18
It is not uncommon for employee share options to be repriced (i.e. the
exercise price is adjusted, usually downwards). This may happen when the
company’s share price is lower than expected with the result that the ‘old’
options are worth very little and have little motivational effect on employees.
Other changes in the terms under which a share option is granted would
include a lengthening of the exercise period, increasing the number of shares
or adding a cash bonus to the existing option.
22 In the UK, FRS 4 ‘Capital Instruments’ requires that, where a warrant lapses unexercised,
the amount previously credited to shareholders’ funds should be reported as a gain in the
statement of total recognised gains and losses. As this is not consistent with the treatment
proposed above, the ASB may consider whether FRS 4 should be amended to state that the
amount should remain within shareholders’ funds.
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7.19 Under vesting date measurement, there is no difficulty if repricing or
other changes in terms occur before vesting date. Given that the transaction
will ultimately be measured at the value of the option at vesting date (plus any
cash bonus added), any amount recognised before vesting date is merely an
estimate; hence any repricing or other changes in terms before vesting date
will simply be accounted for as a change in estimate, resulting in a gain or loss
to the income statement.
7.20 Therefore, the matter to be addressed is whether any adjustment is
required if the options are repriced or otherwise modified after vesting date.
For simplicity, the following paragraphs focus on repricing, but the same
analysis applies to other changes in the terms of the option.
7.21 Repricing changes the terms of the option. The fair value attributed to
the original option was based upon the original terms. Hence, it seems
appropriate to amend that valuation if the terms are changed.
7.22 Another argument for adjusting the transaction amount where options
are repriced is that the repricing is equivalent to the cancellation of one option,
which is replaced by the issue of another. This latter view is the approach
taken by FAS 123, which states that:
“A modification of the terms of an award that makes it more valuable
shall be treated as an exchange of the original award for a new award.
In substance, the entity repurchases the original instrument by issuing a
new instrument of greater value, incurring additional compensation
cost for that incremental value. The incremental value shall be
measured by the difference between (a) the fair value of the modified
option … and (b) the value of the old option immediately before its
terms are modified, determined based on the shorter of (1) its
remaining expected life or (2) the expected life of the modified option.”
benefit from this action. For example, it may believe that the repricing
provides an incentive to the employees, resulting in the entity receiving
additional or enhanced employee services. In many cases, this will be an
explicit requirement, i.e. the employees will be required to complete an
additional period of service before becoming entitled to the repriced options.
Therefore, it is reasonable to conclude that the additional value given to the
employees by repricing the options after vesting date represents payment for
the additional employee services received.
7.24
If repricing after vesting date is to be recognised, this leaves the
question of how to measure such an adjustment. The ‘incremental value’
approach of FAS 123, as described above (paragraph 7.22), measures the
effects of the change in the terms of the option by comparing the option’s
value immediately before and after the change of terms. However, what if that
change of terms simply restored the option’s value to that prevailing at its
original measurement date? Using the earlier example (paragraph 5.3),
assume that the issue of options to subscribe to 120 shares had been measured
at vesting date, when the options were valued at $5 each. Suppose that the
market value of the entity’s shares subsequently falls, so that the options are
now worth only $4 each and the entity repriced the options to restore their
value to $5 each. Should an additional $120 (120 × $1) be recognised? Or
should any adjustment be limited, to ignore any amount that restores (partly or
completely) the option’s value? The effect of each approach would be as
follows:
7.23
It could be argued that because the repurchase of an equity
instrument and issue of another is a transaction with owners, no gain or loss to
the entity arises. However, as noted earlier (paragraphs 3.12-3.14), it is
necessary to recognise the resources received by the entity in respect of the
issue of an equity instrument and a charge to the income statement may arise
when those resources are subsequently consumed by the entity. The entity
received employee services as consideration for the issue of the original share
option. If the entity is prepared to repurchase the original option and issue
another more valuable option, then the entity must believe that it will obtain a
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In all cases below, the transaction was originally measured at the option
value of $5 at vesting date.
Option value
before repricing
$
3.00
4.00
6.00
Option value
after repricing
$
Incremental
value
$
4.00
5.75
8.00
1.00
1.75
2.00
Total transaction
amount
(a)*
or
(b)†
$
$
6.00
5.00
6.75
5.75
7.00
7.00
*where the full amount of the incremental value is recognised
† where the incremental value recognised is limited, to exclude any amount
that restores the option’s value
7.25
Given that the adjustment for repricing is made on the basis that this
represents the effect of cancelling one equity instrument and the issue of
another, as payment for additional employee services received, it follows that
the full amount of the incremental value should be recognised.
7.26
A similar treatment could be applied to an option with a reload
feature, which permits the holder either to exercise the option or to exchange it
for another option. Ideally, in this situation, when the fair value of the option
is estimated at vesting date, that valuation should take into account the reload
feature. However, if it is not feasible to do so, the alternative is to treat the
original option and the reload option separately. Therefore, at the time that
another option is issued, this should be treated as a cancellation of the original
option and issue of a new option in its place. Hence, an adjustment should be
made for any incremental value given by the entity at that time.
