CAEA 2215

FINANCIAL ACCOUNTING & REPORTING III

SEMESTER 2 (2013/14)

Accounting Treatment for

Share-Based Payments

Prepared for:

Dr. Ervina binti Alfan

Prepared by :

Shafiah Nasrin Binti Nasser Ali Khan CEA120119

Kerubashne a/p Paraninathan CEA120031

Vinothini a/p Karuppiah CEA120109

Submission Date : 12 May 2014

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CONTENTS

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Topic Page/s

1. Introduction 3

2. Overview of Accounting Treatment for Share-Based Payments in FRS 2

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3. Relevance of the Accounting Treatments in FRS 2 for Share-Based Payments and Conceptual Framework

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4. Controversies Surrounding FRS 2 7

5. Discussion 8-9

6. Conclusion 10

7. References 11

8. Appendix 12-21

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1.0 INTRODUCTION

Share-based payment is a transaction where a corporation receives good and services

either as factor for its equity instruments or by incurring liabilities for amounts based on the

price of corporation's shares or other equity instruments of the corporation. Accounting

requirements for shared-based payments depend on how the transaction will be settled,

whether by issuance of equity, cash or equity and cash. In entity, if it has a current obligation

to settle cash, the share-based payment is cash settled. Conceptual framework is not

MFRS/FRS. However it is a practical tool to assist IASB when developing and reviewing

IFRSs. Conceptual framework is to improve financial reporting by giving IASB a complete

set of concepts to use when developing or reviews the standards.

On 1 April 2001, the International Accounting Standards Board was established to

replace the International Accounting Standards Committee (IASC). It adopted framework to

serve as guide to the board in developing accounting standards. The International Financial

Reporting Standards (IFRSs) has been developed via the "due process", an international

consultation process which has six stages. through this process, it consults with regulators,

investors and business leaders at every stages of the process. IASB publishes and look for

comments from public on discussion papers and exposure drafts in developing IFRSs. the

interpretations committee follows a transparent, thorough due process in developing

interpretations. When the International Accounting Standards Board(IASB) considers the

comments received on the exposure draft during meetings, the development of an IFRS is

carried out. The IASB do not have authority to impose standards. On 12 December 2013, the

International Accounting Standards Board (IASB) issued two cycles of Annual

Improvements to IFRSs which contains 11 changes to nine standards.

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2.0 OVERVIEW OF FRS 2

2.1 Recognition:

An entity must recognize the goods and services received or acquired in a share-based

payment transaction when it obtains the goods or as the services are received. The entity will

recognise a corresponding increase in equity if the goods or services were received in an

equity-settled share-based payment transaction or a liability if the goods or services were

acquired in cash-settled share-based payment transactions. The goods or services received or

acquired in a share-based payment transaction shall be recognised as expenses if they are not

qualified for recognition as assets.

2.2 Main features of the FRS 2:

FRS identifies three types of share-based payment:

1) For equity-settled transactions, FRS requires an entity to measure the goods or services

received and the corresponding increase in equity at their fair value, unless the fair value

cannot be estimated reliably, the entity is required to measure their value, and the

corresponding increase in equity, indirectly, by reference to the fair value of the equity

instruments granted.

For transactions with employees and other providing same services, FRS requires the entity

to measure the fair value of the equity instruments granted, because it is typically not possible

to estimate reliably the fair value of employee services received. The fair value of the equity

instruments granted is measured at grant date. For a non-employee (or similar) transaction,

there should be a rebuttable presumption that the fair value of the goods or services received

can be estimated reliably.

For goods or services measured by reference to their fair value of the equity instruments

granted, FRS specifies that vesting conditions, other than market conditions, are not taken

into account when estimating the fair value of the shares or option at the relevant

measurement date. Instead, vesting conditions are taken into account by adjusting the number

of equity instruments included in the measurement of the transaction amount.

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2) For cash-settled share-based transactions, FRS requires an entity to measure the goods or

services acquired and the liability incurred at the fair value of the liability. The ultimate cost

of a cash-settled award is the cash paid to the counterparty, which is the fair value at

settlement date. Until the award is settled, entity is required to present the cash-settled award

as a liability and not as an element of equity. Entity recognises the services received and the

liability for those services as the employees render them. If an employee is not required to

provide any service, as is the case for some share appreciations rights, the entity recognize

the expense and the liability immediately upon grant date.

