IFRS 2 (Share based payment) mandates companies to account for expenses for goods or services obtained in exchange for equity instruments or cash-settled share based payments. Share based payments are transactions where an entity issues shares, share options, or equity instruments to employees or other individuals in return for goods or services. These payments are incentives and are made to align the employees’ interests with the company’s interests. Share based payments Ind AS and IFRS 2 have regulations on how these transactions are accounted for in financial reports. Understanding employee share based payments is crucial for companies to ensure compliance and transparency in reporting.
What is Share Based Payments?
Firms utilize share based payments as an incentive or compensation to employees, executives, or service providers. Instead of direct cash compensation, they provide equity instruments like shares or stock options. The compensation scheme ties employees’ earnings into company performance.
In other words, when companies employ share based payments, they encourage employees to work for extended periods, as they will benefit from their shares. It also ensures that employee performance is linked to shareholder value, incentivising them to drive growth. This allows startups and companies in growth mode to conserve cash while providing competitive compensation. It also yields tax advantages for employers and employees, making it a cheaper incentive.
Equity-Settled Share Based Payments
Equity-settled payments are the most popular form of employee share based payments in which the employees are granted shares or options instead of receiving money. Shares are given as an incentive by the company and recorded at the grant date of fair value. No cash flows out because either the company issues new shares or shares from the treasury are given to the employees.
- Measurement: The companies account for the expenses based on the fair value of the equity instruments issued. This assures that the share-based payment cost is reliably recorded.
- Recognition: The company expenses the cost over the vesting period, the period of time during which employees accrue the right to a share. This is a way to accurately reflect the cost of employee compensation over time.
- Journal Entry at Grant Date:
- Charities and non-governmental organisations.
- Credit: Share-Based Payment Reserves (Equity)
- On the Vesting Date: Journal Entry
- To Debits: Share-Based Payment Reserve
- Source: Share Capital / Securities Premium
Example of Equity-Settled Payments
Consider that an organization grants 1,000 stock options to an employee with a fair value of Rs. 100 per option and a vesting period of three years. Cost on a single scenario over the 3 years is Rs. 1,00,000. The annual cost would be calculated as:
| Year | Expense Recognized |
| 1 | Rs. 33,333 |
| 2 | Rs. 33,333 |
| 3 | Rs. 33,334 |
Cash-Settled Share Based Payment Transactions
Unlike equity-settled transactions, employees are not paid shares in cash-settled share based payments. Affiliate makesthe cash settlement of the fair value of the stock option. Employees appreciate stock prices but have no shares. The firm experiences a cash outflow equal to the value of the share at settlement. Since this transaction is treated as a liability rather than equity and needs to be revalued periodically until settlement.
- Measurement: Companies measure expenses at the liability’s fair value each reporting period. Sales price balance valuer (allows accurate valuation, which will be reflected in price changes)
- Recognition: The company will remeasure the liability at each reporting date until it settles it. This assists in updating financial statements with timely market changes.
- Journal Entry at Grant Date:
- Debit: Employee Compensation Expense
- Credit: Share-Based Payment Liability
- Journal Entry at Settlement Date:
- Debit: Share-Based Payment Liability
- Credit: Bank
Example of Cash-Settled Payments
For example, if an employee is granted stock appreciation rights (SARs) on 1,000 shares at an initial fair value amounting to Rs. 100 / share and at the time of settlement Rs.150/share, the liability and expense would be calculated as follows –
| Year | Expense Recognized |
| 1 | Rs. 33,333 |
| 2 | Rs. 50,000 |
| 3 | Rs. 66,667 |
At settlement, the company pays Rs. 1,50,000 (1,000 shares × Rs. 150).
Tax Implications of Share Based Payments
The income tax implications of share-based payments depend on whether the compensation is equity-settled or cash-settled. There is different tax treatments for employees and employers for example income tax, capital gains tax and deductions as an expense. Here’s what you need to know about the tax impact for both employers and employees.
Taxation for Employees
Taxation of employee share based payments is based on whether the payment is equity-settled or cash-settled. Employees must pay income or capital gains tax depending on how and when they receive the benefit. The breakdown below indicates how various kinds of share based payments are taxed.
- Equity-Settled: Employee is taxed in the year from the time of exercise of ESOPs on equity-settled share-based payments as a perquisite under salary. If the exercise price paid by the employee is lower than the fair market value (FMV) of the shares on the exercise date, the taxable amount is the difference. Before issuing shares, the employer deducts TDS (Tax Deducted at source).
