Under IFRS 2, different accounting is required for different types of share-based payment transactions. Three types of transactions are identified in IFRS 2:

• equity-settled share-based payment transactions;
• cash-settled share-based payment transactions; and
• transactions in which the entity receives or acquires goods or services and the terms of the arrangement provide either the entity or the supplier of those goods or services with a choice as to whether the entity settles the transaction in cash (or other assets) or by issuing equity instruments.

Share based payments are classified as either equity-settled or cash-settled, depending on the terms of the arrangement. The classification determines the accounting for the arrangement.

Equity-settled share-based payment transactions

Equity-settled share-based payment transactions are share-based payment arrangements in which an entity receives goods or services as consideration for its own equity instruments. An entity might receive goods or services but have no obligation to settle the transaction with the supplier, because the settlement will be made by a shareholder or another group entity. These transactions are also equity-settled share-based payment transactions for the entity.

Examples of equity-settled share-based payment transactions

Examples include the following: Transactions in which an entity obtains goods or services in exchange for its own equity instruments. For example, start-up entities might obtain consultancy and similar services in exchange for shares; this preserves scarce cash resources and gives the supplier an opportunity to share in the entity’s success. Transactions in which an entity obtains employee services when a shareholder awards shares of the entity to the employees. Transactions in which employees of an entity receive equity instruments of another entity in the same group, either from that other entity, from a parent or from a shareholder.

Accordingly, if a subsidiary receives goods or services but has no obligation to settle the transaction because its parent, or another group entity, is instead obliged to do so, that transaction meets the definition of an equity-settled share-based payment transaction.

Entity purchases own shares from market

Where an entity acquires shares that will be used to satisfy a share-based payment award, the acquisition is a separate transaction; and the way in which the shares are acquired does not impact the classification of share-based payment awards under IFRS 2. For example, a share-based payment award would not be treated as cash-settled simply because an entity is forced to go to a third party to purchase its equity instruments in order to satisfy the award. If employees will always receive shares when they meet the vesting conditions, the award would be treated as equity-settled, because the entity is providing its own equity to employees.

Example – Classification following purchase of own shares from the market an entity grants rights to shares to its employees, subject to specified performance conditions. The entity purchases the shares on the market at the date when its employees satisfy those performance conditions and delivers those shares to its employees. The entity accounts for the arrangement as an equity-settled share-based payment transaction. When the performance conditions are met and the entity purchases the shares on the market, the transaction is recognised in equity as a treasury share transaction, to reflect the purchase of the entity’s own shares. This does not affect the share-based payment accounting.

Settlement in shares net of exercise price

Entity may settle a share option award net (that is, employees receive fewer shares but pay no exercise price). For example, an employee is awarded 100 shares but receives 70 shares, the value of the 30 shares withheld represents the stated exercise price divided by the stock price on the date of exercise. There is no cash outflow or liability for the entity; so, it is not relevant whether the entity sells 30 shares on the market (to generate cash that would otherwise have been provided by the exercise price) or continues to hold them.

The award should be classified as equity-settled; this is because the entity has settled the full value of the award in shares.

Entity acting as a broker selling employee shares

An entity might sometimes act as a broker for its employees, by selling their shares to a third party on the employees’ behalf. Where the entity is acting as a principal (for example, where the employer is the purchaser and the entity has mandated the purchase of shares from the employees), the award would be treated as cash settled. Where the entity is acting as agent (for example, by selling the shares on the market according to the employee’s instruction), the award would be treated as equity-settled; this is because the entity is settling in shares.

Amount to be recognised in each reporting period: grant of a variable number of equity instruments based on a fixed value

On 1 January 20X5, entity H grants a bonus award to employees that entitles them to receive a variable number of shares equivalent to a value of C1,100,000, if they remain in employment for three years. The number of shares that the employees will receive is based on the share price on the vesting date. At the grant date, the share price is C5; at the vesting date, the share price is C10. The risk-free discount rate at grant date is 10%. This is an equity-settled share-based payment, because employees will receive shares.

