Martin Landells, director in KPMG’s Performance and Reward Group and heads the team in the North of England: Just as companies are starting to come to terms with the nuances of accounting for share plans, amendments to the IFRS 2 Share-based Payment were published last month. The changes will particularly affect save-as-you-earn (SAYE) plans and could result in increased accounting charges.
Under IFRS 2 the fair value of equity-settled, share-based payment transactions (for example, share options) are measured at the date of grant and charged against profits over the vesting period. Cash-settled share-based payment transactions, for example, awards under a phantom share plan, are recognised as a liability remeasured at each reporting date.
The IFRS 2 amendments affect the treatment of certain cancellations and restrict the definition of a vesting condition.
Cancellation of an option award by the awarding company has always resulted in an acceleration of the remaining charge for that award. By contrast, forfeiture of an award due to failure to satisfy a vesting condition can result in a reversal of the accounting charge.
The primary objective of IFRS 2 is to measure the value of goods or services received in return for the equity instruments granted. The International Accounting Standards Board (IASB) concluded that if an employee cancels participation in a plan, this does not imply that the services required to pay for the equity instrument have not been (or will not be) rendered, so reversal of the charge is not appropriate. Therefore, all cancellations are to be treated consistently with an acceleration of the accounting charge.
IFRS 2 originally stated that vesting conditions include both service conditions (that is, remaining an employee during the vesting period) and performance conditions. Vesting conditions are those conditions that ensure the employee provides the services required to ‘pay’ for the equity instruments issued.
A number of companies and accountancy firms interpreted IFRS 2 so as to treat the requirement to save under a SAYE plan as a vesting condition. This interpretation gave rise to a reversal of the charge for options held by staff who have stopped making contributions. IFRS 2 now states that vesting conditions are either service conditions or performance conditions. Accordingly, it is now clear that the requirement to save under a SAYE savings contract is not a vesting condition.
Under an SAYE scheme, if employees stop saving (because, for example, the share price falls below the option exercise price) then a charge previously reversed may now be recognised in full over a shortened period of time. The impact on one year’s financial results could be material and yet companies have no control over the matter.
The position is further complicated if an employee ceases one savings contract in favour of another (normally at a lower exercise price than the first). In this situation, the complex modification accounting rules of IFRS 2 apply. This assumes that it will be possible to identify where an employee has simply switched from one savings contract to another, which will not always be clear.
This is also a potential issue for deferred annual bonus and share incentive plans where matching shares are forfeited due to an employee withdrawing purchased shares from the plan.
Better news is that the fair value of the equity instrument should now take into account the probability that employees will cancel their participation. The difficulty is how to determine a suitable discount. In a perfect world, if the estimate was entirely accurate, cancellation or forfeiture treatment should give the same overall accounting result (see box below).
Clearly the estimate of the cancellation rate will be key – if it is too low, the charge will be correspondingly higher. In a worked example we can control how many awards will vest but in reality there is no crystal ball.
The IFRS 2 amendments raise a number of issues, including how to determine and justify the cancellation discount factor used when calculating fair value. The interaction of cancellation and modification of accounting rules is also likely to cause headaches for finance and HR functions alike.
Martin Landells is a director in KPMG’s Performance and Reward Group and heads the team in the North of England