Options with cash alternatives
receive cash instead of exercising the options (i.e. the election is made after
vesting date). The entity rather than the employee may have the choice over
the form of settlement, i.e. whether to pay the cash alternative instead of
issuing options on vesting date or instead of issuing shares upon exercise of
the options. The amount of the cash alternative may be fixed or variable and,
if variable, may be determinable in a manner that is related or unrelated to the
share price of the entity’s shares.
7.28
To avoid unnecessary complexity and a lengthy discussion covering
all possible situations, the following discussion is limited to considering the
situation where either the employee may elect to receive, or the entity to pay, a
cash alternative on or before vesting date (paragraphs 7.29-7.36) and the more
common situation where the employee may choose to receive a cash
alternative after vesting date (paragraphs 7.37-7.44). It is assumed that the
amount of the cash alternative is fixed or determinable in a manner unrelated
to the entity’s share price.
Election made on or before vesting date
7.29
Under vesting date measurement, where the election to receive or pay
cash instead of options is made on or before vesting date, the effect of the
election should be accounted for as an adjustment to the transaction amount.
For example, suppose the employees are entitled to receive 1,000 share
options with an estimated value of $5 each on vesting date, but only 800 share
options are issued, with those entitled to the other 200 share options electing to
receive cash of $4 each instead. This will mean the total transaction amount
will be adjusted to: (800 × $5) + (200 × $4) = $4,800.
7.30
Whilst measurement of the transaction amount under vesting date
measurement is straightforward, there is some uncertainty over the
presentation of the credit side of the entry during the performance period, i.e.
whether it should be shown as a liability or as part of equity.
7.27
Under some share option plans, the employees may be able to choose
to receive cash instead of options, or instead of exercising options. There are
many possible variations of share option plans under which a cash alternative
may be paid. For example, the employees may have more than one
opportunity to elect to receive the cash alternativethe employees may be
able to elect to receive cash instead of options (i.e. the election is made on or
before vesting date) and, if the options are issued on vesting date, elect to
7.31
Some believe that where there is a cash alternative, irrespective of
whether the payment of the cash alternative is the choice of the entity or the
employee, the credit should be shown as a liability.
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7.32
However, the conceptual framework classifies financial interests as
liabilities or equity depending upon whether the entity has an obligation to
transfer economic benefits to another party. Such an obligation would arise if
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the employee has the choice of whether to take the cash alternative, but not
where the entity has that choice.23
7.33
Using this approach, where a share plan includes a cash alternative,
the credit entry recognised during the performance period would be treated as
a liability if the employee has the choice whether to receive the cash
alternative, or included in equity if the entity has the choice whether to pay the
cash alternative.
7.34
However, this is not the only approach that could be applied and
there is still the question of how the accrual should be calculated during the
performance period. Therefore, the treatment of options with cash alternatives
requires further consideration, to determine whether the accrual made during
the performance period should be split between liabilities and equity and
calculated based upon expectations of whether the cash alternative will be
paid. This does not affect the final outcome of the transaction amount
recognised, merely its accrual and presentation during the performance period.
7.35
For example, where the employee has the choice whether to receive
the cash alternative, one suggested approach would be to accrue the amount of
the cash alternative as a liability, and to accrue as part of equity any excess of
the fair value of the option over the amount of the cash alternative, with the
total accrual being based upon the extent to which the employee services have
been received.
7.36
This approach has the effect that:
(a)
if the fair value of the option exceeds the amount of the cash
alternativehence there will be an amount accrued in equity for this
excessthe employees are likely to choose to receive the options,
hence the total accrual reflects that probability, while the
classification of that part of the accrual as a liability reflects the
employees’ right to elect to receive the cash alternative;
(b)
if the amount of the cash alternative exceeds the fair value of the
optionshence there will be no amount accrued in equitythe
employees are likely to choose to receive the cash, hence the accrual
of the amount of the cash alternative reflects that probability.
Election made after vesting date
7.37
In some situations, employees may be able to elect to receive the cash
alternative after vesting date. In other words, employees may have the choice,
during a specified time period between vesting date and the end of the
exercise period, of giving up their vested share options in exchange for cash.
7.38
Similar issues arise regarding the presentation of the accrual during
the performance period as were discussed above (paragraphs 7.30-7.36), i.e.
whether the accrual should be presented in liabilities or equity, or split
between the two, as suggested above (paragraph 7.35). However, where the
employee may elect to receive the cash alternative after vesting date, questions
arise concerning the measurement of the transaction amount and the nature of
the financial instrument issued on vesting date.
