IFRS 2 Accounting
Jon Burg
Radford Valuation Services
Sacramento NASPP – July 27, 2010
Agenda
Overview of IFRS 2
Valuation
Expense Recognition
Income and Payroll Taxes
1
Overview of IFRS 2
Scope of the Standard
Applies to all share-based payment
transactions not in the scope of other
standards
Types of share-based payment
transactions
Equity-settled, cash-settled, or choice
between equity and cash settlement
Recognition of expense in
profit or loss
Yes – allocated over vesting period, if
any
Date of initial measurement
Employees - Grant date
Non-employees – Date goods or
services received
Measurement basis
When valuing awards - fair value e.g.
by applying valuation techniques for
shares and share options
2
Summary of Valuation Related Issues
Topic
Valuation Model
IFRS 2
Preference for Binomial / Lattice
Model
Tranche by tranche valuation
Assumptions
Stratification by employee groups
Country specific requirement
Grant Date and
Expense
Recognition Start
Topic 718
(Formerly FAS 123R)
No preference
Consideration of employee groups
Weighted averages accepted
Generally as service are rendered
but fair value may be marked-tomarket until grant date
Generally after all terms generally
agreed upon and proper approval
received
Expense
Recognition
Methodology*
Accelerated expense recognition
Choice between accelerate expense
recognition (or FIN28) and straightline amortizations
Payroll Tax
Potential fair valuation required at
taxable event
Not applicable
* Not a valuation issue per se, but graded valuation requirement leads to expense difference.
3
Valuation Techniques
> IASB did not prescribe a formula or model to be used
> Should select a model appropriate for the circumstances
- Stronger preference for Binomial or Lattice model [Paragraph B5] – “For
many entities, this might preclude the use of Black-Scholes-Merton
formula, which does not allow for the possibility of exercise before the end
of the option’s life and may not adequately reflect the effects of expected
early exercise.”
> Inputs into model
- Similar to Under Both Standards
- Exercise Price, Market Price, Expected Life, Expected Volatility, Dividend
Yield, and Risk-free rate
> Country by Country Valuation
- Standard suggests country specific assumptions for exercise behavior
- Mixed opinions on whether this is currently applied in IFRS 2 reporting
countries and potential impact on US based companies
- Good rule of thumb: if expected life is differs by more than 1 year, consider
separate assumptions (similar4 to job class stratification)
Valuation of Graded Vesting Options
> Topic 718 allows for a single weighted-average valuation for grants with
graded vesting
> IFRS2 requires a valuation for each tranche
> Example:
> $10.00 at-the-money stock option
> 4 year annual vesting with 10 year contractual term
Weighted
Average Vest
1 Year
2 Years
3 Years
4 Years
2.5 Years
Expected
Life
5.50
6.00
6.50
7.00
Expected
Risk-Free
Dividend
Volatility
Rate
Yield
45.0%
3.0%
1.0%
50.0%
3.5%
1.0%
55.0%
4.0%
1.0%
60.0%
4.5%
1.0%
IFRS Average of Fair Values1:
6.25
52.5%
3.8%
1.0%
Topic 718 Weighted Average Fair Value2:
% difference
Fair Value
$4.12
$4.71
$5.28
$5.82
$4.98
$5.00
0.33%
1 - Under IFRS 2, the expected term is estimated for individual vesting tranches. The IFRS 2 fair values shown for each
tranche should be considered individually and not as a single, weighted average fair value similar to the commonly
applied fair value method under Topic 718.
2 - The Topic 718 Fair Value is calculated using weighted average assumptions
5
Valuation of Graded Options - Assumptions
> Potential Approach #1: Time after Vest
-
For example, if you have 4-year graded vesting (25% per year), and all awards have
historical behavior of 5.50 years. The average vesting is 2.5 (average of 1, 2, 3, and 4
years). Therefore, exercise occurs on average 3.00 years after vest (5.50 – 2.50).
