DipIFR Syllabus B. Elements of financial statements - IFRS 2 Modifications and Cancellations - Notes 7 / 7
IFRS 2 Modifications and Cancellations
The entity might:
Reprice (modify) share options, or
Cancel or settle the options.
Equity instruments may be modified before they vest.
For example, a fall in the actual share price may mean that the original option exercise price is no longer attractive.
Therefore the exercise price is reduced (the option is ‘re-priced’) to make it valuable again.
Such modifications will often affect the fair value of the instrument and therefore the amount recognised in profit or loss.
Accounting treatment
Continue to recognise the original fair value of the instrument in the normal way (even where the modification has reduced the fair value)
Recognise any increase in fair value at the modification date (or any increase in the number of instruments granted as a result of modification) spread over the period between the modification date and vesting date.
If modification occurs after the vesting date, then the additional fair value must be recognised immediately unless there is, for example, an additional service period, in which case the difference is spread over this period.
Illustration 1
At the beginning of year 1, an entity grants 100 share options to each of its 500 employees over a vesting period of 3 years at a fair value of $15.
Year 1: 40 leave, further 70 expected to leave; share options repriced (as mv of shares has fallen) as the FV had fallen to $5. After the repricing they are now worth $8.
Year 2: 35 leave, further 30 expected to leave
Year 3: 28 leave
Solution
The repricing has increased FV by (8-5) = 3
This amount is recognised over the remaining two years of the vesting period, along with remuneration expense based on the original option value of $15.
Year 1
Income statement & Equity
(500-110) x 100 x 1/3 x $15 = 195,000Year 2
Income statement & Equity
[(500 – 105) × 100 × (($15 × 2/3) + ($3 × ½))] 454,250 - 195,000Dr Expenses $259,250
Cr Equity $259,250Year 3
Income statement & Equity
[(500 – 103) × 100 × ($15 + $3 ) 714,600 - 454,250Dr Expenses $260,350
Cr Equity $260,350
Illustration 2
An entity granted 1,000 share options at an exercise price of £50 to each of its 30 key management personnel.
They had to stay with the entity for 4 years
At grant date, the fair value of the share options was estimated at £20 and the entity estimated that the options would vest with 20 managers.
This estimate didn’t change in year 1
The share price fell early in the 2nd year. So half way through that year they modified the scheme by reducing the exercise price to £15. (The fair value of an option was £2 immediately before the price reduction and £11 immediately after.)
It retained its estimate that options would vest with 20 managers.
How should the modification be recognised?
Solution
The total cost to the entity of the original option scheme was: 1,000 shares × 20 managers × £20 = £400,000
This was being recognised at the rate of £100,000 each year.
The cost of the modification is: 1,000 x 20 managers × (£11 – £2) = £180,000
This additional cost should be recognised over 30 months, being the remaining period up to vesting, so £6,000 a month.
The total cost to the entity in the second year and from then on is: £100,000 + (£6,000 × 6) = £136,000.
Cancellations and settlements
An entity may settle or cancel an equity instrument during the vesting period.
Basically treat this as the vesting period being shortened.
Accounting treatment
Charge any remaining fair value of the instrument that has not been recognised immediately in profit or loss (the cancellation or settlement accelerates the charge and does not avoid it).
Any amount paid to the employees by the entity on settlement should be treated as a buyback of shares and should be recognised as a deduction from equity.
If the amount of any such payment is in excess of the fair value of the equity instrument granted, the excess should be recognised immediately in profit or loss.
A cash settlement made to an employee on cancellation
Dr Equity
Dr Income statement (excess over amount in equity)
Cr Cash
An equity settlement made to an employee on cancellation
This is basically a replacement of the option and so is treated as a modification (see earlier) at this value:
Fair value of replacement instruments* X
Less: Net fair value of cancelled instruments (X)
Illustration
2,000 share options granted at an exercise price of $18 to each of its 25 key management personnel.
The management must stay for 3 years.
The fair value of the options was estimated at $33 and the entity estimated that the options would vest with 23 managers.
This estimate stayed the same in year 1
In year 2 the entity decided to abolish the existing scheme half way through the year when the fair value of the options was $60 and the market price of the entity's shares was $70.
Compensation was paid to the 24 managers in employment at that date, at the rate of $63 per option.
How should the entity recognise the cancellation?
Solution
The original cost to the entity for the share option scheme was: 2,000 shares × 23 managers × $33 = $1,518,000
This was being recognised at the rate of $506,000 in each of the three years.
At half way through year 2 when the scheme was abolished, the entity should recognise a cost based on the amount of options it had vested on that date.
The total cost is: 2,000 × 24 managers × £33 = $1,584,000
After deducting the amount recognised in year 1, the year 2 charge to profit or loss is $1,078,000.
The compensation paid is: 2,000 × 24 × $63 = $3,024,000
Equity a/c Dr 1,584,000
P OR L a/c. Dr 1,440,000
To Cash a/c 3,024,000
Cancellation and resistance
Where an entity has been through a capital restructuring or there has been a significant downturn in the equity market through external factors, an alternative to repricing the share options is to cancel them and issue new options based on revised terms.
The end result is essentially the same as an entity modifying the original options and therefore should be recognised in the same way.