7.39
It was concluded earlier (paragraph 5.16) that a share option is an
equity instrument because the instrument does not require the transfer of cash
or other assets to the instrument holder. However, in the situation described
above (paragraph 7.37), the contract between the entity and the employee,
under which the share option is issued to the employee, also gives the
employee the contractual right to demand that the entity pay the cash
alternative, whereupon the employee will surrender the right to the option. It
seems, therefore, that a compound financial instrument is issued to the
employee on vesting date, i.e. a financial instrument that includes both debt
and equity components. The subsequent election by the employee to receive
the cash alternative will result in the settlement of the liability component for
cash, with the equity component surrendered by the employee, while the
expiry of the election period (or the exercise of the option) will result in the
settlement of the liability in exchange for an equity instrument.
23 A similar approach is taken in some existing accounting standards. For example, the UK’s
FRS 7 ‘Fair Values in Acquisition Accounting’ states that, where the acquirer has the choice of
whether to settle part of the consideration due to the vendor in cash or in shares, that part of the
consideration is not a liability because there is no obligation to transfer future economic
benefits. On the other hand, if the vendor has the right to demand cash or shares, that part of
the consideration due is treated as a liability because it is not within the acquirer’s power to
avoid a transfer of assets if the vendor so demands.
7.40
In this situation, the transaction for the purchase of employee services
should be measured at the fair value of the compound financial instrument at
vesting date. The fair value of the compound financial instrument will exceed
both the amount of the cash alternative (because of the possibility that the
option may be more valuable than the cash alternative) and the fair value of
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the option (because of the possibility that the cash alternative may be more
valuable than the option).
7.41
Assuming that an observable market value for the compound
financial instrument does not exist, its fair value should be estimated. FAS
123 (Illustration 8) deals with this issue in the context of a tandem plan, where
the employee has the choice whether to exercise share options or to cash in
phantom share units. The transaction for the purchase of employee services is
measured by valuing separately the two components of the compound
instrumentwith the valuation of each component taking into account the fact
that the employee must forfeit one alternative to receive the otherand adding
the two component values together.
7.42
The liability component of the compound instrument should be
classified as a liability while the equity component should be classified as
equity.24
7.43
The value of the liability component may change after vesting date.
Because liabilities may be remeasured at any time up to and including
settlement date, the transaction amount should be adjusted for any changes in
the value of the liability component. Therefore, at the time of settlement, any
difference between the amount of the liability component previously
recognised and the amount of cash paid or the fair value of the liability
component at the date it is surrendered should be accounted for as an
adjustment to the transaction amount, i.e. as an adjustment to the income
statement. However, changes in the value of the equity component after
vesting date should not be recognised.
7.44
When the employee elects to receive the cash alternative or exercise
the option, or the election period expires, this should be accounted for as
follows:
(a)
If the employee chooses the cash alternative, the cash payment will
settle the liability in full. The amount of the equity component that
was previously recognised should remain in equity, as it represents
the equity component of the compound instrument that has been
surrendered by the employee.
(b)
If the employee does not elect to receive the cash alternative, the
amount of the liability component of the compound instrument that
was previously recognised as a liability should be transferred direct to
equity.
Share appreciation rights
7.45
An entity may grant share appreciation rights (SARs) to employees,
whereby the employee becomes entitled to receive a cash payment (usually)
based upon the increase in the market value of the entity’s shares over a
specified period of time, subject to certain conditions, such as the employee
remaining with the entity during the specified period.
7.46
SARs payable in cash represent conditional or contingent liabilities,
in that a cash outflow from the entity will be required if the specified
conditions are satisfied. Therefore, provided it is considered probable that a
cash outflow will occur, a liability should be accrued over the performance
period in respect of that probable future cash outflow, to the extent that the
employees have performed their side of the arrangement. For example, if the
terms of the arrangement require the employees to perform services over a
three-year period, the liability should be accrued over that three-year period.
7.47
In theory, this accrual should be based upon the expected future cash
outflow. However, this would necessitate making an estimate of the future
increase in the entity’s share price, which may be difficult. Therefore, an
alternative approach is to base the accrual on the entity’s share price at the end
of each reporting period. However, if the entity’s share price is continually
rising over the performance period, this will have the effect of charging larger
amounts to the income statement in later reporting periods compared with
earlier reporting periods during the term of the arrangement. This is because
each reporting period will include the effects of (a) an increase in the liability
in respect of the employee services received during that reporting period and
(b) an increase in the liability due to the increase in the entity’s share price
during the reporting period that increases the amount payable in respect of past
employee services received.
24Alternatively, in jurisdictions where the components of compound instruments are not
accounted for separately, the entire amount of the compound instrument should be classified as
a liability.
7.48
While some may regard such a result as undesirable, the increasing
charge in each reporting period simply reflects the events occurring during
that period, i.e. the employee services received and the increase in the entity’s
share price, both of which occurred during the period. It is also consistent
with the proposals in this Paper on accounting for employee share optionsan
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increase in the entity’s share price is likely to lead to an increase in the fair
value of the option, thus requiring each reporting period to include the effects
of this increase in respect of past employee services received, as illustrated
earlier (paragraph 6.13).
