Accounting for Share-Based Payments Chapter 18 Accounting for Share-Based Payments Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Objectives of this lecture State which share-based payments are covered by AASB 2 Share-based Payment Understand the reasons that ultimately led to the development of AASB 2 Understand what is meant by ‘equity-settled share-based payments’ and ‘cash-settled share-based payments’ and be able to provide the necessary accounting entries for such transactions Understand how to measure share-based payment transactions Understand the effect of various vesting conditions on the accounting treatments required for share-based payments Explain some possible economic implications of the release of AASB 2 Describe the disclosure requirements of AASB 2 Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Introduction to share-based payments The requirement to account for various share-based payment transactions is relatively new and is included in AASB 2 Share-Based Payment In the past, many share-based transactions were not attributed a cost (e.g. share options provided to employees) despite the fact that the use of such instruments as share options in employee reward structures was widespread The introduction of AASB 2 was relatively unpopular with business as it forced them to put a cost on transactions that were previously often treated as being of no cost Prior to the accounting standard (effective from 2005), there was great disparity in treatment of share-based payment transactions. This made inter-firm comparison difficult. This led to a perceived need for an accounting standard Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Definition of a share-based payment transaction A transaction in which the entity receives goods or services as consideration for equity instruments of the entity (including shares or share options), or acquires goods or services by incurring liabilities to the supplier of those goods or services for amounts that are based on the price of the entity’s shares or other equity instruments of the entity Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Scope of AASB 2 According to AASB 2, par. 2, an entity shall apply AASB 2 in relation to: (a) equity-settled share-based payment transactions, in which the entity receives goods or services as consideration for equity instruments of the entity (including shares or share options) (b) cash-settled share-based payment transactions, in which the entity acquires goods or services by incurring liabilities to the supplier of those goods or services for amounts that are based on the price (or value) of the entity’s shares or other equity instruments of the entity, and (c) transactions in which the entity receives or acquires goods or services and the terms of the arrangement provide either the entity or the supplier of those goods or services with a choice of whether the entity settles the transaction in cash (or other assets) or by issuing equity instruments Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Accounting for equity-settled share-based transactions General rule provided at par. 10 of AASB 2 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 AASB 2 defines fair value as: The amount for which an asset could be exchanged, a liability settled, or an equity instrument granted between knowledgeable, willing parties in an arm’s length transaction Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Accounting for equity-settled share-based transactions (cont.) There is a general presumption that transactions with employees cannot be reliably measured on the basis of the value of the services provided. Par 11 states: To apply the requirements of paragraph 10 to 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, as explained in paragraph 12. The fair value of those equity instruments shall be measured at grant date Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Which fair values do we use? Nature of the transaction Amount at which the expense (or asset) and equity account are recognised Transactions where the fair value of the goods or services can be measured reliably At the fair value of the goods or services received Transactions with employees (where there is a maintained assumption that the fair value of the services cannot be measured reliably) At the fair value of the equity instruments being granted In those ‘rare situations’ where the fair value of goods and services provided by non-employees cannot be measured reliably Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Accounting for equity-settled share-based transactions (cont.) Worked Example 18.1 (p. 588) considers the case in which the fair value of goods to be received can be measured reliably Worked Example 18.2 (p. 588) considers the case in which the value of services cannot be determined reliably Paragraph 7 of AASB 2 requires an entity to recognise the goods or services received or acquired when the goods are obtained or the services provided If the goods or services were received in an equity-settled share-based payment transaction, an increase in equity is recognised If they were received as part of a cash-settled share-based transaction, a liability is to be recognised Consistent with paragraph 8 of AASB 2, if the goods or services do not meet the AASB Framework’s criteria for the recognition of an asset, the related expenditure is to be expensed Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Worked Example 18.1—Provision of goods by a supplier in exchange for equity instruments of the reporting entity On 1 July 2011, Supplier X provides Reporting Entity Ltd with some inventory, which has a fair value of $140 000. In exchange for the inventory, Reporting Entity Ltd provides Supplier X with 10 000 shares in Reporting Entity Ltd As it is considered that the fair value of the inventory can be determined ‘reliably’, this is deemed to be the value of the shares being issued. The accounting entry would be: Dr Inventory 140 000 Cr Share capital 140 000 Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Dr Employee benefits expense 15 000 Cr Share capital 15 000 Worked Example 18.2—Provision of services where the value of the services cannot be measured reliably Employee X provides her services to Reporting Entity Ltd in exchange for 10 000 options in the entity. All services have been performed and the options have been granted to Employee X. The options are considered to have a market value of $1.50 each In this case, which involves an employee, the reporting entity would not determine the fair value of the services being provided but instead would consider the fair value of the options Dr Employee benefits expense 15 000 Cr Share capital 15 000 If the goods or services were received in an equity-settled share-based payment transaction, an increase in equity is recognised. If they were received as part of a cash-settled share-based transaction, a liability is to be recognised Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Accounting for equity-settled share-based transactions (cont.) Have