IFRS 2 New Workbook

8/8/2019 IFRS 2 New Workbook

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for Accounting Professionals

IFRS 2: SHARE - BASED PAYMENT

This Project is funded by EU

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PREFACE

This series of workbooks has been updated by the project team of the European Unionproject Implementation of the Accounting Reform in the Russian Federation.

The workbooks cover the concepts of International Financial Reporting Standards(IFRS). They are intended to be practical self-instruction aids

that practicing accountants can use to upgrade their knowledge, understanding and skills.

Each workbook is designed for a maximum of three hours of study.

Each workbook is a combination of:

Information with examples Self Test Questions Multiple choice and Exercises Answers to Self Test Questions

The members of the project team were contributed by PricewaterhouseCoopers,ACCA, FBK and Agriconsulting.

The Workbook Series consists of a range of titles listed on our website.

The copyright of the material contained in each workbook belongs to the EuropeanUnion and, according to its policy, may be used free of charge for any non-commercial purpose.

The project team would like to express thanks to those who have contributed theirtime and thoughts to the content of the workbooks.

Contact:

e-mail [email protected] www.accountingreform.ru

Tel. + 7 495- 967-6046 Fax. + 7 495- 967-6001

Moscow, Russia, April 2007 (updated)

CONTENTS

Background ........................................................................................................................................................................................................................................... ....... 3

Objective of IFRS 2 ......................................................................................................................................................................................................................................4

Definitions ....................................................................................................................................................................................................................................................4

Overview of IFRS 2 ..................................................................................................................................................................................................................................... 7

Measurement mechanisms ...................................................................................................................................................................................................................... ..... 7

Scope ........................................................................................................................................................................................................................................................ ...8

Recognition ..................................................................................................................................................................................................................................... ............ 9

Equity-settled share-based payment transactions - Overview ...................................................................................................................................................................10

Modifications .............................................................................................................................................................................................................................. .............. .13

Cash-settled share-based payment transactions ........................................................................................................................................................................................15

Disclosures ........................................................................................................................................................................................................................................ ........18

Multiple choice questions ..........................................................................................................................................................................................................................20

Answers to multiple choice questions ........................................................................................................................................................................................................23

Appendix 1 aids to calculations .................................................................................................................................................................................................... ..........24

Appendix 2 Valuation considerations .................................................................................................................................................................................................. ...28

Appendix 3 - Tax effects of share-based payment transactions ................................................................................................................................................................30

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Appendix 4 - Applying IFRS 2 in practice - Wayne Holdings .................................................................................................................................................................32

Note:

Material from the following PricewaterhouseCoopers publications has been used in

this workbook:

Share-based Payment

BACKGROUND

Undertakings often grant shares or share options to staff or other parties. Share plansand share option plans are a common feature of member of staff remuneration, fordirectors, senior executives and many other staff. Some undertakings issue shares orshare options to pay suppliers, such as suppliers of professional services.

The reasons for granting shares are primarily for the undertaking to save cash, if therecipient can sell the shares in the market and the undertaking does not have to buyback the shares.

Share options also save cash, and are normally exercised only after a period of atleast one year.

The share option fixes a price (grant price) for the shares at the start, and therecipient hopes that the market price will be higher than the grant price when theshares can be bought (when the option can be exercised).

If the market price is lower, the option is worthless, as it is cheaper to buy shares in

the market. Share options are given to staff to motivate them to improve theperformance of the undertaking to lift the market price of its shares.

Granting shares and options gives a part of the undertaking to the beneficiaries of theshares and options. Existing shareholders that sacrifice part of the undertaking hopethat they will benefit from the cash saving and/or better performance of the companyin the future.

It has been disputed whether there is a cost to the undertaking of these transactions.IFRS 2 says there is a cost to the undertaking and specifies its treatment.

IFRS 2 captures the purchase of all goods or services settled in an undertakings ownequity instruments or in cash, if the amount payable depends on the price of theundertakings shares (or other equity instruments, such as options).

Estimates are now required of the number of options or other instruments expected tobe exercised. Such estimates are complex to calculate where performance criteria,

such as earnings targets, are involved. Specialist valuation skills are likely to berequired in order to determine the amounts to be reported in the financial statements.

Companies using IFRS for the first time will now need to assess the impact of IFRS 2and agree a strategy of how to convey this to stakeholders. Management shouldparticularly consider the potential effect in the income statement from cash-settledschemes, and information about existing or planned share-based payment schemes.

IFRS 2 applies to all types of share-based payment transactions. These include:

1.Equity-settled An undertaking issues or transfers its ownequity instruments, or those of anothermember of the same group,

as consideration for goods or services.

2. Cash-settled An undertaking, or another member of thesame group, pays cash calculated byreference to the price of its own equityinstruments as consideration for goods orservices.

3. Choice of equity-settled or An undertaking or the supplier may choosewhether

cash-settled the undertaking settles in cash or by issuingor transferring equity instruments.

Goods acquired in share-based payment transactions include inventories,consumables, property, plant and equipment, and intangible and other non-financialassets.

Examples of arrangements that come under IFRS 2 are:

Call options that give staff the right to purchase an undertakings shares inexchange for their services;



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Share appreciation rights that entitle staff to payments calculated by reference tothe market price of an undertakings shares or the shares of another undertakingin the same group;

In-kind capital contributions of property, plant or equipment in exchange for sharesor otherequity instruments;

Share ownership schemes under which staff are entitled to receive an undertakingsshares in exchange for their services; and

Payments for services made to external consultants that are calculated byreference to the undertakings share price.

Until IFRS 2 was issued, there was no IFRS covering the recognition andmeasurement of these transactions. Concerns were raised about this gap in IFRSs,given the increasing prevalence of share-based payment transactions in manycountries.

OBJECTIVEOF IFRS 2

The objective of IFRS 2 is to specify the financial reporting of a share-based paymenttransaction. It requires an undertaking to reflect in its income statement and financialposition the effects of share-based payment transactions, including expensesassociated with transactions in which share options are granted to staff.

DEFINITIONS

Binomial model

The Binomial model is an extension of the Black-Scholes model, allowing for thefacility to exercise options within a time window. It is a numerical technique that willexactly reproduce the results of the Black-Scholes formula for an option that can onlybe exercised at the end of its term. The Binomial model has a number of limitations inrelation to executive options:

It is difficult to allow for performance conditions, turnover or exercise patterns in aBinomial model; and

The Binomial model is not valid for executive options because in most cases the

model assumes that the option will be sold rather than exercised. Early exercise isdeemed to occur only in a few scenarios. An executive option cannot be sold in thisway, so the Binomial model is not an appropriate way for dealing with earlyexerciseability of executive options.

Black-Scholes model

The Black-Scholes valuation model is a mathematical formula used to calculate thevalue of a European call option based on the underlying share price, exercise price,

expiration date, risk-free rate of return, and the standard deviation (volatility) of the

share price returns.

A European call option can only be exercised at the end of its life, unlike an

American call option, which can be exercised at any time during its life. The model is

also referred to as the Black-Scholes-Merton formula for pricing an option.

The Black-Scholes model has limitations. These are that performance conditions are

not allowed for; and the option is assumed to be exercised at the end of a fixed term.

cash-settled share-based payment transaction

A share-based payment transaction in which the undertaking acquires goods orservices by incurring a liability to transfer cash (or other assets) to a supplier foramounts that are based on the price (or value) of the undertakings shares or otherequity instruments of the undertaking.

equity instrument

A contract that evidences a residual interest in the assets of an undertaking afterdeducting all of its liabilities.

equity instrument granted

The right (conditional or unconditional) to an equity instrument of the undertakingconferred by the undertaking on another party, under a share-based paymentarrangement.

equity-settled share-based payment transaction

A share-based payment transaction in which the undertaking receives goods orservices as consideration for equity instruments of the undertaking (including sharesor share options).

fair value



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The amount for which an asset could be exchanged, a liability settled, or an equityinstrument granted could be exchanged, between independent, knowledgeable,willing parties.

grant date

The date at which the undertaking and another party (including a member of staff)agree to a share-based payment arrangement, being when the undertaking and thecounterparty have agreed the terms and conditions of the arrangement.