The fair value is measured at grant date and is not subsequently re-measured. Entity H should recognise an expense of C826,446 (C1,100,000/1.1^3), spread over the vesting period. This is because the grant date fair value is independent of the share price and will be the value of the bonus award discounted.

Funding of award: shares purchased by trust

Entity B awards rights to its employees to obtain its shares, subject to a three-year vesting period. Local legislation does not allow the entity to issue new shares to employees or to buy its own shares. The entity will establish a trust that will purchase the entity’s shares from third parties and transfer those shares to entitled employees. The entity will pay to the trust the cash required to purchase those shares. Entity B prepares consolidated financial statements; and so, the trust will be consolidated under IFRS 10.

The fact that the group, via the trust, should buy shares from third parties in order to satisfy the obligation to deliver shares does not change the nature of the award. Employee services will ultimately be settled in shares. As such, the transaction should be treated as an equity-settled transaction (and any share purchase would be treated as a treasury share transaction in the consolidation).

Awards made by shareholders

IFRS 2 states that a share-based payment transaction may be settled by a shareholder (of any group entity) and still be within the scope of IFRS 2.

When a shareholder provides shares for the purposes of an employee share scheme, it will generally be clear that these benefits form part of the remuneration of the employees for their services to the entity. A charge to profit or loss will, therefore, be required in accordance with IFRS 2 for the services received.

On the other hand, a shareholder may make a gift of shares to a close relative who is coincidentally an employee of the entity. Such a gift might not form part of the remuneration of the employee but it will be necessary to look carefully at the facts of each case. For example, it would be necessary to consider whether similar benefits were given to other employees and whether the gift of shares was in any way conditional on continuing employment with the entity.

Leaver provisions

Some share-based payment arrangements often include good and bad leaver provisions. A good leaver is often defined as an individual who leaves the entity due to injury, disability, death, redundancy or on reaching normal retirement age. A bad leaver is usually defined as anyone other than a good leaver. The following example considers the scope implications in relation to typical leaver provisions.

Example – Exit event with good and bad leavers Entity A’s directors have been given an incentive in the form of share options that will vest when an exit event occurs; the entity is unlisted. Each director has paid an upfront exercise price of C10 per share, and will become unconditionally entitled to shares in the entity if he or she is still in service when an exit event occurs. ‘Exit event’ is defined in the plan’s terms and conditions as a trade sale, listing or other change in control. An exit event is expected to occur in the form of a trade sale after three years. The terms and conditions also set out provisions for good and bad leavers. For every share option held, a ‘bad leaver’ will receive cash equal to the lower of the amount paid (C10) and the market value of the share at that time (to be determined by independent valuation consultants).

A ‘good leaver’ will receive cash equal to the higher of the amount paid and the then current market value in respect of each share option held. A director can choose to leave the entity at any time, which would trigger a contractual ‘bad leaver’ cash payment that the entity cannot avoid; so, entity A has a liability in respect of all directors as part of the share-based payment arrangement (that is, for the total number of share options granted).

The liability will be measured at the lower of C10 per share and the market value of the share. In effect, the payments by the directors are an advance payment of an exercise price due when the awards vest. In addition to the bad leaver liability, the arrangement for good leavers and directors who are still in service at the time of the trade sale is within IFRS 2’s scope.

The fair value of share options awarded to any director expected to be a good leaver before the exit event occurs will be treated as a cash-settled share-based payment. This will be in addition to the amount already provided in case each individual becomes a bad leaver. The fair value of share options that are expected to vest as a result of the trade sale will be treated as an equity-settled share-based payment; this will be in addition to the amount already provided in case each individual becomes a bad leaver and will not include amounts in respect of any individual who is expected to become a good leaver before the exit event.

Note that, if the share options do vest as a result of the trade sale, the bad and good leaver liability in respect of each individual for whom the award vests will be transferred into equity.

‘Drag along’ and ‘tag along’ clauses

Some arrangements include ‘drag along’ and ‘tag along’ clauses. For example, if an existing majority shareholder chooses to sell his investment in an entity, a ‘drag along’ clause in an arrangement’s terms and conditions might state that the shareholder can force employee shareholders or share option holders to sell their holdings at the same price or date. Or, if an entity is sold, a ‘tag along’ clause could allow employees to force an acquirer to purchase their holdings at the same price or date.

