Share-based compensation is a common method to incentivize, or to simply "lock in", key employees. Using share-based payments to pay other key suppliers can also be an effective method for early-stage businesses to reduce cash outflow.
It's challenging to implement IFRS 2 Share-based Payments, mainly because of its complexity, and because most companies don't make such deals very often, so they're not familiar with the rules.
Even small changes in an agreement can lead to drastically different accounting treatment, which means you can make mistakes if you don't read it properly.
Farahat & Co takes a look at some areas that commonly cause share-based payments to be hard to account for.
Are They Worth It?
Paying Suppliers Besides Employees
A share-based payment to an employee is valued at the time of grant, and is most likely valued using a Black Scholes, Monte Carlo, or Binomial model.
But it is a common mistake to apply these valuation techniques to payments made to others than employees. Examples include broker payments, bank transfers, or payments for goods or services.
As a result of IFRS 2, if a share-based payment is issued to someone other than an employee, the consideration should be allocated according to the fair value of the goods or services received rather than the fair value of the shares or options issued.
A fair value of the equity instruments issued should only be used when the fair value of the goods or services received cannot be reliably determined.
Using it to determine what expenses to recognize may not be the best method. The fair value should be recognized as an expense when the supplier also supplies the same or similar goods or services for a cash price.
Which Standards Apply to This
Using shares to settle liabilities
In uncertain economic times, it can make sense to settle liabilities with an entity's own shares, particularly if cash is needed to preserve it. If the agreement to settle a liability in shares is reached at a later date, the accounting treatment will differ.
IFRS 2 Share-based payments would apply to arrangements with an option or requirement for share-based payment, while IFRS 9 Financial Instruments would apply to arrangements involving financial instruments (for instance, a convertible debt issue).
IFRIC 19 Extinguishing Financial Liabilities with Equity Instruments applies when a liability is originally intended to be settled in cash, but later agreed to be settled through the issue of shares
The scope of IFRIC 19 is limited in that it does not apply to transactions entered into by shareholders in their capacity as shareholders. Such transactions would be accounted for as equity.
In order to comply with IFRS 2, a charge only needs to be made for goods and services received at fair value. Under IFRIC 19, however, any difference between the fair value of equity instruments issued and the carrying value of the financial liability is accounted for in the income statement.
In Which Circumstances Is A Loan Not A Loan?
Low-recourse loan arrangements
The practice of providing directors with limited recourse loans for the purpose of acquiring shares is common for many companies. A typical contract involves the company loaning the employee money, who then uses the funds to buy shares of the company.
Once the loan has been repaid, the shares will be held in trust for the employee. It is a limited-recourse loan, so if the company fails to make payments, it will only be able to use its issued shares.
The most common mistake is to treat the arrangement as a loan and record a loan receivable once the shares are issued. As a result of such an arrangement, the employee has some degree of control over the amount of stock he or she receives. Since the share price has increased, they have a greater chance of repaying the loan and will therefore enjoy the increased share price of the entity.
However, they may choose to return the shares rather than paying back the loan. The recognition of a loan receivable would not be appropriate because the entity that issued the loan has no contractual right to receive any cash.
In accounting terms, this arrangement should be viewed as a grant of stock options, where the option is regarded as having been exercised after the loan has been repaid.
Audit Firms in Dubai recommend that speak with your local RSM adviser about share-based payment accounting.