At grant date, the undertaking confers on the counterparty the right to cash, otherassets, or equity instruments of the undertaking, provided the specified vestingconditions, if any, are met.

If that agreement is subject to an approval process (for example, by shareholders),grant date is the date when that approval is obtained.

EXAMPLE grant date

In February 2XX5, the company offered options to new staff, subject to shareholderapproval. The awards were approved by the shareholders in June 2XX5. The grantdate is June 2XX5, when the approval was obtained.

intrinsic value

The difference between the fair value of the shares to which the counterparty has the(conditional or unconditional) right to subscribe or which it has the right to receive,and the price (if any) the counterparty is required to pay for those shares.

For example, a share option with an exercise price of $50, on a share with a fair valueof $70, has an intrinsic value of $20.

market condition

A condition upon which the exercise price, vesting or exercisability of an equityinstrument depends that is related to the market price of the undertakings equityinstruments, such as attaining:

- a specified share price, or

- a specified amount of intrinsic value of a share option, or

- achieving a specified target that is based on the market price of the undertakingsequity instruments relative to an index of market prices of equity instruments of otherundertakings.

measurement date

The date at which the fair value of the equity instruments granted is measured for thepurposes of IFRS 2. For transactions with staff and others providing similar services,the measurement date is grant date. For transactions with parties other than staff(and those providing similar services), the measurement date is the date theundertaking obtains the goods or the counterparty renders service.

EXAMPLE Measurement date for transactions with parties other than staff

If the goods or services are received on more than one date, the undertaking shouldmeasure the fair value of the equity instruments granted on each date when goods orservices are received. The undertaking should apply that fair value when measuringthe goods or services received on that date.

However, an approximation could be used in some cases. For example, if anundertaking received services continuously during a three-month period, and its shareprice did not change significantly during that period, the undertaking could use theaverage share price during the three-month period when estimating the fair value ofthe equity instruments granted.

Monte-Carlo model

TheMonte-Carlo valuation modelworks by undertaking several thousand simulationsof future outcomes for share price and other variables, calculating the option pay-out

under each scenario, taking the average pay-out and discounting to the present day togive an option value.

Monte-Carlo modelscan incorporate even very complex performance conditions,turnover and exercise patterns that are a function of gain or time since grant. Thesemodels are generally the best type of model for valuing executive options.

The main disadvantages of Monte-Carlo modelsare the complexity and thecomputing power required.

reload feature



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A feature that provides for an automatic grant of additional share options wheneverthe option holder exercises previously-granted options using the undertakingsshares, rather than cash, to satisfy the exercise price.

reload option

A new share option granted when a share is used to satisfy the exercise price of aprevious share option.

share-based payment arrangement

An agreement between the undertaking and another party (including a member ofstaff) to enter into a share-based payment transaction, which thereby entitles theother party:

to receive cash or other assets of the undertaking for amounts that are based on theprice of the undertakings shares or other equity instruments of the undertaking, or

to receive equity instruments of the undertaking, provided the specified vestingconditions, if any, are met.

share-based payment transaction

A transaction in which the undertaking:

- receives goods or services as consideration for equity instruments of theundertaking (including shares or share options), or

- acquires goods or services by incurring liabilities to the supplier of thosegoods or services for amounts that are based on the price of theundertakings shares or other equity instruments of the undertaking.

share option

A contract that gives the holder the right, but not the obligation, to subscribe to theundertakings shares at a fixed or determinable price for a specified period of time.

staff and others providing similar services

Individuals who render personal services to the undertaking and either:

(1) the individuals are regarded as staff for legal or tax purposes,

(2) the individuals work for the undertaking under its direction in the same way asindividuals who are regarded as staff for legal or tax purposes, or

(3) the services rendered are similar to those rendered by staff.

For example, the term encompasses all management personnel, having authority andresponsibility for planning, directing and controlling the activities of the undertaking,including non-executive directors.

vest

To become an entitlement. Under a share-based payment arrangement, acounterpartys right to receive cash, other assets, or equity instruments of theundertaking vests upon satisfaction of any specified vesting conditions.

vesting conditions

The conditions that must be satisfied for the counterparty to become entitled toreceive cash, other assets or equity instruments of the undertaking, under a share-based payment arrangement.

Vesting conditions include service conditions, which require the other party tocomplete a specified period of service, and performance conditions, which requirespecified performance targets to be met (such as a specified increase in theundertakings profit over a specified period of time).

vesting period

The period during which all the specified vesting conditions of a share-based paymentarrangement are to be satisfied.

EXAMPLE Vesting period

A company grants share options to its staff. Certain performance conditions needto be satisfied over the next three years for the options to be exercisable. Theemployee has to remain working for the company during this period to becomeentitled to the award.

The staff provide their services over the three-year vesting period in exchange for thegranted options. The expense should therefore be recognised over this period.

volatility



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A statistical measure of the fluctuation in the investment return on a share.

OVERVIEWOF IFRS 2

IFRS 2 requires an undertaking to recognise share-based payment transactions in itsfinancial statements, including transactions with staff or other parties to be settled in

cash, other assets, or equity instruments of the undertaking.

There are no exceptions to IFRS 2, other than for transactions to which otherStandards apply.

IFRS 2 sets out measurement principles and specific requirements for three types ofshare-based payment transactions:

1. equity-settled share-based payment transactions, in which the undertaking receivesgoods or services as consideration for equity instruments of the undertaking(including shares or share options);

2. cash-settled share-based payment transactions, in which the undertaking acquires

goods or services by incurring liabilities to the supplier of those goods or services foramounts that are based on the price of the undertakings shares or other equityinstruments of the undertaking; and

3. transactions in which the undertaking receives or acquires goods or services andeither the undertaking or the supplier of those goods or services has a choice ofwhether the undertaking settles the transaction in cash or by issuing equityinstruments.

For equity-settled share-based payment transactions, an undertaking must measurethe goods or services received, and the corresponding increase in equity, directly, atfair value, unless that fair value cannot be estimated reliably.

If the undertaking cannot estimate reliably the fair value of the goods or servicesreceived, the undertaking is required to measure their value, and the correspondingincrease in equity, indirectly, by reference to the fair value of the equity instrumentsgranted.

MEASUREMENTMECHANISMS

1. for transactions with staff and others providing similar services, the undertakingmust measure the fair value of the equity instruments granted, as it is usually notpossible to estimate reliably the fair value of member of staff services received.

The fair value of the equity instruments granted is measured at grant date.

2. for transactions with parties other than staff (and those providing similar services),there is a rebuttable presumption that the fair value of the goods or services receivedcan be estimated reliably.

That fair value is measured at the date the undertaking obtains the goods or services.If the presumption is rebutted, the transaction is measured by reference to the fairvalue of the equity instruments granted, measured at the date the undertaking obtainsthe goods or the counterparty renders service.

3. for goods or services measured by reference to the fair value of the equityinstruments granted, IFRS 2 specifies that vesting conditions, other than marketconditions, are not taken into account when estimating the fair value of the shares oroptions at the relevant measurement date (as specified above).

Example Market vesting conditions

EXAMPLE Market vesting conditions vesting conditions

A company granted share options that become exercisable when the market priceincreases by at least 10% in each year over the next three years. At the end of yearthree, this target has not been met.

