Share Based Payments - Accounting and Vesting Conditions

The accounting for Share Based Payments is usually complicated. This, however, is relevant considering the fact that many entities have started providing compensation based on equity shares in the entity itself to the employees.

The accounting for Share Based Payments has many aspects - one of the most relevant aspects is vesting conditions - whether these are service based or performance based. How the change is measured in the financial statements and the accounting done for share based payments with respect to changes in conditions is discussed in detail.

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Meaning of Commercial Substance under IFRS

Commercial substance:

Commercial substance means that the risks and cash flows associated with one asset would differ from those of other asset. Under exchange, the risks and rewards & cash flows are not going to be incurred had the exchange not happened. The timing, amount and risks should all substantially match.

Example:

AV Ltd acquires 20 acres land in India from B Ltd in exchange of a 50 storey building in the UK it owns. There is no money exchanged between A & B. AV Ltd would need land in India for its construction business. The property in the UK remained idle, and did not reap many benefits.

B Ltd, on the other hand, required a property in the UK to set-up a business there. However, fair values of the assets cannot be determined since there is no basis of calculation of the fair value in India or the UK.

The building is having a carrying amount of $500,000 in the books of AV Ltd.

Solution

Although there is a commercial substance since the risks, timing and amount of cash flows associated with the building AV Ltd are different from those of the land acquired, the fair value criterion is still not met. In the above example, land would be shown at a value of $500,000 in the books of AV Ltd as there is no fair value identified for either of the assets.

Example

AV Ltd exchanges an oil field it owns in UAE with a similar size oil field in Russia from B Ltd. The cash flows associated with the oil fields are same with regard to risks, amount and timing since the oil prices get affected by global needs.

The carrying amount of the oil field it owns in the UAE is $500 million.

In the above example, it is not known if the fair value of the assets can be identified. However, the commercial substance of the transaction does not exist. Therefore, the Russian pipeline acquired by AV Ltd in exchange with the other pipeline would be shown at the carrying amount of the asset given up.

Example

AV Ltd exchanges a building with a carrying amount of $1m with land from TV Ltd. The fair value of land is $1.5m. Fair value of the building is 1.45m. You are required to calculate the value of land in the books of AV Ltd. Show appropriate accounting impact of the transaction.

Solution

Since the above transaction would meet commercial substance, and also that fair values of assets under exchange are available, the incoming asset (land) is shown at its fair value of $1.5m. Difference between the carrying amount of asset given up (building) and asset acquired under exchange is realised gain $500,000 (1.5m – 1m). The accounting impact of above transaction is:

Debit Land (asset acquired under exchange) 1.5m

Credit Building (asset given up) 1.0m

Credit Gain (SOCI) 0.5m

Financial Assets classification under IND AS 109

Classification of financial assets

Under the principles of IND AS 109, a financial asset may be classified under two categories:

1. At amortised cost:

An asset (other than equity instrument) that meets the below mentioned conditions:

• The asset is held within a business model whose objective is to hold assets in order to collect contractual cash flows;

• The contractual cash terms of the financial asset give rise to cash flows on specific dates that are solely payments of principal and interest on the principal amount outstanding;

• The entity has not invoked the fair value option for measurement of financial asset to reduce an accounting or measurement mismatch.

An entity’s business model approach is determined on a higher level, rather than an asset-by-asset basis. Further, the entity may have different assets (portfolio of assets) for business purposes. Accordingly, it may not be right to identify the business model on an entity’s level either. The entity may comprise of a portfolio of assets which is collected on the basis of contractual cash flows, and of a portfolio of assets in which it trades.

Example

AV Ltd, a banking company, issues loans to various customers in retail business. A customer, having taken a 20 years loan, decides to pay off the loan in 5 years’ time. AV Ltd cannot refuse the pre-payment, and would receive the money due from the customer.

In the above case, although AV Ltd realizes the money well before the due date, the recovery is made essentially in form of contractual cash flows (collected by way of recovery of interest and principal during first 5 years, and recovery of balance principal at the end of 5th year). Hence, the loan asset is shown as amortised cost in the books of AV Ltd.

Example

AV Ltd gives loan to various clients in the retail sector. If someone does not pay the Instalment, AV Ltd would follow different measures to recover money. It may further mean to recover money by selling off the collateral. Even in this case, the business model of AV Ltd is essentially recovery of money through recovery of interest and principal amount.

2. Financial assets measured at Fair value:

Any financial asset not measured at amortised cost is measured at fair value.

* Any investment in equity is necessarily measured at fair value. This is so because equity investments do not have a maturity.

IND AS 109 provides that changes in the value of a financial asset measured at fair value, but not held for trading purposes, may be done through Other Comprehensive Income. However, this choice has to be made by the entity at the time of initial recognition of the asset. This decision is irrevocable, and cannot be changed later.

Example

AV Ltd invests $ 1 million in shares of T Ltd. AV Ltd holds these shares for a longer term, rather than trading into these shares. On reporting date, the value of the investment is $1.2 million. In this case, the investment is reported at $1.2 million. However, the gain of $200,000 may be shown through OCI rather than showing as a part of Income statement.

However, if the intentions of the entity appear as if the entity is trading into these shares, the classification would be done as an investment at fair value. Any changes in the value are to be routed through Income statement.

Example

AV Ltd has invested into the shares of T Ltd. AV Ltd invests into the shares with an intention to sell these shares when the prices rise significantly.

In the above case, the investment in shares is considered as at fair value, and changes are shown through Income statement.

Even though it may be difficult to measure the fair value of investment because the investment is not quoted, IFRS 9 requires an entity to measure the value through valuation principles and does not advocate the use of cost method. (For example, investment in shares of an unlisted company).

Equity instruments that are not held for trading purposes, an entity can choose (instrument-by-instrument), to recognise profit and losses in OCI. Dividend income on these instruments though, is recognised in Income statement.

Examples of financial assets under different categories:

AV Ltd invests in 3 years’ redeemable preference shares of T Ltd. AV Ltd holds these shares until maturity and recovers the cash flows through dividend and principal repayment.

In the above case, the shares are considered to be valued at amortised cost since the maturity of these shares is certain after 3 years.

AV Ltd invests in bonds of T Ltd. The intention is to hold these bonds for a longer term. However, AV Ltd decided to value the investment at fair value routed through profit and loss.

In the above case, although the investment is made in bonds with intent to hold them for a long term, the entity’s decision to measure these at fair value would mean that changes therein are measured through income statement.

AV Ltd has receivables of $5 million from T Ltd. The business model of AV Ltd is to sell off the receivables portfolio to 3rd party and recover money the moment sales are made.

In the above case, the business model of AV Ltd is not to collect contractual cash flows, but trade into these receivables. Accordingly, these assets are shown as a part of trading assets (changes in fair value reported through income statement).

AV Ltd has invested in debentures of T Ltd. AV Ltd has an intention to hold these debentures until maturity. However, if AV Ltd identifies a substantial gain, it may sell off the debentures to realise the gain.

In the above case, although AV Ltd thinks of holding the debentures for a long term (until maturity), it is likely to sell these debentures if substantial gains arise during the period before maturity. In this case, the debentures are assumed to be not held for collection of contractual cash flows.

A perpetual debt (with no maturity) is considered at amortised cost.

A debt instrument convertible into equity shares of the entity is considered at fair value, rather than at amortised cost. The recovery is not necessarily coming through contractual cash flows in form of principal and interest.

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