In this month’s newsletter, we discuss the financial reporting by an entity when it undertakes a share-based payment transaction.
The newsletter addresses why AASB 2 Share-based Payment exists in the first place, the scope of AASB 2, as well as some practical examples of the accounting treatment of cash-settled and equity settled share-based payments.
1. Why does AASB 2 exist in the first place?
Prior to the issue of AASB 2 in Australia in 2005, if an entity gave their employees and executives share options, no journal entries were processed. This resulted in entities remunerating their employees and executives via share options as it had no impact on profit, which lead to the provision of inaccurate and misleading information on the performance of the entity. AASB 2 reflects the impact of share based payment transactions in the balance sheet and profit and loss.
Example 1
Company A remunerated its directors and senior staff as follows:
- cash remuneration to the value of $500,000; and
- 2,000,000 share options with a fair value at grant date of $1 each.
Before the issue of AASB 2 in 2005
Company A recorded the following journal in respect of the above remuneration:
| Dr | Salaries & Wages (Profit & Loss) | 500,000 | ||
| Cr | Cash | 500,000 |
Company did not record the issue of the options at all. Therefore, only remuneration of $500,000 was included in the calculation of profit for the year and only $500,000 was disclosed as key management personnel (KMP) remuneration.After the issue of AASB 2 in 2005
Company A recorded the following journals in respect of the above remuneration:
| Dr | Salaries & Wages (Profit & Loss) | 500,000 | ||
| Cr | Cash | 500,000 |
| Dr | Salaries & Wages (Profit & Loss) | 2,000,000 | ||
| Cr | Share-based Payment Reserve | 2,000,000 |
Therefore, remuneration of $2,500,000 was included in the calculation of profit for the year and $2,500,000 was disclosed as key management personnel (KMP) remuneration.
2. Scope of AASB 2
AASB 2 applies to share-based payment transactions in which an entity acquires or receives goods or services. Goods include inventories, consumables, property, plant and equipment, intangible assets and other non-financial assets. Service includes services provided by employees, external consultants, etc.
AASB 2 defines a share-based payment transaction as “A transaction in which the entity:
(a) receives goods or services from the supplier of those goods or services (including an employee) in a share-based payment arrangement; or
(b) incurs an obligation to settle the transaction with the supplier in a share-based payment arrangement when another group entity receives those goods or services”.
AASB 2 defines a share-based payment arrangement as “An agreement between the entity (or another group entity or any shareholder of any group entity) and another party (including an employee) that entitles the other party to receive:
(a) cash or other assets of the entity for amounts that are based on the price (or value) of equity instruments (including shares or share options) of the entity or another group entity; or
(b) equity instruments (including shares or share options) of the entity, or another group entity,
provided the specified vesting conditions, if any, are met.
A share-based payment transaction may be settled by another group entity (or a shareholder of any group entity) on behalf of the entity receiving or acquiring the goods or services. Paragraph 2 also applies to an entity that:
(a) receives goods or services when another entity in the same group (or a shareholder of any group entity) has the obligation to settle the share-based payment transaction; or
(b) has an obligation to settle a share-based payment transaction when another entity in the same group receives the goods or services,
unless the transaction is clearly for a purpose other than payment for goods or services supplied to the entity receiving them.
Example 2
If parent entity A issues shares to the employees of subsidiary 1, it is a share-based payment transaction in parent entity A’s records.
If subsidiary 2 issues share options (for shares in the parent entity) to their employees for services rendered to subsidiary 2, it is a share-based payment transaction in subsidiary 2’s records.
3. Cash-settled Share-based Payment Transactions
An entity shall recognise the goods or services received or acquired in a share-based payment transaction when it obtains the goods or as the services are received. The entity shall recognise a corresponding liability if the goods or services were acquired in a cash-settled share-based payment transaction. When the goods or services received or acquired in a share-based payment transaction do not qualify for recognition as assets, they shall be recognised as expenses.
Therefore, the pro forma journal entry to record a cash-settled share-based payment transaction is as follows:
| Date | Account Description | Dr $ | Cr $ |
| xx.xx.xx | Asset / Expense | xx | |
| xx.xx.xx | Liability | xx | |
| Record cash-settled share based payment transaction | |||
For cash-settled share-based payment transactions, the entity shall measure the goods or services acquired and the liability incurred at the fair value of the liability. Until the liability is settled, the entity shall remeasure the fair value of the liability at the end of each reporting period and at the date of settlement, with any changes in fair value recognised in profit or loss for the period.
Example 3
Cash Flush Limited grants 100 cash share appreciation rights (SARs) to each of its 500 employees on condition that they remained employed by the company for the next 3 years.
During Year 1, 35 employees leave. Estimated that another 60 will leave during Years 2 and 3. During Year 2, another 40 employees leave. Estimated that another 25 will leave during Year 3. During Year 3, another 22 employees leave.