Example – Settlement by an acquirer in cash Entity A grants restricted shares to its employees. The articles state that the shares will remain restricted until entity A is acquired. At the date when the entity is acquired, a ‘drag along’ clause will be invoked, requiring the employees to sell their shares to the acquirer.

In entity A’s financial statements, the award of restricted shares is an equity-settled share-based payment under IFRS 2, because the entity will settle the award in shares. Although the employees might receive cash for their shares, the cash will be paid by the acquirer to the employees as shareholders. Under no circumstances will entity A be required to settle in cash. In some situations, the acquirer could, in substance, initiate the cash payment by the acquiree or reimburse the acquiree for any cash payment.

Equity incentive plans

Some equity incentive plans offer organisations an opportunity to widen share ownership as part of their overall reward strategy. These incentive plans might include one or all of the following awards: Free shares – employers gift shares to employees. Matching shares – employers match shares which have already been purchased by employees, on condition that the employee continues to provide services for a specified period of time. Dividend shares – employers offer dividend reinvestment in extra shares; and those shares are held by employees in another plan.

Free shares Where the award of free shares is not subject to any vesting conditions, the expense will be recognised immediately. This expense will be based on the grant date fair value of the shares. Where the award is subject to vesting conditions, the expense will be recognised over the vesting period. Where recipients of an award can retain their entitlements (even if they leave employment), the award vests at the date when they retain entitlement. At this date, the full expense would have been recognised, because there is no further service period.

Matching shares

The accounting for matching shares should be similar to that for a free share award – that is, the expense would be recognised over the vesting period. A requirement to hold shares in order to receive matching shares is a non-vesting condition (as discussed in para 13.42). Failure to hold the required shares results in a cancellation. Where awards are part of an ongoing arrangement for the employee to purchase shares and then receive matching shares, the charge should be made over the relevant vesting period.

Dividend shares Where shares have vested with employees (for example, through another plan), dividends paid on those shares accrue to the benefit of the employee. Clearly, these dividends will be included within dividends paid by the entity. In some situations, the shares have not vested (for example, where shares are subject to forfeiture), but dividends on those shares do vest (by being paid to the employee or by reinvestment in dividend shares that are not forfeitable). This is a complex area and specialist advice should be obtained.

Matching shares with a service condition and good and bad leaver provisions

An entity operates an equity incentive plan for all of its employees. Under the arrangement, employees have a right to matching shares when they apply for shares; but they should hold their purchased shares and remain with the entity for three years before the matching shares vest unconditionally. ‘Good’ leavers (for example, those leaving due to death, injury, disability, transfer and retirement) will not forfeit their rights to the matching shares. In the case of good leavers, it is assumed that the matching shares vest when they become a good leaver (because there are no service conditions to be satisfied for them to receive the shares). So, any remaining charge should be accelerated when a good leaver leaves.

For an award that will vest on retirement, the vesting period (as anticipated at grant date) ends at the time when the employee is able to retire without requiring the employer’s agreement. Bad leavers, on the other hand, have forfeited their rights to the shares by failing to meet the service condition; so, the related charge should be reversed to the extent that they were not anticipated.

So, when the matching shares are granted, it is necessary to assess the likely number of leavers and when they are going to leave and also to split them into good and bad leavers. For those expected to be good leavers, the estimated vesting period will be reduced to the likely date of their departure (for example, on retirement). But it would be difficult to estimate vesting for death and/or disability events. Where such events are unlikely to be material, vesting for these conditions might not be adjusted until the event takes place. The next example considers the situation where an employee disposes of their purchased shares without leaving.

Matching shares with a non-vesting condition (requirement to hold shares)

An entity enters into a share-based payment arrangement with employees; under the arrangement, each employee is entitled to 1,000 free shares at the end of a three-year period, provided that: The employee completes a three-year service period with the entity from the date of the grant of the award.

The employee elects to take their cash bonus for the current year in the form of 1,000 shares on the grant date and then holds the shares for the three-year period. An employee who leaves the entity before the end of the three-year period (or who sells their shares within this period) will no longer be eligible to receive the free matching shares.