Now, select an expected life for each vesting tranche:
Time To Vest
+ Time After Vest
Total Expected Life
1.00
+ 3.00
4.00
2.00
+ 3.00
5.00
3.00
+ 3.00
6.00
4.00
+ 3.00
7.00
> Potential Approach #2: Expected Life of Each Tranche
-
Probably need to use FIFO (First-in First-out) principles – Data intensive
> Potential Approach #3: Lattice Modeling
-
Determine voluntary exercise and post-vesting termination behavior from experience
-
Used as inputs for a lattice model
6
Graded Vesting Example
> Company grants 1,000 options each with a fair value of $10
> 4-year annual vesting
> Under IFRS 2, companies are required to treat each installment as a
separate share option grant because each installment has a different
vesting period
> Topic 718 allowed for a choice between this method or straight-line
Award
Year 1
Year 2
Year 3
Year 4
Tranche 1 [(10,000 ÷ 4) × 1/1]
$2,500
Tranche 2 [(10,000 ÷ 4) × 1/2]
$1,250
$1,250
Tranche 3 [(10,000 ÷ 4) × 1/3]
$833
$833
$833
Tranche 4 [(10,000 ÷ 4) × 1/4]
$625
$625
$625
$625
IFRS 2 Total Expense
$5,208
$2,708
$1,459
$625
Topic 718 Total Expense
$2,500
$2,500
$2,500
$2,500
7
Straight-Line vs. Accelerated Amortization
> Same example as prior page
> 52% of the expense would be recognized in Year 1 under IFRS 2 while
only 5% would be attributed to Year 4
> Assuming an identical group of awards is granted each year, both
expense attribution methods reach a steady state that begins in year 4
$6,000
$12,000
Topic 718
IFRS 2
$10,000
Compensation Expense
Compensation Expense
$5,000
$4,000
$3,000
$2,000
$8,000
$6,000
$4,000
Topic 718
$1,000
IFRS 2
$2,000
$0
$0
Year 1
Year 2
Year 3
Year 4
8
Year 1
Year 2
Year 3
Year 4
Year 5
Graded Vesting and Forfeitures
> Forfeitures impact the latter tranches more than the earlier ones
> These tranches generally have a greater fair value due to the higher
expected life assumption
> The ultimate expense recorded under IFRS2 will generally be lower
under than under Topic 718
> Example:
> Same assumptions and fair value as before
> 1,000 options granted with 10% forfeitures per year
Vesting
Tranche
1
2
3
4
Totals
Fair
Value
$5.00
$5.00
$5.00
$5.00
TOPIC 718
IFRS 2
Vested
Total
Fair
Vested
Total
Percent
Options Percent Expense Value Options Percent Expense Difference
1,000
90%
$4,498 $4.12 1,000
90%
$3,708
-17.6%
1,000
80%
$3,999 $4.71 1,000
80%
$3,768
-5.8%
1,000
70%
$3,499 $5.28 1,000
70%
$3,696
5.6%
1,000
60%
$2,999 $5.82 1,000
60%
$3,491
16.4%
$14,995
$14,662
-2.2%
9
Expense Recognition and Grant Date
> Services should be recognized when provided
> Services in return for an award usually begin on the grant date
> Grant date might occur after the employee has begun to provide
services in return for the award (¶IG4 of IFRS 2)
> Entity should estimate the grant date fair value of the equity instruments for
the purposes of recognizing the services received during the period between
service commencement date and grant date. The estimate should be revised
once the grant date has been achieved.
> The grant date is:
> The entity and another party (including an employee) agree to a share-based
payment arrangement
> The entity confers on the counterparty the right to cash, other assets, or
equity instruments of the entity, provided the specified vesting conditions, if
any, are met
> Approval is obtained (if subject to an approval process)
10
Expense Recognition and Grant Date
> Example:
> June 1, 2009 – Offer letter specifying the number of restricted shares to be granted
> September 1, 2009 – Hire Date
> December 31, 2009 – Board of Directors approval
> When does expense recognition begin?
> Topic 718: December 31, 2009 (“Grant Date”)
> IFRS 2: September 1, 2009 (Hire Date with mark-to-market until the grant date)
Period of service before Grant Date
IFRS 2 Expense Recognition
Date of Hire
(Sept 1, 2009)
Board Approval
Grant Date
(Dec 31, 2009)
11
Year end
(Dec 31, 2010)
Topic 718 Expense Recognition
Income Taxes
> Guidance found in IAS 12
> Deferred tax asset is re-measured at each reporting date
-
Based on current assessment of tax deduction (¶BC324 of IFRS 2)
> Allocation – equity settled share-based payments
-
Estimated tax deduction ≤ cumulative recognized compensation expense
> DTA recognized in income statement (¶BC326 of IFRS 2)
-
Estimated tax deduction > cumulative recognized compensation expense
> Excess DTA recognized in equity (¶BC326 of IFRS 2)
> For cash-settled (Liability) awards, the DTA is recognized in income statement
> Under FAS 123(R), DTA is computed based on the expense and is recognized in
the income statement
-
Upon settlement of an award under US GAAP:
> Excess tax benefits are recorded to APIC and increase the APIC Pool
> Tax deficits reduce APIC or are charged to P&L if APIC Pool is insufficient
12
P&L Differences: Comp Expense and Tax Benefit
To illustrate the differences in income tax accounting for options under FAS
123R and IFRS, we have illustrated the following:
Nonqualified Stock Options




1,500,000 options granted on 3/01/03
$26.00 exercise price
$9.00 option fair value at grant date
5 year graded vesting
Assumed share price data at quarterly reporting dates during the vesting period.