the entitlements to the equity instruments vested? Something ‘vests’ if it has become an unconditional entitlement Whether an entitlement has vested will have implications for when the associated asset or expense will be recognised If the equity investments vest at ‘grant date’ the entity will recognise the whole transaction on that date on the assumption that the ‘counterparty’ has rendered services in full in return for the equity instrument Conversely, if the equity instruments do not vest at grant date there is a presumption that they are a payment for services to be received during the vesting period Consider Worked Example 18.3—Employee costs with a vesting period—on p. 590 Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Measuring fair value of equity instruments Easier if instruments traded on a stock exchange If not traded, then estimates of fair value must be made In the absence of market values, fair value might be determined using valuation techniques, such as option pricing models for measuring share options. Such models take account of: (a) the exercise price of the option (b) the life of the option (c) the current price of the underlying shares (d) the expected volatility of the share price (e) the dividends expected on the shares (if appropriate) (f) the risk-free interest rate for the life of the option Where fair value cannot be determined then equity instruments are to be measured at their ‘intrinsic value’ Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Cash-settled share-based payment transactions Defined as: A share-based payment transaction in which the entity acquires goods or services by incurring a liability to transfer cash or other assets to the supplier of those goods or services for amounts that are based on the price (or value) of the entity’s shares or other equity instruments of the entity Required accounting treatment (par. 30) 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 each reporting date and at the date of settlement, with any changes in fair value recognised in profit or loss for the period Consider Worked Example 18.8 (p. 600)—Share appreciation rights Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Worked Example 18.8—Accounting for share appreciation rights On 1 July 2012 Coogee Ltd provides its managing director with a share-based incentive according to which she is offered a bonus that is calculated as 200 000 times the increase in the fair value of the entity’s share price above $2.50 When the bonus was offered the share price was $2.25 If the managing director does not leave the organisation the accrued entitlement will be paid after three years. However, if she leaves the organisation the accrued entitlement will be paid out upon departure—that is, the benefit will not be forfeited Other information The share price at 30 June 2013 is $3.00 The share price at 30 June 2014 is $2.90 The share price at 30 June 2015 is $4.10 The managing director stays for three years and is paid the bonus on 1 July 2015 REQUIRED Prepare the journal entries that would appear in the accounting records of Coogee Ltd to account for the issue of the share appreciation rights Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Worked Example 18.8—Solution Remuneration Year end Calculation expense for period 30 June 2013 200 000 × ($3.00 – $2.50) $100 000 30 June 2014 200 000 × ($2.90 – $2.50) – $100 000 ($20 000) 30 June 2015 200 000 × ($4.10 – $2.50) – $80 000 $240 000 30 June 2013 Dr Employee benefits expense 100 000 Cr Accrued salaries payable 100 000 30 June 2014 Dr Accrued salaries payable 20 000 Cr Employee benefits expense recouped (revenue) 20 000 30 June 2015 Dr Employee benefits expense 240 000 Cr Accrued salaries payable 240 000 1 July 2016 Dr Accrued salaries payable 320 000 Cr Bank 320 000 Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Share-based payment transactions with cash alternatives This is the third category of share-based payment transactions covered by AASB 2 Defined as transactions in which the entity receives or acquires goods or services and the terms of the arrangement provide either the entity or the supplier with the choice of whether the entity settles in cash or by issuing equity instruments Where the other party to the transaction has the right to demand cash or equity settlement, the transaction may be considered to give rise to a compound financial instrument with both a liability and an equity component The equity component would be measured as the difference between the fair value of the goods and services received and the fair value of the liability component as at the date on which the goods and services are provided Consider Worked Example 18.10 (p. 603)—Share-based payment transaction with a cash alternative Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Summary of some of the main elements of AASB 2 Scope of AASB 2: Applies to share-based transactions involving both employees and non-employees Basis of measurement: Fair value Measurement date: Grant date When is cost recognised? If involving a period of service the expense is recognised over the period of the service (vesting period). If shares or options vest immediately the fair value is expensed at the grant date Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Summary of some of the main elements of AASB 2 (cont.) What option pricing model is to be used? If the options are short term, generally the Black–Scholes option pricing model would be used, otherwise other option pricing models might be employed. The models need to take into account the exercise price; current price; expected volatility; expected dividends; risk- free rate of return; and the life of the options Cash-settled share-based payment transactions—debt or equity? Cash-settled share-based payment transactions are to be measured at fair value and disclosed as a liability. Fair value is remeasured at each reporting date and the movement in fair value is to be treated as part of profit or loss Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Possible economic implications of AASB 2 Given that a cost must now be attributed to items such as share options, do we consider that this will impact on the propensity of firms to use them? What economic implications might there be if firms reduce their usage of incentive schemes based on share options? Does the issue of share options actually ‘cost’ the firm anything? Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Disclosure requirements AASB 2 requires extensive disclosure under three main headings. The entity is required to provide information to enable the users of the financial statements to understand: the nature and extent of share-based payment arrangements that existed during the period how the fair value of the goods or services received or the fair value of the equity instruments granted during the year was determined, and the effect of expenses arising from share-based transactions on the entity’s profit or loss for the period and on its financial position Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e