No expense would be recognised for the free shares if the employee leaves employment within the three-year period because he would have failed to meet the service vesting condition. Selling the shares would be failure to meet a non-vesting condition and therefore be treated as a cancellation. IFRS 2 makes it clear that the requirement to hold restricted shares for three years is not a vesting condition. Even though the requirement occurs during the service period, it is wholly within the employee’s control and does not determine whether the entity receives the services linked to the matching shares.

The probability of employees selling their restricted shares (and so losing the matching shares) will need to be taken into account when calculating the grant date fair value. An employee’s failure to hold the restricted shares is treated as a cancellation. This would result in the acceleration of any unvested portion of the award on the date when the employee sells the restricted shares and receives the cash instead.

Some transactions are ‘share-based’, even though they do not involve the issue of shares, share options or any other form of equity instrument. Cash-settled share-based payment transactions are transactions “in which the entity pays the supplier or employee cash amounts based on the price or value of equity instruments of the entity or another group entity”

Cash payments to employees made by acquirer in a business combination

Some equity-settled share-based payment arrangements include a clause that, in the event of a change in control of the entity, the employees will be required (or may be permitted) to sell their shares or share options to the acquirer on the same terms as are available to other vendors (i.e. at the same price, adjusted, if appropriate, for the option exercise price).

Such a clause does not alter the classification of the arrangement as equity-settled under IFRS 2. The entity does not have any obligation to pay cash if it is acquired. An acquirer may incur such an obligation in the future as a consequence of the acquisition of the entity. However, that obligation would be outside of the scope of IFRS 2 from the acquired entity’s perspective because it does not have the obligation to make the payment.

Therefore, the fact that a potential acquirer may pay cash to the employees at some point in the future does not affect the entity’s assessment that this is an equity-settled arrangement.

Cash-settled share-based payment transactions

Definition

Appendix A of IFRS 2 defines a cash-settled share-based payment transaction as “[a] share-based payment transaction in which the entity acquires goods or services by incurring a liability to transfer cash or other assets to the supplier of those goods or services for amounts that are based on the price (or value) of equity instruments (including shares or share options) of the entity or another group entity”.

Therefore, the definition includes transactions when the transfer of cash or other assets is based on the price (or value) of the equity instruments of another group entity (e.g. a parent).

Examples of cash-settled share-based payment transactions

The most common examples of cash-settled share-based payment transactions are employee incentive plans, such as share appreciation rights and ‘phantom’ share plans. These plans involve the payment of an amount based on the price of the employing entity’s shares after a period of time.

Social security contributions

IAS 19 concludes that, in the context of short-term employee benefits, social security contributions (such as NIC in the UK or FICA in the US) are employee benefits, and they should be considered in the same way as wages, salaries and so on. Social security contributions payable on long-term employee benefits and on contributions to long-term benefit funds are included in the measurement of the benefit obligation.

Thus, social security contributions are considered to be payments for employee services. This suggests that the social security contributions payable in connection with a grant of share options should be considered as either an integral part of the grant itself or a share-based payment transaction. So, the accounting for the social security contributions will be dictated by IFRS 2, and the charge will be treated as a cash-settled transaction.

The accounting for social security contributions as a cash-settled share-based payment transaction means: A liability should be recognised over the vesting period for social security contributions payable in respect of options to be exercised.

The amount of the liability will depend on the number of options that are expected to be exercised (that is, vesting conditions are taken into account). The expense should be allocated over the period from the grant date to the end of the vesting period. From the end of the vesting period to the date of actual exercise, the liability should be adjusted by reference to the current market value of the shares (that is, fair value of the liability at the end of the reporting period).

The important point is that the liability will be based on an estimate of fair value (as an element of a cash-settled share-based payment transaction), rather than the market price of the shares at the balance sheet date. This is illustrated in the following example.