7.49
In some cases, the amount due to employees in respect of SARs may
be settled by the issue of shares or by a combination of cash and shares. In
such situations, the transaction amount should ultimately be measured at the
amount of cash paid plus the fair value of any shares issued. However,
assuming that the fair value of the consideration to be given, whether in the
form of shares or cash, will equate to the specific amount due under the SAR
arrangement, the transaction amount should ultimately be the same regardless
of the form of payment made in settlement. Accordingly, the accrual made
during the performance period will be based upon the increase in the entity’s
share price over the specified base price by the end of each reporting period,
as discussed above (paragraph 7.47).
Employee share purchase plans
7.50
In some jurisdictions, employee share purchase plans may provide an
opportunity for employees to purchase a specific number of shares at a
discounted price, i.e. at an amount that is less than the fair value of the shares.
The employee’s entitlement to discounted shares will usually be conditional
upon certain performance conditions being satisfied, such as remaining in the
service of the entity over the term of the plan.
7.51
Accordingly, the transactionthe issue or transfer of shares to
employeesshould be measured based upon the fair value of the shares on
vesting date. Any difference between the fair value of those shares and the
price paid by the employees will therefore be charged to the income statement.
An accrual for this amount should be made during the performance period, to
reflect the extent to which the employee has provided the services necessary to
become entitled to purchase the discounted shares.25
25 However, it may be appropriate not to require recognition of a charge to the income
statement where the discount given to employees is very small, such as where the discount is
equivalent to the transaction costs that would otherwise have been incurred had the share issue
been made in a public offering. This issue would need to be addressed in any accounting
standard developed from this Paper, i.e. whether, and in what circumstances, it would be
acceptable not to require recognition of a charge to the income statement in respect of such
discounts.
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Application to other forms of share-based payment
7.52
As mentioned in Chapter 1, while the discussion of share-based
payment has focused on employee share plans, the proposals in this Paper
apply also to other forms of share-based payment. For example, a company
may enter into an arrangement with a supplier of professional services,
whereby instead of paying cash for those services, it issues shares or share
options to the supplier.
7.53
Under vesting date measurement, this transaction would be measured
at the value of the shares or options issued on vesting date. In the case of
shares or options issued to suppliers, there is likely to be a much shorter
performance period (if any), hence the difference between the value of the
shares or options at grant date, over the service period and at vesting date will
probably be less significant (or non-existent). It is also unlikely that any
options will lapse before vesting date because of non-performance by the
supplier or that repricing (or other changes in the terms) of options will occur
after vesting date. Accordingly, many of the issues discussed in this Paper are
less relevant, making accounting for such transactions more straightforward.
An example is given in Appendix C.
7.54
One issue that is likely to be more relevant is possible difficulties in
measuring the value of shares or options issued by start-up companies. This is
more likely to be a problem early in the performance period and in some cases
it may be argued that it is necessary to delay recognition of an accrual for the
transaction until later in the performance period, when a fair value may be
established. However, it is expected that by vesting date a fair value of the
shares or options should be able to be determined. Also, as discussed in
Chapter 4, an alternative measure that may be used in rare cases where the fair
value of the shares or options is difficult to determine is the fair value of the
services (or goods) received. Therefore, if it were difficult to calculate an
accrual based upon the fair value of the options at the time the services or
goods are received, the entity could make an estimate of the transaction
amount based upon the fair value of those goods or services received. This
estimate could then be revised when a fair value of the option is able to be
determined, on or before vesting date (or, if necessary, exercise date). In the
rare cases where an alternative measure is used, it should be necessary to
disclose that this has been done and the reasons for doing so.
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Chapter 8 Summary and conclusion
8.1
Where an entity obtains goods and services from other parties,
including employees and suppliers, with payment taking the form of shares or
share options issued by the entity to those other parties, the transaction should
be measured at the fair value of the shares or options issued at vesting date,
being the date upon which the other party (the employee or supplier), having
performed all of the services or provided all of the goods necessary, becomes
unconditionally entitled to the options or shares. Usually, an option pricing
model should be applied to establish the fair value of an option.
8.2
In extremely rare cases, where an entity is unable to estimate reliably
either the fair value of its options at vesting date or the fair value of the goods
or services received, it should be required to apply exercise date measurement.
8.3
Where performance by the other party occurs between grant date,
being the date when the contract between the entity and the other party (the
employee or supplier) is entered into, and vesting date, and it is probable that
the entity will be required to perform its side of the contract on vesting date
(i.e. it is probable that all performance conditions will be met, thus requiring
the entity to issue the shares or options), an accrual should be made at the end
of each reporting period to the extent that performance by that other party has
occurred. For example, if an employee share plan requires the employees to
perform services over a three-year period, with the options vesting at the end
of this period, an accrual should be made in each reporting period in respect of
employee services received by the end of that reporting period.
8.4
The accrual should be based upon the fair value of the shares or
options at the end of each reporting period, as illustrated earlier (paragraph
6.13). Consequently, each reporting period should include a charge to the
income statement for the employee services received during that period and a
charge or credit to the income statement for the effects of changes in the fair
value of the shares or options during the reporting period on the accrual
previously made in respect of employee services previously received.