The company should not revise the grant date fair value and should not reverse thestaff benefits expense already recognised, because the increase in share price is amarket-based criterion. It was included in determining the fair value of the options atthe grant date.



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x

Instead, vesting conditions are taken into account by adjusting the number of equityinstruments included in the measurement of the transaction amount so that,ultimately, the amount recognised for goods or services received as consideration forthe equity instruments granted is based on the number of equity instruments thateventually vest.

EXAMPLE Non-market vesting conditions Example Non-market vesting condition

Management introduced a new equity-settled compensation plan with a non-marketperformance condition. During the following year, after a downturn in the companysfortunes, it considers that there is no chance that it will meet the target.

The cumulative expense at the end of the second year will be adjusted to nil, and thecharge is reversed in the current year.

Hence, on a cumulative basis, no amount is recognised for goods or servicesreceived if the equity instruments granted do not vest because of failure to satisfy avesting condition (other than a market condition).

4. IFRS 2 requires the fair value of equity instruments granted to be based on marketprices and to take into account the terms and conditions upon which those equityinstruments were granted.

In the absence of market prices, fair value is estimated, using a valuation technique,to estimate what the price of those equity instruments would have been on the

measurement date in an independent transaction between knowledgeable, willingparties.

5. IFRS 2 also sets out requirements if the terms and conditions of an option or sharegrant are modified (eg an option is repriced) or if a grant is cancelled, repurchased orreplaced with another grant of equity instruments.

For example, irrespective of any modification, cancellation or settlement of a grant ofequity instruments to staff, IFRS 2 generally requires the undertaking to record, as aminimum, the services received measured at the grant date fair value of the equityinstruments granted.

For cash-settled share-based payment transactions, IFRS 2 requires an undertakingto measure the goods or services acquired and the liability incurred at the fair value ofthe liability. Until the liability is settled, the undertaking is required to remeasure thefair value of the liability at each reporting date and at the date of settlement, with anychanges in value recognised in the income statement for the period.

For share-based payment transactions in which either party has a choice of whether

the undertaking settles the transaction in cash or by issuing equity instruments, theundertaking is required to account for that transaction as a cash-settled share-basedpayment transaction if the undertaking has incurred a liability to settle in cash (orother assets), or as an equity-settled share-based payment transaction if no suchliability has been incurred.

IFRS 2 prescribes various disclosure requirements to enable users to understand:

1. the nature and extent of share-based payment arrangements that existed duringthe period;

2. how the fair value of the goods or services received, or the fair value of the equityinstruments granted, during the period was determined; and

3. the effect of share-based payment transactions on the undertakings profit or lossfor the period and on its financial position.

SCOPE

An undertaking shall apply IFRS 2 in accounting for all share-based paymenttransactions including:

1. equity-settled share-based payment transactions, in which the undertaking receivesgoods or services as consideration for equity instruments of the undertaking

(including shares or share options),

2. cash-settled share-based payment transactions, in which the undertaking acquiresgoods or services by incurring liabilities to the supplier of those goods or services foramounts that are based on the price of the undertakings shares or other equityinstruments of the undertaking, and

3. transactions in which the undertaking receives or acquires goods or services andeither the undertaking or the supplier of those goods or services has a choice of



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whether the undertaking settles the transaction in cash (or other assets) or by issuingequity instruments,

Transfers of an undertakings equity instruments by its shareholders to parties thathave supplied goods or services to the undertaking (including staff) are share-basedpayment transactions, unless the transfer is clearly for a purpose other than paymentfor goods (or services) supplied to the undertaking.

This also applies to transfers of equity instruments of the undertakings parent, orequity instruments of another undertaking in the same group as the undertaking, toparties that have supplied goods or services to the undertaking.

A transaction with a member of staff (or other party) in his/her capacity as a holder ofequity instruments of the undertaking is not a share-based payment transaction.

EXAMPLE - the member of staff has received a right in his/her capacity as ashareholder

An undertaking might grant all holders of a particular class of its equity instrumentsthe right to acquire additional equity instruments of the undertaking at a price that isless than the fair value of those equity instruments.

If a member of staff receives such a right because he/she is a holder of that particularclass of equity instruments, the granting or exercise of that right should not be subjectto the requirements of IFRS 2, as the member of staff has received that right in his/hercapacity as a shareholder, rather than as a member of staff.

This transaction is not subject to the requirements of IFRS 2.

IFRS 2 applies to share-based payment transactions in which an undertakingacquires or receives goods or services. Goods include inventories, consumables,

property, plant and equipment, intangible assets and other non-financial assets.

However, an undertaking shall not apply IFRS 2 to transactions in which theundertaking acquires goods as part a takeover, to which IFRS 3 BusinessCombinations applies.

Equity instruments granted to staff of a purchased undertaking in their capacity asstaff (in return for continued service) are within the scope of IFRS 2. Similarly, thecancellation, replacement or other modification of share-based paymentarrangements because of a business combination or other restructuring shall beaccounted for under IFRS 2.

IFRS 2 does not apply to share-based payment transactions in which the undertakingreceives or acquires goods or services under a contract within the scope ofparagraphs 8-10 of IAS 32 Financial Instruments: Presentation or paragraphs 5-7 ofIAS 39 Financial Instruments: Recognition and Measurement.

Examples of these are contracts for the purchase of goods that are within the scopeof IAS 39, such as commodity contracts entered into for speculative purposes, that is,

other than to satisfy the reporting entitys expected purchase or usage requirements.

RECOGNITION

An undertaking shall recognise the goods or services acquired in a share-basedpayment transaction when it obtains the goods or as the services are received. Theundertaking shall recognise a corresponding increase in equity if the goods orservices were received in an equity-settled share-based payment transaction, or aliability if the goods or services were acquired in a cash-settled share-based paymenttransaction.

When the goods or services acquired in a share-based payment transaction do not

qualify for recognition as assets, they shall be recorded as expenses.

Typically, an expense arises from the consumption of goods or services. Forexample, services are usually consumed immediately, in which case an expense isrecorded as the counterparty renders service.

Goods might be consumed over a period of time or, in the case of inventories, sold ata later date, in which case an expense is recorded when the goods are consumed orsold. However, sometimes it is necessary to record an expense before the goods orservices are consumed or sold, because they do not qualify for recognition as assets.

For example, an undertaking might acquire goods as part of the research phase of aproject to develop a new product. Although those goods have not been consumed,

they might not qualify for recognition as assets under the applicable IFRS.

The debit side of the transaction grant date

The debit side of the IFRS 2 transaction measures the fair value of the resourcesreceived. This is consideration for the issue of equity instruments.

The goods or services received should be measured at their fair value at the datewhen the undertaking obtains those goods or as the services are received.



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However, if the fair value of the services received is not readily determinable, then asurrogate measure must be used, such as the fair value of the share options orshares granted. This is the case for staff services.

If the fair value of the equity instruments granted is used, the fair value of the servicesreceived during a particular accounting period is not affected by subsequent changesin the fair value of the equity instrument.

EXAMPLE - vesting date and exercise date measurement are inappropriate

Services are received during years 1-3 as the consideration for share options that areexercised at the end of year 5.

For services received in year 1, subsequent changes in the value of the share optionin years 2-5 are unrelated to, and have no effect on, the fair value of those serviceswhen received.Service date measurement measures the fair value of the equity instrument at thesame time as the services are received. This means that changes in the fair value ofthe equity instrument during the vesting period affect the amount attributed to theservices received.

IASB concluded that, at grant date, it is reasonable to presume that the fair value ofboth sides of the contract are substantially the same, ie the fair value of the servicesexpected to be received is substantially the same as the fair value of the equityinstruments granted.

