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Share-based payments - a new accounting challenge Back  
With 39 per cent of Irish companies providing shares or share options as an employee benefit, the new IFRS 2 standard on share-based payments will have a significant impact writes Brendan Sheridan.
The release of IFRS 2 Share-based Payment in February 2004 completes one of the major objectives of the International Accounting Standards Board (IASB) and fills a void that has existed in International Financial Reporting Standards (IFRS). It is effective for accounting periods beginning on or after 1st January 2005.

Harmonisation of standards
Our current standard-setters, the Accounting Standards Board (ASB), released FRS 20 in April which has identical requirements to IFRS 2 except that implementation of the standard for unlisted entities has been deferred one year to 1st January 2006 to allow more time for unlisted entities to prepare themselves for implementation. Accordingly, all companies with shared-based schemes will have to adhere to the new requirements in due course. This is irrespective of whether the Irish government decides to extend the scope of application of IFRS beyond listed entities.

In the US, the Financial Accounting Standards Board (FASB) has issued proposals that are consistent with the requirements set out in IFRS 2. Currently, companies in the United States are permitted, but not required, to recognise stock options as part of employee compensation cost. Several hundred listed companies (out of about 15,000) recognise the expense in their income statement. Even if they elect not to charge the cost to expense, companies must disclose the fair values of options granted.

Objectives of the standard
The objective of IFRS 2 is to specify the financial reporting by an entity when it undertakes a share-based payment transaction. In particular, the IFRS requires an entity to reflect in its profit and loss account the effects of share-based payment transactions, including expenses associated with transactions in which share options are granted to employees. The intention is therefore that no matter what form of remuneration is used, the entity recognises the associated costs.

The concept of share-based payments is broader than employee share options for example, the Standard encompasses share appreciation rights, employee share purchase plans, employee share ownership plans and plans where the issuance of shares (or rights to shares) may depend on market or non-market related conditions.
IFRS2 applies to all entities. There is no exemption for private or smaller entities. Furthermore, subsidiaries using their parent’s or fellow subsidiary’s equity as consideration for goods or services are within the scope of the Standard.

Valuation and measurement
The fair value of the share-based payment is determined at the grant date and should be expensed over the vesting period. If the shares are fully vested, it is assumed that they relate to past service, requiring an amount equivalent to fair value at grant date to be expensed immediately. If vesting is over-say-a three year period, the charge would be expensed over that period with adjustments to be made to the charge in the event of departures occurring during that period.

Any modification of the terms on which equity instruments are granted may have an effect on the expense that will be recorded. The cancellation or settlement of equity instruments is accounted for as an acceleration of the vesting period and therefore any amount unrecognised that would otherwise have been charged should be recognised immediately.
IFRS 2 has a rebuttable presumption that if the share-based payment is for goods or services other than from employees, the share-based payment should be measured by reference to the fair value of goods or services. If the share-based payment is to employees (or those similar to employees), the transaction should be measured by reference to the fair value of the equity instruments granted.

An entity shall measure the fair value of equity instruments granted at the measurement date, based on market prices if available. If market prices are not available, the entity shall estimate the fair value of the equity instruments granted using a valuation technique to estimate what the price of those equity instruments would have been on the measurement date in an arms’ length transaction. The valuation technique used shall be consistent with generally accepted valuation methodologies for pricing financial instruments.

In rare cases, the fair value of equity instruments cannot be reliably measured. In those rare cases, the entity shall measure the equity instruments at their intrinsic value (i.e. fair value less exercise price), initially at grant date and subsequently at each reporting date and at the date of final settlement.

Taxation consequences
One of the issues corporates will want addressed is whether the expense incurred in the profit and loss account is deductible in computing the corporation tax of the company. To date, no deduction has been available for such an expense. In the UK, tax legislation was announced that provides for a corporate tax deduction for amounts which are, or would be, subject to tax in the employee’s hands which, while providing for a deduction, has not aligned the tax treatment with the accounting standard. Legislation will be required in order for Irish companies to obtain a corporate tax deduction for such an expense. This will clearly be an important planning issue for corporates and they will need to take this into account in formulating their remuneration policy.

Employee share schemes
The prominence of employee share schemes in Ireland is highlighted by a Deloitte survey which indicated the 39 per cent of Irish companies provide shares or share options as an employee benefit. Pro-Share, an independent organisation founded by the London Stock Exchange and related bodies some years ago to promote wider share ownership, carried out a survey in the UK in 2003 which concluded that introduction of the standard would mean:-
Estimated reduction in pre-tax profits will typically be 5 per cent;

If implemented, 42 per cent of respondents say that their company would be unlikely to carry on with their all-employee option schemes as before; and
A quarter of companies (25.7 per cent) of companies would stop granting options under their all-employee option schemes (such as Sharesave) and would not use other share plans.

There is continuing concern being expressed regarding the impact of the standard on ‘all-employee’ schemes. Many believe that it may lead to a discontinuance of such schemes and liken it to the move away from defined benefit pension schemes following the introduction of FRS17.

Implementation process
The transition arrangements for implementation of IFRS 2 require its application to all equity-settled share-based payments granted after 7 November 2002 (date of issue of the Standard’s exposure draft) that are not yet vested at the effective date of IFRS 2 which is 1st January 2005. Comparative amounts and opening reserves will have to be amended accordingly.

• Companies will be required to take the following action steps for each share-based payment measured under IFRS 2:
• Calculate the fair value of the share-based payment at the date of grant;
• Calculate the expense for each period based on the company’s revised estimate of shares that will vest;
• For cash-settled share-based payments, determine the fair value of the share-based payment at each reporting date; and
• Develop a system or programme to capture the data necessary for fulfilling the disclosure requirements.

The new standard addresses an area where there has been a significant gap in the accounting framework. It will address the concerns of investors and other stakeholders with regard to ensuring that remuneration charges are measured consistently by companies and that there is transparency and comparability of information. Companies will need to plan now to gauge the impact on their reported earnings and whether going forward they need to re-assess the overall effectiveness of their incentive schemes.

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