Estimated the cumulative compensation cost recorded in P&L under IFRS vs. FAS
123R.
Estimated the difference between the cumulative tax benefit actually recognized in
P&L vs. the maximum tax benefit on compensation cost which could be recorded in
P&L.
Please note that for illustrative purposes, we have assumed that the value for
each tranche of options is $9.00. Under IFRS, each tranche would be required to
be valued separately
13
Cumulative Compensation Cost Recorded in P&L
(exercise price - $26; option value at grant - $9; 5-year graded vesting)
(in thousands)
The bar chart illustrates the difference in the book expense amortization, over time, between
awards expensed straight-line under US GAAP versus accelerated expense attribution as
required under IFRS (assuming identical FV amounts under US GAAP and IFRS).
$16,000
$14,000
IFRS
FAS 123R
Compensation Cost
$12,000
$10,000
EXAMPLE
$8,000
$6,000
$4,000
$2,000
$0
Q1
Q2
Q3
2003
Q4
Q1
Q2
Q3
2004
Q4
Q1
Q2
Q3
Q4
Q1
Q2
Q3
2005
2006
Quarterly Reporting Dates Starting Q1 2003
14
Q4
Q1
Q2
Q3
2007
Q4
Q1
2008
Cumulative Tax Benefit Actually Recognized in P&L under IFRS vs. Maximum Tax Benefit
that Could be Recorded in P&L
(exercise price - $26; option value at grant - $9; 5-year graded vesting)
(in thousands)
The bar chart illustrates the difference in the tax benefit impact to the P&L (i.e., the Deferred Tax
Asset – DTA), over time assuming various share FMV prices, between US GAAP and IFRS
approaches (assuming identical FV amounts under US GAAP and IFRS).
Note the Volatility.
$6,000
$5,000
Tax Benefit Actually Recognized in P&L
Full Tax Benefit on Compensation Cost
$3,000
EXAMPLE
$2,000
$1,000
2003
2005
2004
2006
Share Price at Quarterly Reporting Dates Starting Q1 2003
15
2007
$18.00
$20.00
$31.00
$28.00
$25.00
$24.00
$24.00
$22.00
$26.00
$29.00
$32.00
$40.00
$35.00
$42.00
$33.00
$37.00
$35.00
$34.00
$36.00
$35.00
$0
$35.00
Tax Benefit
$4,000
2008
Payroll Taxes
Current IFRS Requirements
> Payroll or other employment taxes (representing additional
expense to company) are accrued over service period.
- Typically, these are social insurance taxes and/or fringe
benefit taxes paid by employer.
- US tax accrual may be minimal / immaterial
> The liability is measured at each balance sheet date.
> After the vesting period, the liability continues to accrue until
settlement of the awards.
> Under U.S. GAAP, payroll tax liabilities are recognized when
the taxes are levied.
16
IFRS Implementation
Considerations
17
Current Considerations
Steps that could be taken now:
> Understand the potential impact of an IFRS conversion on the
DTA and the effective tax rate.
> Estimate the transitional and post-adoption financial statement
effect of conversion on amortization expense for share-based
payments.
> Review the rules and processes required to support sharebased compensation tax deductions in each country, including
recharge reimbursements and transfer pricing implications.
18
Current Considerations
Steps that could be taken now (continued):
> Assess financial system implications, including the reporting
and recordkeeping systems of the share-based compensation
plan administrator.
> Develop new processes and controls for the accrual of payroll
tax liabilities for both domestic and cross-border employees.
> Conduct IFRS training for human resource, tax, and
financial executives within your organization to prepare
for the road ahead.
19
Questions?
20