Thus, the grant date is the most appropriate measurement date for the purposes ofproviding a surrogate measure of the fair value of the services received.

The credit side of the transaction grant date

Although focusing on the debit side of the transaction is consistent with the primaryaccounting objective, some approach the measurement date question from theperspective of the credit side of the transaction: the issue of an equity instrument.

Staff must perform their side of the arrangement by providing the necessary servicesand meeting any other performance criteria before the undertaking is obliged toperform its side of the arrangement.

The provision of services is the consideration they use to 'pay' for the share option.

IASB concluded that, no matter which side of the transaction one focuses upon (ie thereceipt of resources or the issue of an equity instrument), grant date is theappropriate measurement date, as it does not require remeasurement of equity

interests and it provides a reasonable surrogate measure of the fair value of theservices received from staff.

EQUITY-SETTLEDSHARE-BASEDPAYMENTTRANSACTIONS -OVERVIEW

For equity-settled share-based payment transactions, the undertaking shall measurethe goods or services received, and the corresponding increase in equity, directly, atthe fair value of the goods or services received, unless that fair value cannot beestimated reliably.

If the undertaking cannot estimate reliably the fair value of the goods or servicesreceived, the undertaking shall use the fair value of the equity instruments granted.

The undertaking shall measure the fair value of staff services received by reference tothe fair value of the equity instruments granted, as typically it is not possible toestimate reliably the fair value of the services received. The fair value of those equityinstruments shall be measured at the grant date.

Typically, shares, share options or other equity instruments are granted to staff aspart of their remuneration package, in addition to a cash salary and other employmentbenefits.

Shares or share options are sometimes granted as part of a bonus arrangement,rather than as a part of basic remuneration, as an incentive to the staff to remain inthe undertakings employ or to reward them for their efforts in improving theundertakings performance.

For transactions with parties other than staff, there shall be a rebuttable presumptionthat the fair value of the goods or services received can be estimated reliably. Thatfair value shall be measured at the date the undertaking obtains the goods or thecounterparty renders service.

If the undertaking rebuts this presumption, the undertaking shall measure the goodsor services received, and the corresponding increase in equity, indirectly, byreference to the fair value of the equity instruments granted, measured at the date theundertaking obtains the goods or the counterparty renders service.



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Transactions in which services are received

If the equity instruments granted vest immediately, the counterparty is not required tocomplete a specified period of service before becoming unconditionally entitled tothose equity instruments.

The undertaking shall presume that services rendered by the counterparty asconsideration for the equity instruments have been received. In this case, on grantdate the undertaking shall record the services received in full, with a correspondingincrease in equity.

If the equity instruments granted do not vest until the counterparty completes aspecified period of service, the undertaking shall presume that the services will bereceived in the future, during the vesting period. The undertaking shall account forthose services as they are rendered by the counterparty during the vesting period,with a corresponding increase in equity. For example:

1. if a member of staff is granted share options conditional upon completing threeyears service, then the undertaking shall presume that the services will be received inthe future, over that three-year vesting period.

2. if a member of staff is granted share options conditional upon the achievement of aperformance condition and remaining in the undertakings employ until thatperformance condition is satisfied, and the length of the vesting period variesdepending on when that performance condition is satisfied, the undertaking shallpresume that the services will be received in the future, over the expected vestingperiod.

The undertaking shall estimate the length of the expected vesting period at grant

date, based on the most likely outcome of the performance condition.

-If the performance condition is a market condition, the estimate of the length of theexpected vesting period shall be consistent with the assumptions used in estimatingthe fair value of the options granted, and shall not be subsequently revised.

-If the performance condition is not a market condition, the undertaking shall revise itsestimate of the length of the vesting period, if necessary, if subsequent informationindicates that the length of the vesting period differs from previous estimates.

Transactions measured by reference to the fair value of the equityinstruments granted

Determining the fair value of equity instruments granted

For transactions measured by the fair value of the equity instruments granted, anundertaking shall measure the fair value at the measurement date, based on marketprices if available, taking into account the terms and conditions upon which thoseequity instruments were granted.

If market prices are not available, the undertaking shall estimate the fair value using avaluation technique to estimate what the price of those equity instruments would havebeen on the measurement date in an independent transaction betweenknowledgeable, willing parties.

The valuation technique shall be consistent with generally accepted valuationmethodologies for pricing financial instruments, and shall incorporate all factors andassumptions that knowledgeable, willing market participants would consider in settingthe price.

Treatment of vesting conditions

A grant of equity instruments might be conditional upon satisfying specified vestingconditions.



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For example, a grant of shares or share options to a member of staff is typicallyconditional on the member of staff remaining in the undertakings employ for aspecified period of time.

There might be performance conditions that must be satisfied, such as theundertaking achieving a specified growth in profit or a specified increase in theundertakings share price.

Vesting conditions, other than market conditions, shall not be taken into account whenestimating the fair value of the shares or share options at the measurement date.

Instead, vesting conditions shall be taken into account by adjusting the number ofequity instruments included in the amount so that, ultimately, the amount recordedshall be based on the number of equity instruments that eventually vest.

Hence, on a cumulative basis, no amount is recorded for goods or services received ifthe equity instruments granted do not vest due to failure to satisfy a vesting condition,such as the counterparty fails to complete a specified service period, or aperformance condition is not satisfied.

EXAMPLE Changes in vesting estimates

A company granted options to its staff with a fair value of 300,000, determined usingthe Black-Scholes model, and made the following estimates:

Estimate at grant date of the percentage of staff leaving the company before theend of the three-year vesting period; 10%

Revised estimate, made in the second year, of the portion of staff leavingthe company before the end of three years; 5%

Actual percentage of leavers; 6%

The expense in the first year should be 90,000 (300,000 x 1/3 x 90%). As a resultof a change in accounting estimate of the percentage of staff expected to leave, anexpense of 100,000 will be recognised in the second year. The cumulative expenseat the end of the second year is 190,000 (300,000 x 2/3 x 95%).

At the end of the third year, 94% of the options vest, so the cumulative expense overthe vesting period is 282,000 (300,000 x 3/3 x 94%), and the expense in the thirdyear is 92,000 (282,000-190,000).

The undertaking shall recognise an amount for the goods or services received duringthe vesting period based on the best available estimate of the number of equityinstruments expected to vest and shall revise that estimate, if necessary, ifsubsequent information indicates that the number of equity instruments expected tovest differs from previous estimates.

On vesting date, the undertaking shall revise the estimate to equal the number ofequity instruments that ultimately vested.

Market conditions, such as a target share price upon which vesting (when the optionmay be exercised and the shares purchased) is conditioned, shall be taken intoaccount when estimating the fair value of the equity instruments granted.

Thus, for grants of equity instruments with market conditions, the undertaking shallrecord the goods or services received from a counterparty who satisfies all othervesting conditions (such as services received from a member of staff who remains inservice for the specified period of service), irrespective of whether that marketcondition is satisfied.

Treatment of a reload feature

Reload features shall not be taken into account when estimating the fair value ofoptions granted at the measurement date. Instead, a reload option shall be accountedfor as a new option grant, if and when a reload option is subsequently granted.

After vesting date

Having recorded the goods or services received, and a corresponding increase inequity, the undertaking shall make no subsequent adjustment to total equityafter vesting date.

For example, the undertaking shall not subsequently reverse the amount recorded forservices received from a member of staff if the vested equity instruments are later

forfeited or, in the case of share options, the options are not exercised.

However, this requirement does not preclude the undertaking from recording atransfer within equity, such as a transfer from one component of equity to another.