SARs are exercised as follows:
- end of Year 3, 150 employees;
- end of Year 4, 140 employees; and
- end of Year 5, 113 employees.
Estimates of fair value of the share appreciation rights at the end of each year are as follows:
| Year | Fair Value | Cash Paid Out |
| 1 | $ 14.40 | |
| 2 | $ 15.50 | |
| 3 | $ 18.20 | $ 15.00 |
| 4 | $ 21.40 | $ 20.00 |
| 5 | $ 25.00 |
Based on the details above, the share-based payment expense and liability for each of years 1 – 5 can be calculated as follows:
| Year | Calculation | Remuneration Expense | Liability |
| 1 | (500-95) employees X 100 SARs X $ 14.40 X 1/3 years | 194,400 | 194,400 |
| 2 | [(500-100) employees X 100 SARs X $ 15.50 X 2/3 years] less $ 194,400 | 218,933 | 413,333 |
| 3 | [(500-97 – 150) employees X 100 SARs X $ 18.20 X 3/3 years] less $ 413,333 expense what’s left after payout PLUS 150 employees X 100 SARs X $15 expense how much paid out |
47,127
225,000 |
460,460 |
| 4 | [(500-97 – 150 – 140) = 113 employees X 100 SARs X $ 21.4] less $ 460,460 expense what’s left after payout PLUS 140 employees X 100 SARs X $20 expense how much paid out |
(218,640)
280,000 |
241,820 |
| 5 | (0 employees X 100 SARs X $ 25.00) less $ 241,820 expense what’s left after payout PLUS 113 employees X 100 SARs X $25 expense how much paid out |
(241,820)
282,500 |
NIL |
| TOTALS | 787,500 |
4. Equity-settled Share-based Payment Transactions
An entity shall recognise the goods or services received or acquired in a share-based payment transaction when it obtains the goods or as the services are received. The entity shall recognise a corresponding increase in equity if the goods or services were acquired in an equity-settled share-based payment transaction. When the goods or services received or acquired in a share-based payment transaction do not qualify for recognition as assets, they shall be recognised as expenses.
Therefore, the pro forma journal entry to record an equity-settled share-based payment transaction is as follows:
| Date | Account Description | Dr $ | Cr $ |
| xx.xx.xx | Asset / Expense | xx | |
| xx.xx.xx | Equity (For example, Share-based Payment Reserve) | xx | |
| Record equity-settled share based payment transaction | |||
For equity-settled share-based payment transactions, the entity shall measure the goods or services received, and the corresponding increase in equity, directly, at the fair value of the goods or services received, unless that fair value cannot be estimated reliably. If the entity cannot estimate reliably the fair value of the goods or services received, the entity shall measure their value, and the corresponding increase in equity, indirectly, by reference to the fair value of the equity instruments granted.
However, in respect of transactions with employees and others providing similar services, the entity shall measure the fair value of the services received by reference to the fair value of the equity instruments granted, because typically it is not possible to estimate reliably the fair value of the services received. The fair value of those equity instruments shall be measured at grant date. The measurement principles are included in the following decision tree:
Example 4
Generous Limited grants share options to each of its 100 employees in its sales department at the beginning of Year 1.
The share options will vest at the end of Year 3 providing that the following conditions are met:
- the employee is still with the company at the end of Year 3; and
- the volume of sales Product A increases by at least an average of 5% p.a.
The numbers of options each employee will receive is as follows:
- Sales of Product A increases by an average of 5 – 10% p.a. → 100 options
- Sales of Product A increases by an average of 10 – 15% p.a. → 200 options
- Sales of Product A increases by an average of > 15% p.a. → 300 options
Assumptions at grant date:
- FV per option is $ 20
- Sales volume of Product A will increase between 10 and 15 %, i.e. 200 options will vest per employee
- 20% of employees will leave before the end of Year 3
By the end of Year 1:
- 7 employees have left
- A total of 20 employees expected to leave by end of year 3, i.e. 80 to remain
- Product A sales have increased 12% and pattern expected to continue
By the end of Year 2:
- Another 5 employees have left – 12 to date
- A total of 15 employees expected to leave by end of year 3, i.e. 85 to remain
- Product A sales have increased 18% and pattern expected to continue
- 300 options expected to be issued at end of year 3
By the end of Year 3:
- Another 2 employees have left – 14 to date
- Product A sales have increased 16% over the three years
- 300 options were issued at end of year 3 to 86 employees
Based on the details above, the share-based payment expense for each of Years 1, 2 and 3 can be calculated as follows:
| Year | Calculation | Remuneration Expense | Cumulative Remuneration Expense |
| 1 | 80 employees X 200 options X $ 20 X 1/3 years | 106,667 | 106,667 |
| 2 | (85 employees X 300 options X $ 20 X 2/3 years) less $106,667 | 233,333 | 340,000 |
| 3 | (86 employees X 300 options X $ 20) less $340,000 | 176,000 | 516,000 |