3) For share-based payment transactions in which the terms of the arrangement provide

either the entity or the supplier of goods or services with a choice of whether the entity settles

the transaction in cash or by issuing equity instruments, the entity is required to account for

that transaction, or the components of that transactions, as a cash-settled share-based payment

transaction if, and to the extent that, the entity has incurred a liability to settle in cash (or

other assets), or as an equity-settled share-based payment transaction if, and to the extent that,

no such liability has been incurred.

2.3 Disclosure

The FRS prescribes various disclosure requirements to enable users of financial statements to

understand the nature and extent of share-based payment arrangements, their effect on the

period’s financial statements, and the methodologies used in arriving at the numbers included

in the financial statements.

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3.0 SHARE BASED PAYMENTS (FRS2) RELEVENCE TO CONCEPTUAL

FRAMEWORK

Objectives of Financial Reporting by Business Enterprises, states that financial reporting

should provide information that is useful in making business and economic decisions.

Recognizing compensation cost incurred as a result of receiving employee services in

exchange for valuable equity instruments issued by the employer will help achieve that

objective by providing more relevant and reliable information about the costs incurred by the

employer to obtain employee services in the marketplace.

Qualitative Characteristics of Accounting Information, explains that comparability of

financial information is important because information about an entity gains greatly in

usefulness if it can be compared with similar information about other entities. Establishing

the fair-value-based method of accounting as the required method will increase comparability

because similar economic transactions will be accounted for similarly, which will improve

the usefulness of financial information.

Completeness is identified as an essential element of representational faithfulness and

relevance. To faithfully represent the total cost of employee services to the entity, the cost of

services received in exchange for awards of share-based compensation should be recognized

in that entity’s financial statements.

Elements of Financial Statements, defines assets as probable future economic benefits

obtained or controlled by a particular entity as a result of past transactions or events.

Employee services received in exchange for awards of share-based compensation qualify as

assets, though only momentarily—as the entity receives and uses them—although their use

may create or add value to other assets of the entity. This Statement will improve the

accounting for an entity’s assets resulting from receipt of employee services in exchange for

an equity award by requiring that the cost of such assets either be charged to expense when

consumed or capitalized as part of another asset of the entity

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4.0 CONTROVERSIES SURROUNDING FRS 2

Stock-based compensation expense is a general term. It is stock options granted to

employees. Prior to 2006, the vast majority of the stock options that firms issued would not

have been recognized in firms’ income in any way, he says. However, since then, revisions to

generally accepted accounting procedures in the United States, or GAAP, have required firms

to recognize stock-based compensation expense. The reason these regulations came down is

the perception of the Securities Exchange Commission that a lot of firms were attempting to

fool investors by reporting these non-GAAP numbers. They were including items that should

have been excluded and excluding items that should have been included. So there was a

significant concern that the only reason that managers were producing these numbers was to

fool investors.

The GAAP revisions are just one of many reforms that came about after accounting

scandals came to light in the early twenty-first century, such as the Enron scandal involving

the accounting firm Arthur Andersen and the Adelphia Communications scandal involving

the accounting firm Deloitte & Touche. Still, the regulation about recognizing stock-based

compensation expense is controversial. “Normally, high-level people in government opining

about accounting issues, but this is one issue where senators, representatives, and other

officials were taking strong stands on whether stock-based compensation gives rise to an

expense or doesn’t give rise to an expense.

Although the regulation became effective in 2006, many people still do not agree that

including stock-based compensation expense is necessary. In fact, some managers and

analysts continue to exclude stock-based compensation expense when they present measures

of net income in earnings announcements (non-GAAP earnings) and consensus earnings

forecasts (Street earnings).

However, due to the requirements of the SEC’s Regulation G, when managers present

non-GAAP earnings, they have to reconcile any such numbers with numbers prepared in

compliance with the GAAP standards. In other words, even though managers are required to

include stock-based compensation expense in calculating their income for financial reporting

purposes, such as filing with the SEC, a significant number of them exclude stock-based

compensation expense when reporting alternative numbers.

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5.0 DISCUSSION

In recent years, IFRS 2 was one of the most opposed and controversial standards

issued by the IASB. The purpose of IFRS 2 was to provide better comparable, transparent,

high-quality information to annual statement users. Firstly, share-based payments are an

expense according to the conceptual framework of the IASB. Secondly, the payment for

goods and services by share-based payments is no different than paying for these goods and

services by cash. The employee would not accept payment for his services if the share-based

payment had no value. It can be concluded that share-based payments are indeed an expense.