If the fair value of the equity instruments cannot be estimated reliably

The undertaking may be unable to estimate reliably the fair value of the equityinstruments granted at the measurement date. In these rare cases only, theundertaking shall instead:



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1. measure the equity instruments at their intrinsic value, initially at the date theundertaking obtains the goods or service and subsequently at each reporting dateand at the date of final settlement, with any change in intrinsic value recognised in theincome statement.

For a grant of share options, the share-based payment arrangement is finally settledwhen the options are exercised, are forfeited or lapse (at the end of the options life).

2. record the goods or services received based on the number of equity instrumentsthat ultimately vest or are ultimately exercised. For share options, for example, theundertaking shall record the goods or services received during the vesting period, ifany.

The amount recognised for goods or services received during the vesting period shallbe based on the number of share options expected to vest. The undertaking shallrevise that estimate, if necessary, if subsequent information indicates that the numberof share options expected to vest differs from previous estimates.

On the vesting date, the undertaking shall revise the estimate to equal the number ofequity instruments that ultimately vested. After vesting date, the undertaking shall

reverse the amount recognised for goods or services received if the share options arelater forfeited, or lapse at the end of the share options life.

1. If the settlement occurs during the vesting period, the undertaking shall account forthe settlement as an acceleration of vesting, and shall therefore record immediatelythe amount that would otherwise have been recorded for services received over theremainder of the vesting period.

2. Any payment made on settlement shall be accounted for as the repurchase ofequity instruments, as a deduction from equity, except to the extent that the paymentexceeds the intrinsic value of the equity instruments, measured at the repurchasedate. Any such excess shall be recognised as an expense.

MODIFICATIONS

An undertaking might modify the terms and conditions on which the equityinstruments were granted. For example, it might reduce the exercise price of optionsgranted to staff (ie reprice the options), which increases the fair value of thoseoptions.

Modifications should be viewed as incremental instruments in their own right. IFRS 2requires an undertaking to ignore a modification if it does not increase the total fair

value of the share-based payment arrangement or is not otherwise beneficial to themember of staff or service provider. However, reductions in the number of optionsgranted are treated as cancellations. The following diagram illustrates thesetransactions:

If a modification increases thefair valueof the equity instrumentsgranted (for example, by reducing the exercise price ofshare options),the incremental fair valueshould be added to the amount beingrecognised for the services received.

Ifamodification increases the number of equity instruments granted,thefair valueof these additionalinstruments is added to the amountrecognised. This will be in addition to any amount recognised inrespect of the original instrument, which should continue to be

recognised over the remainder of the original vesting period unless

there is a failure to satisfy the original non-marketvesting conditions.

If a modification occurs during thevesting period, the incremental fairvalueshould be recognised over the period from the modification dateuntil the date on which the modified equity instruments vest. If themodification occurs after thevestingdate, the incremental fair valueshould be recognised immediately, or over the revisedvesting period ifthe employee is required to complete an additional period of servicebefore becoming unconditionally entitled to the modified instruments.



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If a modification provides some other benefit tostaff,this shouldbe taken into account in estimating the number of equityinstruments that are expected tovest. For example, avestingconditionmight be eliminated.

EXAMPLE- Beneficial Modification

An undertaking granted 100 share options to each of its five key executives. The

share options vest only if the undertaking achieves its next years sales target of100 million. During the year the sales target was revised to 90 million.

A reduction in the sales target makes the options more likely to vest, and theundertaking recognises an increased expense.

Cancellations

An undertaking may cancel and replace a grant of equity instruments. In thiscase, the incremental fair value is the difference between the fair value of thereplacement instruments and the fair value of the original instruments. Thereplacement is treated as a modification.

Early settlements

An undertaking may cancel or early settle an award without replacement. On earlysettlement, the undertaking should recognise immediately the balance that wouldhave been charged over the remaining period.

When applied to share-based payment transactions with parties other than staff anyreferences in to grant date shall instead refer to the date the undertaking obtains thegoods or the counterparty renders service.

The undertaking shall recognise, as a minimum, the services received measured atthe grant date fair value of the equity instruments granted, unless those equity

instruments do not vest because of failure to satisfy a vesting condition (other than amarket condition) that was specified at grant date.

This applies irrespective of any modifications to the terms and conditions on which theequity instruments were granted, or a cancellation or settlement of that grant of equityinstruments. In addition, the undertaking shall recognise the effects of modificationsthat increase the total fair value of the share-based payment arrangement, or areotherwise beneficial to the member of staff.

If the undertaking cancels or settles a grant of equity instruments during the vestingperiod (other than a grant cancelled by forfeiture when the vesting conditions are notsatisfied):

1. the undertaking shall account for the cancellation or settlement as an accelerationof vesting, and shall therefore record immediately the amount that otherwise wouldhave been recorded for services received over the remainder of the vesting period.

2. any payment made to the member of staff on the cancellation or settlement of thegrant shall be accounted for as the repurchase of an equity interest, ie as a deductionfrom equity, except to the extent that the payment exceeds the fair value of the equityinstruments granted, measured at the repurchase date. Any such excess shall berecognised as an expense.

3. if new equity instruments are granted to the member of staff and, on the date whenthose new equity instruments are granted, the undertaking identifies the new equityinstruments granted as replacement equity instruments for those cancelled, theundertaking shall account for the granting of replacement equity instruments in thesame way as a modification of the original grant of equity instruments.

The incremental fair value granted is the difference between:

- the fair value of the replacement equity instruments and

- the net fair value of the cancelled equity instruments,

at the date the replacement equity instruments are granted.

The net fair value of the cancelled equity instruments is their fair value, immediatelybefore the cancellation, less the amount of any payment made to the member of staffon cancellation of the equity instruments that is accounted for as a deduction fromequity.

If the undertaking does not identify new equity instruments granted as replacement

equity instruments for the cancelled equity instruments, the undertaking shall accountfor those new equity instruments as a new grant of equity instruments.

If an undertaking repurchases vested equity instruments, the payment made to themember of staff shall be accounted for as a deduction from equity, except to theextent that the payment exceeds the fair value of the equity instruments repurchased,measured at the repurchase date. Any such excess shall be recognised as anexpense.



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CASH-SETTLEDSHARE-BASEDPAYMENTTRANSACTIONS

For cash-settled share-based payment transactions, the undertaking shall measurethe goods or services acquired and the liability at the fair value of the liability. Until theliability is settled, the undertaking shall remeasure the fair value of the liability at eachreporting date and at the date of settlement, with any changes in fair value recognisedin the income statement for the period.

For example, an undertaking might grant share appreciation rights to staff as part oftheir remuneration package, whereby the staff will become entitled to a future cashpayment (rather than an equity instrument), based on the increase in theundertakings share price from a specified level over a specified period of time.

EXAMPLE Share appreciation rights

A company granted share appreciation rights to its 100 staff in March 2003, vesting inMarch 2007. The following estimates were made by management in March 2004:

Estimate of the awards that will vest80%

Fair value of each share appreciation right at March 20045,000

Thefair valueof the liability to be recorded in March 2004 is 100,000(100 x5,000 x 80% x 1/4).

Management revised its estimates in March 2005 as follows:

Estimate of the awards that willvest90%Fair value of each share appreciation right at March 20056,000

The accrued liability at that reporting date is270,000 (100 x6,000 x 90% x 2/4).

The increase in the liability of170,000 (270,000-100,000) is recognised as anexpense in the income statement within staff costs.

Or an undertaking might grant to its staff a right to receive a future cash payment bygranting to them a right to shares (including in the form of share options) that areredeemable, either mandatorily (upon cessation of employment) or at the member ofstaffs option.

The undertaking shall recognise the services received, and a liability to pay for thoseservices, as the members of staff render service.

For example, some share appreciation rights vest immediately, and the staff aretherefore not required to complete a specified period of service to become entitled tothe cash payment.