8.5
Where the entity will be required, or has the choice whether, to issue
an equity instrument (shares or options) on vesting date, the accrual made
during the performance period should be presented as part of equity.
Conversely, where the entity will be required to pay cash (e.g. share
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appreciation rights), or the employee has the choice whether to receive cash,
on vesting date, the accrual should be presented within liabilities.
8.6
However, the treatment of options with cash alternatives requires
further consideration, for example, to determine whether the accrual made
during the performance period should be split between liabilities and equity
and calculated based upon expectations of whether the cash alternative will be
paid. In the case of employee share plans where the employee has the choice
whether to receive cash or options, one suggested approach is to base the
accrual on (a) the cash alternative, which is presented as a liability, and (b) the
excess of the fair value of the options over the cash alternative, if any, which
is presented as part of equity. Where the cash alternative is available after
vesting date, the financial instrument issued on vesting date is a compound
financial instrument, i.e. a financial instrument that has both debt and equity
components. Therefore, the transaction amount should be measured at the
estimated fair value of the compound instrument issued on vesting date. Any
changes in the fair value of the debt component after vesting date should be
recognised as an adjustment to the transaction amount.
8.7
Share appreciation rights should be accrued over the performance
period, i.e. at the end of each reporting period an accrual should be made in
respect of services received to the balance sheet date based upon the increase
in the share price to that date.
8.8
Where shares or options will never be issued (or it is considered
probable that this will be the case) because of an actual or expected failure to
meet the performance criteria (for example, because the employee leaves
during the performance period), then the transaction amount should be
adjusted to reflect this actual or expected event. In this way, the total
transaction amount recognised by vesting date will equate to the fair value of
the shares or options at vesting date.
8.9
Where options lapse after vesting date, i.e. they are not exercised, no
adjustment should be made to the transaction amount previously recognised,
because that transactionthe receipt of goods or services and the issue of the
optionis complete at vesting date. In common with the treatment of other
options or warrants that lapse unexercised, the amount previously recognised
in respect of the issue of the option should remain within equity (although
some transfer within equity may be required for presentational purposes).
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8.10
Where an option is repriced, or other changes in its terms are made
before vesting date, i.e. before the option is issued, the transaction amount
should be adjusted so that the total amount recognised by vesting date equates
to the fair value of the option at vesting date. Hence that fair value will be
based upon the option’s modified terms. Where any such change in the
option’s terms occurs after vesting date, which means that the original option
issued on vesting date is cancelled and a new option issued in its place, the
transaction amount should be adjusted to reflect the difference between (a) the
fair value of the original option immediately before its cancellation (i.e. its fair
value at the time the repricing or other modification occurs) and (b) the fair
value of the new option issued in place of the original option.
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Service date
APPENDIX A:
Example with falling share price
On 1 January 2000 a company grants an employee rights to subscribe, between
the dates 31 December 2003 and 31 December 2004, for 120 shares at $17
each. The market value of the shares on 1 January 2000 was $16 each and the
fair value of the option is estimated to be $3.50.
There are no performance conditions, except that the employee must remain
employed by the company until 31 December 2002: if the employee leaves the
company’s employment at any time before that date all the options will be
forfeited. It is expected that this condition will be fulfilled throughout the
three-year period. The options vest on 31 December 2002.
The following table gives the share prices on the last day of the year, as well
as the fair value of the option at those dates:
Year
Share price
Fair value of option
2000
$16
$3
2001
$16
$2
2002
$15
$1
It is assumed that, if the share price is below the exercise price, the options
will not be exercised.
Assuming that the fair value of the option at the end of each year represents a
reasonable approximation of the fair value of the option during the year, the
transaction amount would be calculated as follows:
Year
Calculation
$
2000
120 shares × 1/3 × $3
=
120
2001
120 shares × 1/3 × $2
=
80
2002
120 shares × 1/3 × $1
=
40
Total
240
Vesting date
The transaction is measured at the fair value of the option at vesting date, i.e.
$1. As 120 options vested, the amount to be recognised is $120.
Exercise date
Nil, if lapsed unexercised, as the value of the option would be nil at that point.
If after vesting date (and before the end of the exercise period), the share price
eventually rose, the options might be exercised, at which point a transaction
amount would be recognised.
The transaction will be measured as follows under each method.
Grant date
The transaction amount is measured and fixed at the date of grant when the
fair value of the option was $3.50. As there were 120 options granted, the
amount to be recognised is $420.
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APPENDIX B:
Example where options vest in instalments
The following is an example of vesting date measurement, with recognition
over the performance period, where options vest in instalments and there are
changes in expectations of whether employees will meet the performance
criteria.
On 1 January 2000 the entity grants to its employees 1,200 rights to subscribe
to the entity’s shares, provided certain performance conditions are met. The
options vest in instalments, with 200 vesting on 31 December 2000, 400
vesting on 31 December 2001 and the final 600 vesting on 31 December 2002.