Example – Treatment of social security contributions

On 1 January 20X5, entity A made an award of 1,000 options to each of its 60 employees. The only condition associated with the award was that recipients should remain in the employment of entity A for three years. At the date of the award, management estimated that 10% of employees (that is, six employees) would leave the entity before the end of three years. On 31 December 20X6, management revised their estimate of leavers to 5% (that is, three employees). However, awards to 55 employees actually vested on 31 December 20X7. All options should be exercised by the end of 20X9. On 31 December 20X8, when the intrinsic value of each option was C10, 10 employees exercised their options. The remaining 45 employees exercised their options on 31 December 20X9; at that date, the intrinsic value of each option was C14. The fair value of an option at each year-end is shown below: Year Fair value at year end 31 December 20X5 6 31 December 20X6 8 31 December 20X7 9 31 December 20X8 12 31 December 20X9 14 If the rate for employers’ social security contributions throughout this period is 13.8%, entity A will pay 13.8% of the intrinsic value of options exercised. For example, the amount payable at 31 December 20X8 is C12,800 (13.8% × C10 × 1,000 × 10). But the amount recognised as a liability at each period end should be based on an estimate of the fair value of an option at that date. So, the amount recognized as an expense in each year (and as a liability at each year-end) is as follows:

Year Expense Liability Calculation of liability C C 31 December 20X5 13,824 13,824 54 × 1,000 × 6 × 13.8% × 1⁄3 31 December 20X6 25,088 38,912 57 × 1,000 × 8 × 13.8% × 2⁄3 31 December 20X7 24,448 63,360 55 × 1,000 × 9 × 13.8% 31 December 20X8 18,560 69,120 45 × 1,000 × 12 × 13.8%

Expense reflects the extent to which social security contributions paid (C12,800) exceed the liability at the previous year’s end in respect of the 10 employees who exercised their options (C11,520) plus an adjustment to the liability of C17,280 (45 × 1,000 × (12 − 9) × 13.8%). 31 December 20X9 11,520 0 Liability extinguished. Expense reflects the extent to which social security contributions paid exceed the liability at the previous year’s end (45 × 1,000 × 14 × 13.8% = C80,640 less C69,120). The accounting treatment described above differs from accounting for the corporation tax effects of equity-settled share-based payments; this is because the accounting for deferred tax is based on the intrinsic value at the year-end rather than an estimate of the fair value of the equity instrument.

Reimbursement or transfer of the liability for social charges

In some jurisdictions, employers and employees can agree that the employee will pay the employer’s social security contributions on share options. Where an employee agrees to reimburse all or part of the employer’s social security contributions, the employer will recognize a liability. When considering the presentation of the reimbursement from the employee,

IAS 19 would only permit recognition of a separate asset if it is virtually certain that the entity will be reimbursed if the social security contribution expenditure is incurred (this is normally the case because the entitlement to the award that will trigger the social security is made conditional on the reimbursement); a net presentation is permitted in the statement of comprehensive income.

As an alternative to recognition of a reimbursement right, the additional payment from the employee could be treated as an adjustment to the exercise price of the options. Where the arrangement between the employer and employee legally transfers the liability to the employee, no liability appears in the employer’s financial statements, unless the awards are settled net of this liability.

Transactions that appear to be settled in shares should be treated as cash-settled if this reflects the substance of the transaction. For example, an entity might grant to its employees a right to shares that are redeemable, either mandatorily (such as when the employee leaves employment) or at the employee’s option. The transaction would be treated as cash-settled, because the entity has an obligation to make a cash payment.

 Impact of post-vesting restrictions on classification

Post-vesting restrictions could affect the classification (as well as measurement) of share-based payment transactions. IFRS 2 requires entities to consider the post-vesting terms and conditions of a share-based payment.

Example – Post-vesting restriction

A post-vesting restriction might be a pre-emption right. For example, employees receive shares in the entity on vesting, but they should offer them for sale to the entity if they resign or otherwise terminate their employment. Where the entity has an intention or established practice of exercising the pre-emption right, this would indicate that the award is cash-settled (there is no time limit when looking at this right as there is for example in USGAAP).

Repurchase of shares on termination of employment

Entity A is the sponsoring entity of a trust that administers an employee share-based compensation plan. Entity A issues new shares to the trust. The trust issues these shares to employees who satisfy the plan’s vesting conditions.