In the absence of evidence to the contrary, the undertaking shall presume that theservices rendered by the staff in exchange for the share appreciation rights havebeen received. Thus, the undertaking shall recognise immediately the services

received and a liability to pay for them.

If the share appreciation rights do not vest until the staff have completed a specifiedperiod of service, the undertaking shall recognise the services received, and a liabilityto pay for them, as the staff render service during that period.

The liability shall be measured, initially and at each reporting date until settled, at thefair value of the share appreciation rights, by applying an option pricing model, takinginto account the terms and conditions on which the share appreciation rights weregranted, and the extent to which the staff have rendered service to date.

EXAMPLE Remeasurement of share appreciation rights after vesting

A company granted share appreciation rights to 1,000 staff on 1 January 2005 basedon 1 million shares.

The rights vest on 31 December 2005, but payment is in January 2007.

The share price at 1 January 2005 was 8, at 31 December 2005 it was 10, and at31 December 2006 it was 9.

A liability is recognised at 31 December 2005 of 2 million (1 million shares x (10-8)).

In 2006 the company should recognise a gain of 1 million (1 million shares x (10-9)), and reduce the liability to 1 million.

Cash alternatives

For share-based payment transactions where either has the choice of whether theundertaking settles the transaction in cash or by issuing equity instruments, theundertaking shall account for that transaction, or the components of that transaction,as a cash-settled share-based payment transaction if the undertaking has incurred aliability to settle in cash or other assets, or as an equity-settled share-based paymenttransaction if no such liability has been incurred.



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Counterparty has a choice of settlement

If an undertaking has granted the counterparty the right to choose whether a share-based payment transaction is settled in cash or by issuing equity instruments, theundertaking has granted a compound financial instrument, which includes a debtcomponent (the right to demand payment in cash) and an equity component (the rightto demand settlement in equity instruments rather than in cash).

1 See also diagram on the right2 See also Undertaking chooses settlement method on the right.3 If the counterparty chooses settlement in cash, any equity componentpreviously recognised in equity will remain there, although there might be atransfer from one component of equity to anothe r.4 If the counterparty chooses settlement in equity instruments, thebalance of the liability is transferred to equity as consideration for the

equity instrument.

For transactions with parties other than staff, in which the fair value of the goods orservices received is measured directly, the undertaking shall measure the equitycomponent of the compound financial instrument as the difference between:

- the fair value of the goods or services received and

- the fair value of the debt component,

at the date when the goods or services are received.

1,2 See also diagram on the left.



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For other transactions, including transactions with staff, the undertaking shallmeasure the fair value at the measurement date, taking into account the terms andconditions on which the rights to cash or equity instruments were granted.

The undertaking shall first measure the fair value of the debt component, and thenmeasure the fair value of the equity componenttaking into account that thecounterparty must forfeit the right to receive cash in order to receive the equity

instrument. The fair value of the compound financial instrument is the sum of the fairvalues of the two components.

However, share-based payment transactions in which the counterparty has the choiceof settlement are often structured so that the fair value of one settlement alternative isthe same as the other.

For example, the counterparty might have the choice of receiving share options orcash-settled share appreciation rights. In such cases, the fair value of the equity

component is zero, and hence the fair value of the compound financial instrument isthe same as the fair value of the debt component.

EXAMPLE Goods or non-staff services with settlement alternatives

An undertaking purchased 10kg of gold worth 80,000. The supplier can choose howthe purchase price is settled. It can:

1) receive 100 of the undertakings shares two years after delivery (the fair value ofthis alternative is estimated at 87,000 at the date of purchase); or

2) obtain a payment equal to the market price of 90 shares at the end of the first yearafter delivery (fair value of this alternative is estimated at 75,000 at the date of

purchase).

At the date of obtaining the 10kg of gold, the undertaking should record a liability of75,000 and an increase in equity of 5,000, determined as the difference betweenthe value of 10kg of gold of 80,000 and fair value of the liability of 75,000.

Conversely, if the fair values of the settlement alternatives differ, the fair value of theequity component usually will be greater than zero, in which case the fair value of the

compound financial instrument will be greater than the fair value of the debtcomponent.

The undertaking shall account separately for the goods or services received oracquired in respect of each component of the compound financial instrument.

-For the debt component, the undertaking shall recognise the goods or servicesacquired, and a liability to pay for those goods or services, as the counterparty

supplies goods or renders service, as in cash-settled share-based paymenttransactions.

-For any equity component, the undertaking shall recognise the goods or servicesreceived, and an increase in equity, as the counterparty supplies goods or rendersservice, as in equity-settled share-based payment transactions.

At the date of settlement, the undertaking shall remeasure the liability to its fair value.If the undertaking issues equity instruments on settlement rather than paying cash,the liability shall be transferred direct to equity, as the consideration for the equityinstruments issued.

If the undertaking pays in cash on settlement rather than issuing equity instruments,

that payment shall be applied to settle the liability in full. Any equity componentpreviously recognised shall remain within equity.

Example Staff services with settlement alternatives

Staff entitled to a bonus may choose between obtaining a cash payment equal to themarket price of 100 of the undertakings shares, or obtaining 100 shares. The quotedmarket price of one share is 5.

The undertaking should record a liability of 500 for each entitled employee. Theequity component is nil, being the difference between the fair value of 100 shares(500) and the fair value of the alternative cash payment (500).

By electing to receive cash on settlement, the counterparty forfeited the right toreceive equity instruments. However, this requirement does not preclude theundertaking from recording a transfer within equity, (a transfer from one component ofequity to another).

Undertaking has a choice of settlement

For a share-based payment transaction in which the terms of the arrangementprovide an undertaking with the choice of whether to settle in cash or by issuing



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equity instruments, the undertaking shall determine whether it has a presentobligation to settle in cash, and account for the share-based payment transactionaccordingly.

The undertaking has a present obligation to settle in cash if the choice of settlement inequity instruments has no commercial substance (if the undertaking is legallyprohibited from issuing shares), or the undertaking has a past practice or a statedpolicy of settling in cash, or usually settles in cash whenever the counterparty asks for

cash settlement.

If the undertaking has a present obligation to settle in cash, it shall account for thetransaction in accordance with the requirements applying to cash-settled share-basedpayment transactions.

If no such obligation exists, the undertaking shall account for the transaction inaccordance with the requirements applying to equity-settled share-based paymenttransactions. Upon settlement:

1. if the undertaking elects to settle in cash, the cash payment shall be accounted foras the repurchase of an equity interest, ie as a deduction from equity, except as notedin (3) below.

2. if the undertaking elects to settle by issuing equity instruments, no furtheraccounting is required (other than a transfer from one component of equity to another,to debit share options and credit issued equity shares), except as noted in (3) below.

3. if the undertaking elects the settlement alternative with the higher fair value, as atthe date of settlement, the undertaking shall recognise an additional expense for theexcess value given, the difference between:

-the cash paid and

-the fair value of the equity instruments that would otherwise have been issued,

or the difference between:

- the fair value of the equity instruments issued and- the amount of cash that would otherwise have been paid,

whichever is applicable.

DISCLOSURES

An undertaking shall disclose information that enables users to understand the natureand extent of share-based payment arrangements that existed during the period.

The undertaking shall disclose at least the following:

1. a description of each type of share-based payment arrangement that existed at anytime during the period, including the general terms and conditions of eacharrangement, such as:

- vesting requirements,

-the maximum term of options granted, and

-the method of settlement (eg whether in cash or equity).

An undertaking with substantially similar types of share-based payment arrangementsmay aggregate this information, if it does not mask the nature and extent of thearrangements.