- Cash-Settled: As opposed to handing shares to employees, with cash-settled share based payments, employees receive cash compensation based on stock price movements. The received amount is taxed as salary income in the financial year the payment is paid. Similar to normal salary payments, TDS is deducted from employers based on applicable income tax slabs.
- Capital Gains Tax: If employees settle their stock options by selling shares, they will be liable for capital gains tax on profit if they hold shares for a certain period. If they sell within 12 months, those are short-term capital gains and are axed at 15%. If held for over 12 months, the gains are long-term capital gains, taxed at 10% on gains exceeding ₹1 lakh.
Taxation for Employers
Employer taxation of share-based payments varies depending on whether they are equity-settled or cash-settled. Whereas business expenses, hence cash payments, qualify for deductions, no deductions apply to equity transactions. The principal employer tax implications regarding share-based compensation are described below.
- Expense Deduction: Only cash settle share based payments are treated as business expenses which can be claimed by companies as expense deduction. It will be spread over the vesting period, and the deduction is non-cash, i.e., it is not based on cash outflows, as companies do not incur cash costs during equity-settled transactions. Employers must treat share-based payments as equity expenses in their books.
- GST Applicability: Share based payment does not fall under the ambit of the supply of goods or services, and hence GST is not applicable. No GST liability arises where companies give shares or make cash payments referable to the scrip price. Companies still have to follow income tax requirements when reporting these transactions.
Disclosure Requirements Under IFRS 2
Firms should reveal important facts about share based payment agreements for transparency and respect for financial disclosure requirements. Sound disclosure enables the investor and regulatory bodies to make sense of their effect on accounts.
- Terms and Nature: Firms should make public the kind of share-based payment, number of instruments granted, and vesting conditions incorporated. They should also provide details on the exercise price, term of expiration, and subsequent changes made after the grant date. Disclosures help stakeholders comprehend the terms of the agreement.
- Fair Value Determination: Companies must disclose how they determine fair value and whether they use the Black-Scholes model or an alternative method such as Monte Carlo simulation. They also need to report significant assumptions such as volatility, risk-free rate of return, and expected life of the options. This is useful for assessing the accuracy of share-based payment valuation.
- Expense Recognized: The aggregate expense of share-based payments recognized in the company financial statements. They should state how much expense hits each year and whether it is listed as employee compensation or other expenses. The impact on the bottom line of share-based compensation is appropriately visible to investors.
- Liability Change: In the case of cash-settled share-based payments, companies need to include a new footnote for the adjustments of liabilities in related to fair value changes. They should disclose the degree to which liability has decreased or increased and whether it is a profit or loss. Timely updates facilitate monitoring of the implications of cash-settled transfers for financial stability.
Relevance to ACCA Syllabus
share based payments are addressed under IFRS 2 (Share-Based Payment) within the ACCA Financial Reporting (FR) and Strategic Business Reporting (SBR) syllabus. Share-based compensation needs to be understood to recognise stock options, restricted stock units (RSUs), and performance-based share schemes. ACCA students need to know how such transactions impact financial statements, including the recognition of expenses, valuation, and equity classification.
Share Based Payments ACCA Questions
- What is the IFRS standard that prescribes the accounting treatment for share based payments?
A) IFRS 9
B) IFRS 15
C) IFRS 2
D) IFRS 16
Ans: C) IFRS 2
- What menthod should an entity use to measure its equity settled share based payments at grant date?
A) At intrinsic value
B) The fair value of the equity instruments granted
C) At the carrying value of the shares issued
D) At the historical cost of the shares
Ans: B) At fair value of the equity instruments granted
- What is the accounting for share related payments under IFRS 2?
A) immediate spend in the period provided)
B) as an expense over the vesting period
C) Liability till exercised
D) At the time of exercise of the shares
Ans: B) Expense on P&L over the vesting period
- What happens if an employee loses stock options before the vesting period is over?
A) The entity keeps re/recognizing the expense
B) The entity reverses prior expense recognition
C) The cost is credited to retained earnings.
D) The cost is recorded as an asset
Ans: B) The entity recognized expenses previously recognized
- Which of the statement is NOT a consideration in fair value measurement of share based payments?