The shares are non-transferable for as long as employees remain in entity A’s employment, and each employee is required to sell the shares acquired through the plan back to the trust on leaving employment. The trust buys the shares back at fair value when they are returned. Entity A prepares consolidated financial statements; and so, under IFRS 10, the trust should be consolidated. When employment is terminated, the award is settled in cash based on entity A’s share price; and so, the transaction should be accounted for as a cash-settled award.

What is the exception to cash-settled classification?

Employers may include a mandatory requirement to withhold some shares in a share-based payment arrangement to settle a tax exposure on behalf of an employee. The amount paid to the tax authority is deemed to be an equity-settled transaction, despite being paid in cash.

Awards settled net of tax

An entity might agree to pay employee tax on an employee’s behalf when a share option award is exercised; and so, the entity would give the employee fewer shares in exchange. A limited scope amendment, effective from 1 January 2018, introduced an exception for awards that are settled net of tax. Where the deduction and payment of the tax is required by tax law or regulation, IFRS 2 provides an exception that classifies the whole award as equity-settled. Where the withholding exceeds the minimum amount required by tax law, any excess should be treated as a cash-settled award.

Employees’ taxes on share-based payments paid by employer

Entity A grants share options to senior employees under a share-based payment arrangement within the scope of IFRS 2. Options granted under the arrangement vest after four years if the employees remain in Entity A’s employment at that date.

Under the tax regime in which Entity A operates, the employee is taxed at the grant date based on the market value of the shares at that date. The tax paid at the grant date cannot be recovered if the share options do not vest.

Under the terms of the share-based payment arrangement, Entity A has agreed to pay the employees’ taxes on behalf of the employees. The employees have no obligation to refund the taxes paid on their behalf.

The employees’ tax should be expensed in the period in which it is due.

The employees’ tax is paid at the grant date and it is not reimbursable. Payment of the employees’ tax by Entity A on behalf of its employees is a separate benefit from the grant of share options. In substance, it is a cash-settled share-based payment award with no vesting period because it cannot be recovered by Entity A if the employees leave before the end of the four-year vesting period.

Accounting for employment taxes payable on share-based payments

When the amount of tax is based on the gain made by the employee (i.e. intrinsic value at exercise date), the entity needs to consider whether it has a liability before the employee exercises the options and if so, how that liability should be measured at the end of each reporting period.

Such payments of tax are outside the scope of IFRS 2 because they are not payments to the suppliers of goods or services. However, these are similar to the questions addressed in IFRS 2 for cash-settled share-based payments. A liability should, therefore, be recognized at the end of each reporting period for such tax. This is consistent with the requirements of IAS 37 as well as those of IFRS 2 because the ‘obligating event’ is the granting of the options by the entity rather than the exercise of the options by the employees. The liability could be measured on the same basis as required by IFRS 2, although it is acceptable to use intrinsic value at the end of the reporting period rather than the fair value determined using an option pricing model, given that the liability is outside the scope of IFRS 2. Measuring the liability at fair value by IFRS 2 is nevertheless to be preferred.

Under IFRS Standards, staff costs generally are within the scope of IAS 19, which requires staff costs to be recognized over the period in which services are provided. Therefore, in the absence of any conflicting interpretation by the IFRS Interpretations Committee, the liability could be built up over the vesting period.

For example, on 1 January 20X5, Entity A grants 200 share options to each of its 100 employees. Each grant is conditional upon the employees working for the entity over the next two years.

Employment taxes are payable by Entity A based on the gain made by each employee on the exercise of their share options (i.e. the intrinsic value of the share options at the exercise date.

Entity A estimates that 10 percent of employees will leave during the two years and therefore forfeit their rights to the share options. During 20X5, four employees leave. The entity revises its estimate of total employee departures over the two years from 10 percent to eight percent. During 20X6, a further two employees leave. Hence, a total of six employees forfeited their rights to the share options during the two years, and a total of 18,800 share options (94 employees x 200 options per employee) vest at the end of 20X6.

All options must be exercised by the end of 20X7. All employees exercise their options on 31 December 20X7.