Employee stock options are defined as a right given to an employee, but not an

obligation, to buy a specific number of shares of stock at a specific price and time, despite

market changes. Prior to IFRS 2 the accounting procedure for Employee stock options was

the ‘intrinsic method’, which means the intrinsic method recognizes an ESO expense based

on the intrinsic value. The intrinsic value of a stock option is the difference between market

value on the date the option is granted (grant date) and the exercise price of the option.

The implications of the main findings is that IFRS 2 did not only change the way

Employee Stock Options are accounted in the financial statements but it changed the decision

making behavior of managers. Firms that had to mandatory adopt IFRS 2 chose to reduce the

number of options granted to employees. The economic consequence of IFRS 2 is that the

managers of firms decide to reduce or eliminate the use of Employee Stock Options when the

favorable accounting treatment of ESO disappears. The possible reason for this is that when

the favorable accounting treatment disappears managers will have to reassess the cost of it.

The choice of how employees are remunerated after the introduction of IFRS 2 must then be

made on the economic fundamentals of the compensation method rather than on the biased

accounting rules. After the introduction of IFRS 2 the playing field for equity based

compensation has become equal.

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Based on the investigation on the effect of expensing share-based payments on basic

earnings per share of South African listed companies, The introduction of IFRS 2 caused

small but not necessarily immaterial changes to the income profile of companies

(Denice,2013).This is important for analysts and general users of financial statements who

need to be aware of these changes. It is also important for the companies themselves when

revising the structure of their remuneration packages. It is further more important for

companies to know how other companies have responded to the mandatory expensing of SBP

transactions due to the implementation of IFRS 2.

Second, according to the journal of accountancy, A Road Map for Share-Based

Compensation, in order to find a best strategy for rewarding employees, a company should

understand how judgments and underlying assumptions affect fair value when using a pricing

model or technique. Potential dilutive effect on earnings per share, book value per share and

ownership distribution is also important as well, (Anne, 2007).

Third, the investigation on impact of the most controversial and strongly-opposed

accounting standards of recent years affecting UK companies, IFRS 2.The study investigated

impact of this on selected largest companies listed on London Stock Exchange. According to

that, this implementation of new standard do not give big impact on the companies and it is

immaterial. The results did not identify substantial effect of size or rapid growth, and no

companies reported as loss solely as result of expensing option.(Radha,2010)

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6.0 CONCLUSION

These standards determine that the value of a SBP is an expense of the entity and

should therefore be expensed through profit or loss over the vesting period. According to the

basis for conclusions of IFRS 2 one of the reasons behind the change from disclosure to

recognition of SBP transactions is to provide high quality transparent and comparable

information to financial statement users.

The use of SBP, before the implementation of FRS 2, gave managers and owners the

ability to compensate employees at a rate higher than their normal remuneration package,

without diminishing profits and cash flows, in that the SBP transactions were not expensed.

Before the implementation of IFRS 2 companies had the opportunity to examine their equity

incentive schemes to make sure that they have effectively linked the cost of these schemes for

the company with the value perceived by the employees

The introduction of IFRS 2 caused small but not necessarily immaterial changes to the

income profile of companies. This is important for analysts and general users of financial

statements who need to be aware of these changes. It is also important for the companies

themselves when revising the structure of their remuneration packages. It is further more

important for companies to know how other companies have responded to the mandatory

expensing of SBP transactions due to the implementation of IFRS 2.

Thus , it can be concluded that it is not right for the business community to oppose

and did not accept the FRS 2.

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7.0 REFERENCES

Anne L,Raymond A, (2007) Road Map for Share-Based Compensation, Journal of Accountancy

Denice Pretorius, Charl de Villiers,(2013), The effect of expensing share-based payments on basic earnings per share of South African listed companies, Journal of Meditari Accounting Research 21(2),178-190

Holt, G. 2009. “IFRS 2, Share-Based Payments”. Accounting and Business magazine, http://www.accaglobal.com/members/publications/accounting_business/CPD/2539654 viewed 17 January

IASB(2004) International Financial Reporting Standard No.2, Share based payments.

London. International Accounting Standard Board

MASB (2007) Financial Reporting Standard 2, Share Based Payment,Malaysia. Malaysian

Accounting Standard Board

MASB (2007) The Conceptual Framework for Financial Reporting,Malaysia. Malaysian

Accounting Standard Board

Radha K.Shiwakoti, Brian A.Rutherford (2010), Expensing of share based payments and its impact on large UK companies, Journal of The British Accounting Review 42, 269-279

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