2. the number and weighted-average exercise prices of share options for each of thefollowing groups of options:

i. outstanding at the beginning of the period;ii. granted during the period;iii. forfeited during the period;iv. exercised during the period;v. expired during the period;vi. outstanding at the end of the period; andvii. exercisable at the end of the period.

3. for share options exercised during the period, the weighted-average share price atthe date of exercise.

If options were exercised on a regular basis throughout the period, the undertakingmay instead disclose the weighted-average share price during the period.

4. for share options outstanding at the end of the period, the range of exercise pricesand weighted-average remaining contractual life.

If the range of exercise prices is wide, the outstanding options shall be divided intoranges that are meaningful for assessing the number and timing of additional shares



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that may be issued and the cash that may be received upon exercise of thoseoptions.

An undertaking shall disclose information that enables users to understand how thefair value of the goods or services received, or the fair value of the equity instrumentsgranted, during the period was determined.

If the undertaking has measured the fair value of goods or services received for equity

instruments of the undertaking indirectly, by reference to the fair value of the equityinstruments granted, the undertaking shall disclose at least the following:

1. for share options granted during the period, the weighted-average fair value ofthose options at the measurement date and information on how that fair value wasmeasured, including:

i. the option pricing model used and the inputs to that model, including the weighted-average share price, exercise price, expected volatility, option life, expecteddividends, the risk-free interest rate and any other inputs to the model, including themethod used and the assumptions made to incorporate the effects of expected earlyexercise;

ii. how expected volatility was determined, including an explanation of the extent towhich forecast volatility was based on historical volatility; and

iii. whether and how any other features of the option grant were incorporated into themeasurement of fair value, such as a market condition.

2. for other equity instruments granted during the period (ie other than share options),the number and weighted-average fair value of those equity instruments at themeasurement date, and information on how that fair value was measured, including:

i. if fair value was not measured on the basis of an observable market price, how itwas determined;

ii. whether and how expected dividends were incorporated into the measurement offair value; and

iii. whether and how any other features of the equity instruments granted wereincorporated into the measurement of fair value.

3. for share-based payment arrangements that were modified during the period:

i. an explanation of those modifications;

ii. the incremental fair value granted (as a result of those modifications); and

iii. information on how the incremental fair value granted was measured, consistentlywith the requirements set out in (1) and (2) above, where applicable.

If the undertaking has measured directly the fair value of goods or services receivedduring the period, the undertaking shall disclose how that fair value was determined,(whether fair value was measured at a market price for those goods or services).

If the undertaking has rebutted the presumption that the fair value of goods andservices can be reliably measured, it shall disclose that fact, and give an explanationof why the presumption was rebutted.

An undertaking shall disclose information that enables users to understand the effectof share-based payment transactions on the undertakings profit or loss for the periodand on its financial position.

The undertaking shall disclose at least the following:

1. the total expense recognised for the period arising from share-based paymenttransactions in which the goods or services received did not qualify for recognition as

assets and hence were recorded immediately as an expense, including separatedisclosure of that portion of the total expense that arises from transactions accountedfor as equity-settled share-based payment transactions;

2. for liabilities arising from share-based payment transactions:

i. the total carrying amount at the end of the period; and

ii. the total intrinsic value at the end of the period of liabilities for which thecounterpartys right to cash or other assets had vested by the end of the period (egvested share appreciation rights).



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MULTIPLECHOICEQUESTIONS

1. IFRS 2 applies to all types of share-based payment transactions. These include:

i. Equity-settled

ii. Cash-settled

iii. Choice of equity-settled or cash-settled

iv. Share sales in stock markets.

1. i2. i-ii3. i-iii4. i-iv

2. Examples of arrangements that come under IFRS 2 are:

i Call options that give staff the right to purchase an undertakings shares inexchange for their services;

ii Share appreciation rights that entitle staff to payments calculated by reference tothe market price of an undertakings shares or the shares of another undertakingin the same group;

iii In-kind capital contributions of property, plant or equipment in exchange for sharesor otherequity instruments;

iv Share ownership schemes under which staff are entitled to receive anundertakings shares in exchange for their services; and

v Payments for services made to external consultants that are calculated byreference to the undertakings share price.

1 i2 i-ii3. i-iii4. i-iv

5. i-v

3. In March, the undertaking offered options to new staff, subject to shareholderapproval. The awards were approved by the shareholders in August. The schemestarted in September.

The grant date is:

1. March.2. August

3. September

4. Measurement date for transactions with parties other than staff

If the goods are received on more than one date, the undertaking should measure thefair value of the equity instruments granted on

1. the date that the first goods are received;

2. each date when goods or services are received;

3. the date that the last goods are received.

5. Vesting period

A undertaking grants share options to its staff. Certain performance conditions needto be satisfied over the next four years for the options to be exercisable. Theemployee has to remain working for the undertaking during this period to becomeentitled to the award.

The expense should therefore be recognised:

1. at the grant date;

2. over the four-year period;3. at the end of the four-year period.



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6. If the undertaking cannot estimate reliably the fair value of the goods or servicesreceived, the undertaking:

1. is required to measure their value, and the corresponding increase in equity,indirectly, by reference to the fair value of the equity instruments granted;

2. should use the par value of the shares given;

3. should use the reload option.

7. Market vesting conditions vesting conditions

A undertaking granted share options that become exercisable when the market priceincreases by at least 10% in each year over the next three years. At the end of yearthree, this target has not been met.

1. The undertaking should revise the grant date fair value and should reverse the staffbenefits expense already recognised.

2. The undertaking should not revise the grant date fair value and should not reversethe staff benefits expense already recognised.

3. The undertaking should transfer the staff benefits expense to equity.

8. Non-market vesting conditions Example Non-market vesting condition

Management introduced a new equity-settled compensation plan with a non-marketperformance condition. During the following year, after a downturn in theundertakings fortunes, it considers that there is no chance that it will meet the target.

1. The cumulative expense at the end of the second year will be adjusted to nil, andthe charge is reversed in the current year.

2. The undertaking should not revise the grant date fair value and should not reversethe staff benefits expense already recognised.

3. The undertaking should transfer the staff benefits expense to equity.

9. Fair value of equity instruments

In the absence of market prices:

1. The undertaking should revise the grant date fair value and should reverse the staffbenefits expense already recognised;

2. The undertaking should use the par value of the shares given;

3. The undertaking should use the reload option;

4. Fair value is estimated, using a valuation technique, to estimate what the price ofthose equity instruments would have been on the measurement date in anindependent transaction between knowledgeable, willing parties.

10. For cash-settled share-based payment transactions, IFRS 2 requires anundertaking to measure the goods or services acquired and:

1. Establish a liability which remains unchanged;

2. Establish a liability. Until the liability is settled, the undertaking is required toremeasure the fair value of the liability at each reporting date and at the date ofsettlement, with any changes in value recognised in the income statement for theperiod;

3. Hold the cost in equity;

4. The undertaking should use the reload option.

11. IFRS 2 prescribes various disclosure requirements to enable users to understand:

i. the nature and extent of share-based payment arrangements that existed during theperiod;

ii. how the fair value of the goods or services received, or the fair value of the equityinstruments granted, during the period was determined;

iii. the effect of share-based payment transactions on the undertakings profit or lossfor the period and on its financial position;

iv. the impact on clients of these transactions.

1. i2 i-ii3. i-iii4. i-iv



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12. IFRS 2 covers:

1. transfers of equity instruments of the undertakings parent to parties that havesupplied goods or services to the undertaking;

2. transfers of equity instruments of another undertaking in the same group as theundertaking, to parties that have supplied goods or services to the undertaking;

3. Both 1+ 2;

4. Neither 1 nor 2.

13. Business Combinations

IFRS 2 covers:

i Equity instruments granted to staff of a purchased undertaking in their capacity asstaff (in return for continued service);

ii The cancellation, replacement or other modification of share-based payment

arrangements because of a business combination or other restructuring;

iii Transactions in which the undertaking acquires goods as part a takeover.