In each case, the vested options relate to performance provided by the
employees since grant date. For example, the 400 options that are due to vest
on 31 December 2001 relate to performance by the employees over the period
from 1 January 2000 to 31 December 2001. The options may be exercised
during a one-year period that begins one year after the date of vesting. The
exercise price is $17 per share and the market price on 1 January 2000 was
$16 per share.
The market price of the share and fair value of the option are as follows:
As at
Share price
31 Dec 2000
31 Dec 2001
31 Dec 2002
$19.00
$20.00
$22.00
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On 31 December 2000 the performance criteria are satisfied by all employees
and 200 options vest. It is estimated that 80 per cent of employees will meet
the performance criteria in respect of the 400 options due to vest on 31
December 2001 and that 60 per cent of employees will meet the performance
criteria in respect of the 600 options due to vest on 31 December 2002. The
charge for the year ended 31 December 2000 is as follows:
31 Dec
2000
(a)
Number of options
(b)
(c)
Options vested or due to vest on:
31 Dec
31 Dec
2001
2002
200
400
600
Fair value per option
$5.00
$5.50
$6.00
Relevant service
completed
100%
50%
33.33%
Proportion vested or
expected to vest
100%
80%
60%
Charge (a) × (b) × (c) × (d)
$1,000
$880
$720
(d)
Total charge for year
$2,600
Fair value of options due to vest on
31 Dec 2000 31 Dec 2001 31 Dec 2002
$5.00
n/a
n/a
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$5.50
$6.00
n/a
$6.00
$7.00
$8.50
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On 31 December 2001 85 per cent of employees satisfied the performance
criteria. It is now expected that 65 per cent of the employees will meet the
performance criteria in respect of the options due to vest on 31 December
2002. The charge for the year ended 31 December 2001 is as follows:
Options vested or due to vest on:
31 Dec
31 Dec
2001
2002
(a)
Number of options
400
600
(b)
Fair value per option
$6.00
$7.00
(c)
Relevant service completed
100%
66.66%
(d)
Proportion vested or expected
to vest
85%
65%
Options vested on
31 Dec 2002
(a)
Number of options
600
(b)
Fair value per option
$8.50
(c)
Relevant service completed
100%
(d)
Proportion vested
67%
Cumulative charge to date
(a) × (b) × (c) × (d)
$3,417
Less charge recognised in
previous years
Cumulative charge to date
(a) × (b) × (c) × (d)
$2,040
(1,820)
$1,820
Total charge for year
Less charge recognised in
previous year
(880)
(720)
Charge for year
1,160
1,100
Total charge for year
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On 31 December 2002 67 per cent of employees satisfy the performance
criteria. The charge for the year ended 31 December 2002 is as follows:
$1,597
$2,260
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APPENDIX C:
APPENDIX D:
Example of accounting for non-employee share-based
payment
Types of share-based payment currently in use
On 1 January 2001 an entity enters into a contract with a management
consultancy firm, whereby the consultancy firm is to review the efficiency and
effectiveness of the entity’s management structure. It is expected that the
project will take three months to complete. Subject to the receipt of the
specified consultancy services, the entity will issue 1,000 share options to the
consultancy firm. The fair value of these options on 1 January 2001 is
estimated to be $4.60 each.
There was some delay in starting the project, and it was completed on 30 April
2001. The fair value of the entity’s share options on 30 April 2001 was
estimated to be $5.
The entity has a balance sheet date of 31 March 2001, at which time its share
options were valued at $4.75. It is estimated that the consultancy firm had
completed two-thirds of the project by that date and it was expected that the
project would be satisfactorily completed.
Applying the proposals in this Paper would result in the transaction (the
purchase of professional services and issue of share options) being measured
at the fair value of the options at vesting date, 30 April 2001, which equates to
$5,000 (1,000 × $5). However, as the entity’s balance sheet date falls within
the period during which services were received, the amount recognised in each
reporting period is as follows:
Period ended 31 March 2001: 1,000 × /3 × $4.75 =
$3,167
Period ended 31 March 2002: (1,000 × $5) - $3,167 =
$1,833
Total
$5,000
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Descriptions of the types of share-based payment plans in use are given below.
It should be noted that some plans are complex, involving variations and/or
combinations of the types of plans described below. There is also some
overlap in the use of terms. For example, ‘share appreciation rights’ that are
settled in shares might be, in some cases, more appropriately described as
‘share awards’.
Share options
A variety of share option plans are in use. Two of the more common types of
plans are ‘plain vanilla’ plans and performance vesting plans.
‘Plain vanilla’ share options
These plans generally give an employee the right to purchase a number of
common shares at a fixed price for a specific period of time.
Performance vesting share options
There are basically two types of share options under this category:
•
Performance vesting. Options do not vest until performance criteria are
achieved.
•
Performance-accelerated vesting. Options vest earlier than through time
vesting if performance criteria are achieved. Time vesting sometimes
takes place close to the end of the option term.
Performance criteria may include, for example, share price increases or
meeting specified share price targets, return on equity performance, meeting
return on investment targets or operating performance targets, and earnings
per share growth.