The fair value of the share options at the end of each year is shown below. The intrinsic value of the options at the end of each year is also shown below:

Year	Fair value	Intrinsic value
	CU	CU
31 December 20X5	14.40	13.50
31 December 20X6	15.50	14.50
31 December 20X7	16.00	16.00

The entity’s rate of employment tax is 13.8% throughout this period.

A liability for employment taxes should be recognized at the end of each reporting period for such tax. As explained above the liability could be measured on the same basis as required by IFRS 2 (i.e. fair value determined using an option pricing model), although it is also acceptable to use intrinsic value at the end of the reporting period given that the liability is outside the scope of IFRS 2. The application of both of these methods is shown below:

Method 1 – Application of requirements applying IFRS 2 principles

Year	Calculation	Expense	Liability
CU	CU
1	(100-8) employees x 200 share options x CU14.40 x ½ x 13.8%	18,282	18,282
2	((100-6) employees x 200 share options x CU15.50 x 13.8%) – CU18,282	21,931	40,213
3	True up for actual tax based on intrinsic value at 31 December 20X7 94 employees x 200 share options x CU 16.00 x 13.8% – CU40,213	1,297	41,510
	Total liability for employment taxes at 31 December 20X7		41,510

Method 2 – Application of requirements using intrinsic value

Year	Calculation	Expense	Liability
CU	CU
1	(100-8) employees x 200 share options x CU13.50 x ½ x 13.8%	17,140	17,140
2	((100-6) employees x 200 share options x CU14.50 x 13.8%) – CU17,140	20,479	37,619
3	True up for actual tax based on intrinsic value at 31 December 20X7 (94 employees x 200 share options x CU 16.00 x 13.8%) – CU37,619	3,891	41,510
	Total liability for employment taxes at 31 December 20X7		41,510

Preference shares with conversion option issued as consideration for purchase of goods

Company A acquires an intellectual property intangible asset from Company X. Consideration is in the form of preference shares issued at the time of the transaction.

The issued preference shares have the following characteristics:

• entitlement to an annual non-discretionary eight percent dividend to perpetuity;
• the holder of the shares has the right to convert the preference shares to ordinary shares of Company A (adjusted only for capital reorganizations or capitalization issues that affect all holders of the ordinary shares). The holder can exercise this option at any time from the date of issue of the instruments;
• entitlement to a share of net assets on liquidation after distribution to another class of preference shareholders; and
• no maturity date (i.e. will remain in existence unless converted).

The arrangement should be accounted for as a share-based payment transaction under IFRS 2 and not as a financial instrument by IAS 32 and IFRS 9 (or, for entities that have not adopted IFRS 9, IAS 39). Company A has received goods from Company X and has, in return, provided Company X with a choice of settlement in cash (perpetual dividend stream) or equity (ordinary shares). Consequently, the transaction falls within the scope of IFRS 2.

IFRS 2 clarifies that if an entity has granted the counterparty the right to choose whether a share-based payment transaction is settled in cash or by the issue of equity instruments, the entity has granted a compound instrument. The instrument has:

• a liability component – Company X’s right to receive a perpetual stream of 8 percent dividends; and
• an equity component – Company X’s right to convert to ordinary shares.

Each component is accounted for separately as required by IFRS 2:

• the liability component is measured at fair value; and
• the equity component is measured as the difference between the fair value of the intangible asset received and the fair value of the liability component, at the date when the goods or services are received.

The liability component should, by IFRS 2, be recognised in the statement of financial position at fair value and remeasured at the end of each accounting period, with all movements in fair value being recognised in profit or loss. The fair value of the equity component is recognised in equity, with no further remeasurement.

If Company X chooses to exercise the conversion option, at the date of conversion, the liability component is remeasured to its fair value and is transferred directly to equity as the consideration for the equity instruments issued.

The recognition of liability and equity components at the date of issue of the preference shares is similar to the equivalent requirements of IAS 32; however, the treatment of the liability component subsequent to the issue of the preference shares differs from the equivalent requirements of IFRS 9 (or, for entities that have not yet adopted IFRS 9, IAS 39), which would not require the liability component to be remeasured to fair value on an ongoing basis.