A) Expected price FY volatility
B) Dividend yield
C) The total revenue of the company
D) Expected option life
Ans: C) Company’s total revenue
Relevance to US CMA Syllabus
Under financial statement analysis, share-based compensation is covered, and in cost management, the US CMA syllabus includes it. As performance-based compensation influences decisions and financial performance, CMAs should consider its effect on the company at the profitability and incentive design level. This data is particularly valuable for management decision making, budgeting, and aligning corporate strategy with employee incentives.
Share Based Payments US CMA Questions
- Which of the following with respect to share based payments is TRUE under US GAAP?
A) Stock options must be expensed at the fair value on the date of grant
B) It is optional whether to expense stock options
C) share based payments only recorded on exercise
D) Stock-based compensation does not affect financial statements
Ans: A) Stock options are to be expensed at their grant-date fair value
- How should the company recognize the stock-based compensation cost under US GAAP?
A) Over the vesting period
B) Upon exercising the shares in the year
C) At the time of the employee receiving the shares
D) & D) On the date of the grant as a one time charge
Ans: A) Proportionate basis over the vesting period
- What model is used to find fair value of stock options?
A) Discounted Cash Flow Model
B) Black-Scholes Model
C) Gordon Growth Model
D) Cost-Plus Pricing Model
Ans: B) Black-Scholes Model
- What share-based payment gives a liability rather than equity?
A) Share based payments that are settled in equity
B) Share based payments cash settled
C) Performance stock units
D) Restricted stock awards
Ans: B) Cash settled share based payments
Relevance to CFA Syllabus
CFA candidates learn share based payments in financial reporting and analysis, corporate finance, and equity valuation. For investment analysis, it is important to know how stock-based compensation influences financial statements, valuation, and motivation of employees. Adjustments that analysts need to make in earnings when firms report stock-based compensation are also covered in the CFA curriculum.
Share Based Payments CFA Questions
- Why do they make adjustments to reported earnings for share-based compensation?
A) To remove the tax effect
B) Stock-based compensation is a non-cash expense
C) Since it’s an extraordinary item
D) To maximize the company’s market capitalization
Ans: B) Since stock-based compensation is a non-cash expense
- Accordingly, how does a company’s stock-based compensation impact its financial statements?
A) Increases cash outflows
B) Compensating expense reduces net income
C) Results in a balance sheet intangible asset
D) Is classified only as a liability
Ans: B) Reduces net income because of the compensation expense
- What is one of the most common criticism against stock based compensation?
A) Earnings are not affected by it
B) It may reduce shareholder value
C) It does not influence executive decision-making
D) Employees will always be tax-free.
Ans: B) It may dilute the value of shares held by shareholders
- Which financial ratio gets significantly impacted by stock-based compensation?
A) Debt-to-Equity Ratio
B) Earnings Per Share (EPS)
C) Quick Ratio
D) Asset Turnover Ratio
Ans: B) Earnings Per Share (EPS)
Relevance to US CPA Syllabus
The US CPA syllabus addresses share based payments in FAR and REG. CPA candidates should know the recognition, measurement, and disclosure of stock-based compensation according to ASC 718 (Stock Compensation) under US GAAP. CPAs also encounter tax effects of stock options and reporting compliance needs for stock-based incentives.
Share Based Payments US CPA Questions
- Based on the provided date, you are familiar with ASC 718, how should a company recognise stock-based compensation?
A) Granted x$ as a single, one-time charge on the grant date
B) Expensed over the vesting period
C) After the employee exercises the option
D) Only when the stock price goes up
Ans: B) amortised as expense over vesting period
- What is the main tax benefit of incentive stock options (ISOs) for employees?
A) Ordinary income tax is not applicable at exercise
B) They offer a tax deduction to the company
C) They have to be treated as salary income at the time of grant
D) Automatically reduce corporate tax liability
Ans: A) Ordinary income tax does not apply on exercise
- What happens if an employee exits the company before their stock options vest?
A) The options expire worthless
B) The tax deduction is recognized in the same period by the company
C) The employee has a right to exercise the options in the following days
D) The company needs to recognize a liability
Ans: A) The options expire and are lost
- Which of the following elements is NOT taken into account in the process of valuing stock-based compensation?
A) Exercise price
B) Expected stock volatility
C) CEO’s annual salary
D) Time to expiration
Ans: C) CEO’s annual salary
- How was this type of change (modification) to stock based compensation recorded under US GAAP?
A) Treat extra cost as a sunk cost instantly
B) Leave the change be and do original accounting
C) Future expenses should reflect the new fair value
D) Backtrack previous outlays and start fresh with different conditions
Ans: C) Future expenses including any adjustments based on new fair value