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specified period of time the employee becomes entitled to the units, and their
appreciated value is paid in the form of a cash bonus.
Share awards
Shares are issued to employees, as part of their remuneration package.
Entitlement may be based upon service only, or there may be other
performance conditions, in the same manner as with share option plans
described above.
Share appreciation rights (SARs)
This arrangement grants an award to employees in an amount equal to the
excess of the market value at a specified future date over a stated price,
usually the market price at the date of grant, of a stated number of company
shares.
Other performance-related plans
Other long-term incentive plans may exist that are based upon some measure
of performance other than the entity’s share price. Payments to the employee
are generally made in cash; however, if settlement may be made in the form of
shares or a combination of cash and shares, those plans would be regarded as
share-based payment plans.
In some cases, payment of the amount due to the employee may be made in
the form of shares rather than cash (or a combination of cash and shares).
SARs may be issued in tandem with traditional share options. In a tandem
plan, the employee may elect to exercise either the SAR or the option, but not
both (choosing one alternative eliminates the other).
Share purchase plans
These plans, which are commonly administered by a trust, provide employees
with the opportunity to purchase a specific number of shares, normally at fair
market value as at a specified date such as grant date or, in some jurisdictions,
at a small discount to fair market value. The employee may contribute a
portion of salary to the trust on an ongoing basis. In some jurisdictions, the
entity may also make cash contributions to the trust.
Phantom share plans
These plans are in effect a proxy for existing common shares of the employer
company, and are often used in closely held private companies. The plans are
a deferred bonus arrangement where the amount of the bonus is related to the
value of the company’s shares.
The employee is granted a number of phantom shares (or units). Fluctuation in
unit value is linked to fluctuation in the value of the company’s actual shares.
Other performance indicators may be used in place of share values. After a
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APPENDIX E:
the Australian Securities and Investment Commission has listed it as an item it
will monitor.
Accounting treatment of employee share plans in various
jurisdictions
Canada
Australia
No charge is made to the income statement in respect of stock options issued
to employees, regardless of the terms and provisions of the option agreements.
Australian Accounting Standards AASB 1028 and AAS 30 ‘Accounting for
Employee Entitlements’, issued in March 1994, do not apply to the recognition
and measurement of employee entitlements in the form of equity-based
remuneration plans. Certain disclosures are required to be made, including the
number and types of shares or other equity interests that have been issued to
employees during the financial year, the total market value of those shares or
other equity interests at issue date and the total amount received and/or
receivable from employees for those shares or other equity interests.
Certain plans provide the employee with the right to request the company to
purchase from the employee for cash all or part of the options at a price equal
to the difference between the current market price and the exercise price.
Many believe that option plans with such terms are equivalent to cash share
appreciation rights and that they should be accounted for as such. However,
there are instances where these payments are charged to retained earnings as
the cost of acquisition of an equity option.
Exposure draft ED 97 ‘Employee Benefits: Amendments to AAS 30/AASB
1028’, issued in September 1998, proposed amendments to AASB 1028 and
AAS 30. However, it did not propose recognition and measurement
requirements for equity compensation benefits. It proposed certain disclosures
about equity compensation benefits including, where practicable, the fair
value, at the date of issue, of the entity’s own equity instruments (including
share options) issued by the entity to equity compensation plans or to
employees, or by equity compensation plans to employees, during the
reporting period.
Work is also progressing on a draft exposure draft ‘Director and Executive
Disclosures’. It is still work in progress, but has been drafted to propose
specific requirements on measuring the amount of equity compensation
benefits to be disclosed. In 1999, the Boards decided that measurement of
remuneration in the form of equity compensation benefits should be based on
the fair market value of the equity instruments at the date of vesting (being the
date the employee becomes entitled to the beneficial interest, on satisfaction of
service or performance hurdles). The fair value of options would be
determined using a pricing model that includes the six variables used in the
Black-Scholes option pricing model (adjusted for dividends).
Present practice varies but it is common to declare that the fair value of equity
compensation benefits cannot be determined, and therefore it is not disclosed.
A Parliamentary Joint Committee has declared its concern on the matter and
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The CICA’s Emerging Issues Committee’s Abstract EIC 37 covers phantom
stock option plans. Where a company establishes a bonus plan under which
the amount of bonus is calculated by reference to increases in the market price
of a stated number of company shares and the bonus is paid in cash and not
through the issue of shares, EIC 37 requires that the bonus be accrued over the
period to which it relates based on the value of the relevant performance
indicators at period-end, and accounted for as an expense. This guidance also
applies to share appreciation rights.
Cash contributions made to a trust in respect of an employee share purchase
plan are charged to the income statement.
There is no specific guidance concerning non-share-based long-term
performance plans, which may be settled in cash or shares or a combination of
both, although it appears that most Canadian companies recognise an accrual
for obligations arising under such plans in their income statements.
The CICA Handbook, Section 3240, states that details of share capital
transactions should be disclosed as to “the number of shares issued since the
date of the last balance sheet, indicating the value attributed thereto and
distinguishing shares issued for cash (showing separately shares issued
pursuant to options or warrants), shares issued directly or indirectly for
services and shares issued directly or indirectly for other considerations.”