1. i2 i-ii3. i-iii

14. If the fair value of the equity instruments granted is used, the fair value of the

services received during a particular accounting period:

1. is not affected by subsequent changes in the fair value of the equity instrument;

2. is adjusted by subsequent changes in the fair value of the equity instrument.

15. If the performance condition is a market condition, the estimate of the length ofthe expected vesting period shall be consistent with the assumptions used inestimating the fair value of the options granted, and:

1. the undertaking shall revise its estimate of the length of the vesting period;

2. shall not be subsequently revised.

16.If the performance condition is not a market condition, the estimate of the length of

the expected vesting period shall be consistent with the assumptions used inestimating the fair value of the options granted, and:

1. the undertaking shall revise its estimate of the length of the vesting period;

2. shall not be subsequently revised.

17. If the vested equity instruments are later forfeited or, in the case of share options,the options are not exercised;

1. The undertaking should use the reload option.

2. The undertaking shall subsequently reverse the amount recorded for servicesreceived from staff.

3. The undertaking shall not subsequently reverse the amount recorded for servicesreceived from staff.

18. Treatment of a reload feature

Reload features shall:

1. be taken into account when estimating the fair value of options granted at themeasurement date;

2. not be taken into account when estimating the fair value of options granted at themeasurement date.



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19. Modifications should be viewed as:

1. Cancellations;

2. Compound financial instruments.

3. Incremental instruments.

20. Modifications. If it does not increase the total fair value of the share-basedpayment arrangement or is not otherwise beneficial to the member of staff or serviceprovider:

1. It should be treated as a compound financial instrument;2. It should be treated as an incremental instrument;

3. It should be treated as a reload feature;

4. It should be ignored.

ANSWERSTOMULTIPLECHOICEQUESTIONS

Question Answer1. 32. 53. 24. 25. 26. 17. 28. 1

9. 410. 211. 312. 313. 214. 115. 216. 1

17. 118. 219. 320. 4



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APPENDIX 1 AIDSTOCALCULATIONS

Estimating the fair value of equity instruments granted

Shares

For shares granted to staff, the fair value of the shares shall be measured at themarket price of the undertakings shares (or an estimated market price, if theundertakings shares are not publicly traded), adjusted to take into account the termsand conditions upon which the shares were granted.

For example, if the member of staff is not entitled to receive dividends during thevesting period, this factor shall be taken into account when estimating the fair value ofthe shares granted.

Similarly, if the shares are subject to restrictions on transfer after vesting date, thatfactor shall be taken into account, but only to the extent that the post-vestingrestrictions affect the price that a knowledgeable, willing market participant would pay

for that share.

For example, if the shares are actively traded in a deep and liquid market, post-vesting transfer restrictions may have little, if any, effect on the price that aknowledgeable, willing market participant would pay for those shares.

Restrictions on transfer or other restrictions that exist during the vesting period shallnot be taken into account when estimating the grant date fair value of the sharesgranted, because those restrictions stem from the existence of vesting conditions.

Share options

For share options granted to staff, in many cases market prices are not available,

because the options granted are subject to terms and conditions that do not apply totraded options. If traded options with similar terms and conditions do not exist, the fairvalue of the options granted shall be estimated by applying an option pricing model.

The undertaking shall consider factors that knowledgeable, willing market participantswould consider in selecting the option pricing model to apply. For example, many staffoptions have long lives, are usually exercisable during the period between vestingdate and the end of the options life, and are often exercised early.

For many undertakings, this might preclude the use of the Black-Scholes-Mertonformula, which does not allow for the possibility of exercise before the end of theoptions life and may not adequately reflect the effects of expected early exercise. Italso does not allow for the possibility that expected volatility and other model inputsmight vary over the options life.

However, for share options with relatively short contractual lives, or that must beexercised within a short period of time after vesting date, the factors identified above

may not apply. In these instances, the Black-Scholes-Merton formula may produce avalue that is substantially the same as a more flexible option pricing model.

All option pricing models take into account, as a minimum, the following factors:

1. the exercise price of the option;2. the life of the option;3. the current price of the underlying shares;4. the expected volatility of the share price;5. the dividends expected on the shares (if appropriate); and6. the risk-free interest rate for the life of the option.

Other factors that knowledgeable, willing market participants would consider in setting

the price shall also be taken into account (except for vesting conditions and reloadfeatures that are excluded from the measurement of fair value).

For example, a share option granted to a member of staff typically cannot beexercised during specified periods (eg during the vesting period or during periodsspecified by securities regulators). This factor shall be taken into account if the optionpricing model applied would otherwise assume that the option could be exercised atany time during its life.

However, if an undertaking uses an option pricing model that values options that canbe exercised only at the end of the options life, no adjustment is required for theinability to exercise them during the vesting period (or other periods during theoptions life), because the model assumes that the options cannot be exercised during

those periods.

Similarly, another factor common to member of staff share options is the possibility ofearly exercise of the option, for example, because the option is not freely transferable,or because the member of staff must exercise all vested options upon cessation ofemployment. The effects of expected early exercise shall be taken into account.

Factors that a knowledgeable, willing market participant would not consider in settingthe price of a share option (or other equity instrument) shall not be taken into accountwhen estimating the fair value of share options (or other equity instruments) granted.



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For example, for share options granted to staff, factors that affect the value of theoption from the individual member of staffs perspective only are not relevant toestimating the price that would be set by a knowledgeable, willing market participant.

Inputs to option pricing models

In estimating the expected volatility of and dividends on the underlying shares, the

objective is to approximate the expectations that would be reflected in a currentmarket or negotiated exchange price for the option. Similarly, when estimating theeffects of early exercise of member of staff share options, the objective is toapproximate the expectations that an outside party with access to detailed informationabout staff exercise behaviour would develop based on information available at thegrant date.

When there is likely to be a range of reasonable expectations about future volatility,dividends and exercise behaviour, an expected value should be calculated, byweighting each amount within the range by its associated probability of occurrence.

Expectations about the future are generally based on experience, modified if thefuture is reasonably expected to differ from the past. In some circumstances,

identifiable factors may indicate that unadjusted historical experience is a relativelypoor predictor of future experience.

For example, if an undertaking with two distinctly different lines of business disposesof the one that was significantly less risky than the other, historical volatility may notbe the best information on which to base reasonable expectations for the future.

In other circumstances, historical information may not be available. For example, anewly-listed undertaking will have little, if any, historical data on the volatility of itsshare price.

In summary, an undertaking should not simply base estimates of volatility, exercisebehaviour and dividends on historical information without considering the extent to

which the past experience is expected to be reasonably predictive of futureexperience.

Expected early exercise

Staff often exercise share options early, for a variety of reasons. For example,member of staff share options are typically non-transferable. This often causes staff toexercise their share options early, because that is the only way for the staff toliquidate their position. Also, staff who cease employment are usually required toexercise any vested options within a short period of time, otherwise the share options

are forfeited. Other factors causing early exercise are risk aversion and lack of wealthdiversification.

The means by which the effects of expected early exercise are taken into accountdepends upon the type of option pricing model applied. For example, expected earlyexercise could be taken into account by using an estimate of the options expected life(which, for a member of staff share option, is the period of time from grant date to thedate on which the option is expected to be exercised) as an input into an option

pricing model (eg the Black-Scholes-Merton formula). Alternatively, expected earlyexercise could be modelled in a binomial or similar option pricing model that usescontractual life as an input.

Factors to consider in estimating early exercise include:

1. the length of the vesting period, because the share option typically cannot beexercised until the end of the vesting period. Hence, de

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