New Zealand
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There is no specific guidance on accounting for share-based payment. FRS 30
‘Reporting Share Ownership Arrangements Including Employee Share
Ownership Plans’ requires disclosure of various information, such as details of
those who are entitled to participate in the share ownership plan, the shares
held by the plan, control of the plan and the financial commitments of the
plan. Where the plan has more than 5 per cent of the voting rights of the
entity, abbreviated statements of financial performance and financial position
are disclosed.
UK
UITF Abstract 17 ‘Employee share schemes’ requires that where shares or
share options are awarded to employees, a specified minimum amount should
be recognised over the period to which the employee’s performance relates.
The minimum amount recognised is calculated as the difference between:
(a)
the fair value of the shares at date of grant or, where purchases of
shares have been made by an employee share ownership plan
(ESOP) trust at fair value and reflected in the company’s balance
sheet in accordance with UITF Abstract 13 (described below) or
have been revalued, the book value of shares that are available for
the award; and
(b)
the amount of consideration, if any, that the employees may be
required to pay for those shares.
UITF Abstract 13 ‘Accounting for ESOP Trusts’ requires, amongst other
things, that until such time as the shares held by an ESOP trust vest
unconditionally in employees, they should be recognised as assets of the
sponsoring company. Any permanent diminution in value should be
recognised immediately. Where shares are gifted or put under option to
employees at below the book value, the difference between book value and
residual value (nil in the case of a gift, or the exercise price of the option)
should be recognised as an operating cost over the period of service of the
employees concerned.
FRS 12 ‘Provisions, Contingent Liabilities and Contingent Assets’ does not
specifically discuss employee remuneration, but it will apply to share
appreciation rights, phantom share plans and other types of share-based
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payment that require the entity to pay cash to employees. Hence such
liabilities are recognised as an accrual over the performance period.
There is no guidance relating to share-based payments made to nonemployees, other than the general requirement of FRS 4 ‘Capital Instruments’
that the issue of shares or warrants should be reported at the net proceeds
received.
USA
APB Opinion 25 ‘Accounting for Stock Issued to Employees’ requires an
employer to recognise a charge for stock issued through fixed employee stock
option, purchase, and award plans as the difference between the quoted market
price of the stock at the measurement date less the amount, if any, the
employee is required to pay. The measurement date is the date at which the
exercise price and the number of shares to which the employee is entitled are
known, which for fixed plans typically is the date of grant or award. That cost
is to be charged to expense over the periods in which the employee performs
the related services. Because the exercise price of most fixed plans is set at
the market price of the stock at the grant date, no expense usually is
recognised for such plans. Some plans, referred to as noncompensatory plans,
involve no compensation expense because the employees’ purchase price is
not set lower than would reasonably be required in an offer of shares to all
shareholders for the purpose of raising an equivalent amount of capital.
The measurement date for stock appreciation rights and other variable stock
option and award plans typically is not the date of grant or award.
Compensation relating to such variable plans is measured at the end of each
period as the amount by which the quoted market value of the shares of the
employer’s stock covered by a grant exceeds the option price or value
specified under the plan and is to be charged to expense over the periods the
employee performs the related services. Changes in the quoted market value
are reflected as an adjustment of accrued compensation and compensation
expense in the periods in which the changes occur until the date the number of
shares and purchase price, if any, are both known.
FAS 123 ‘Accounting for Stock-Based Compensation’ requires a charge to be
made for the fair value of shares or options granted to a party other than an
employee. The fair value of an option is estimated using an option pricing
model. FAS 123 does not reach a conclusion on the measurement date for
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transactions with non-employees. However, EITF Issue No. 96-1826 provides
a ‘modified’ vesting date approach.
Companies are encouraged to also apply the fair value based method instead
of the intrinsic value based method in Opinion 25 for transactions with
employees.
Entities electing to retain the accounting in APB Opinion 25 must make pro
forma disclosures of net income and, if presented, earnings per share, as if the
fair value based method of accounting defined in FAS 123 had been applied.
International Accounting Standards
IAS 19 (revised 1998) ‘Employee Benefits’ provides guidance on the
recognition and measurement of all employee benefits except share-based
payment. In the case of profit sharing and bonus plans requiring a cash
payment, a cost is recognised where the entity has a legal or constructive
obligation to make a payment and a reliable estimate of that payment can be
made.
The standard does not contain recognition or measurement requirements for
employee share-based payment. However, certain disclosures are required,
such as the nature and terms of equity compensation plans, the accounting
policy for such plans, the number and terms of equity instruments issued
during the period (including dividend and voting rights, conversion rights,
exercise date, exercise price and expiration dates), and the number of share
options that lapsed or were exercised during the period.
26 EITF Issue No. 96-18 ‘Accounting for Equity Instruments That Are Issued to Other Than
Employees for Acquiring, or in Conjunction with Selling, Goods or Services'
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