Accounting Solutions

Accounting Solutions

Issue 1 - Determination of Grant date

Fact Pattern

On 1 January, Company A hires a Managing Director. As part of the offer letter, an entity is obliged to provide the Managing Director ESOPs which will vest over the following three years. The award is subject to board approval, which is given two months later on 1 March.

Issue

What is grant date? From which date ESOP expenses should be recognized in profit and loss account?

Accounting considerations

The determination of grant date is critical to the measurement of equity–settled share–based transactions with employees, since grant date is the date at which such transactions must be measured.

To determine grant date, analogy can be taken from guidance given in implementation guidance which accompanies IFRS 2 as the said implementation. guidance is equally relevant for Ind AS since there are no GAAP differences in this respect.

As per Ind AS 102 and IFRS 2, grant date is defined as “The date at which the entity and another party (including an employee) agree to a share–based payment arrangement, being when the entity and the counterparty have a shared understanding of the terms and conditions of the arrangement. At grant date the entity confers on the counterparty the right to cash, other assets, or equity instruments of the entity, provided the specified vesting conditions, 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”.

IFRS 2 and the accompanying implementation guidance emphasise that a grant occurs only when all the conditions are understood and agreed by the parties to the arrangement and any required approval process has been completed. Thus, for example, if an entity makes an award ‘in principle’ to an employee of options for whose terms are subject to review or approval by a remuneration committee or the shareholders, ‘grant date’ is the later date when the necessary formalities have been completed.

The implementation guidance to IFRS 2 further emphasises that, “the word ‘agree’ is used in its usual sense, which means that there must be both an offer and an acceptance of that offer…”. Therefore, there cannot be a grant unless an offer by one party has been accepted by the other party. The guidance notes that agreement will be explicit in some cases (e.g., if an agreement has to be signed), but in others it might be implicit, such as when an employee starts to deliver services for the award.

The implementation guidance to IFRS 2 further notes that employees may begin rendering services in consideration for an award before it has been formally ratified. For example, a new employee might join the entity on 1 January and be granted options relating to performance for a period beginning on that date, but subject to formal approval by the remuneration committee at its next quarterly meeting on 15 March. In that case, the entity would typically begin expensing the award from 1 January based on a best estimate of its fair value, but would subsequently adjust that estimate so that the ultimate cost of the award was its actual fair value at 15 March. This reference to formal approval could be construed as indicating that, in fact, IFRS 2 requires not merely that there is a mutual understanding of the award (which might well have been in existence since 1 January), but also that the entity has completed all processes necessary to make the award a legally binding agreement.

View point

Considering guidance above, in order for a grant to have been made, there must not merely be a mutual understanding of the terms – but there must also be a legally enforceable arrangement. Thus, if an award requires board or shareholder approval for it to be legally binding on the reporting entity, for the purposes of Ind AS 102, it has not been granted until such approval has been given, even if the terms of the award are fully understood at an earlier date. Hence in the example, grant date is 1 March as that is the date when board has approved ESOP plan.

However, if services are effectively being rendered for an award from a date earlier than the grant date as defined in Ind AS 102, the cost of the award should be recognized over a period starting with that earlier date. An estimate of the grant date fair value of the award is used (e.g., by estimating the fair value of the equity instruments at the end of the reporting period), for the purposes of recognizing the services received during the period between service commencement date and grant date. In the present case, the company will accrue for ESOP expenses from 1 Jan onwards based on estimate of grant date fair value. ESOP cost should be trued up once grant date fair value is crystallized.

Issue 2 - Awards vesting in tranches along with IPO condition

Fact Pattern

Company A issues an award to employees at the beginning of year 1 with graded vesting over four years. The award will vest 25% in each year of service over the four-year period. In addition to the service condition there is an Initial public offering (IPO) condition that must be met at the end of year 4.

Issue under consideration

Whether IPO condition is vesting or non-vesting condition?

Accounting considerations

Ind AS 102 defines service condition as “ A vesting condition that requires the counterparty to complete a specified period of service during which services are provided to the entity. If the counterparty, regardless of the reason, ceases to provide service during the vesting period, it has failed to satisfy the condition. A service condition does not require a performance target to be met”

Implementation guidance paragraph 11 of IFRS 2 states “In some situations, share options or other equity instruments granted might vest in instalments over the vesting period. For example, suppose an employee is granted 100 share options, which will vest in instalments of 25 share options at the end of each year over the next four years. To apply the requirements of the IFRS, the entity should treat each instalment as a separate share option grant, because each instalment has a different vesting period, and hence the fair value of each instalment will differ (because the length of the vesting period affects, for example, the likely timing of cash flows arising from the exercise of the options)”. This guidance is equally relevant for Ind AS as there is no GAAP difference.

Ind AS 102 defines vesting condition as “A condition that determines whether the entity receives the services that entitle the counterparty to receive cash, other assets or equity instruments of the entity, under a share based payment arrangement. A vesting condition is either a service condition or a performance condition”.

Ind AS 102 further defines performance condition as “ A vesting condition that requires:

a) the counterparty to complete a specified period of service (ie a service condition); the service requirement can be explicit or implicit; and

b) specified performance target(s) to be met while the counterparty is rendering the service required in (a).

The period of achieving the performance target(s):

a) shall not extend beyond the end of the service period; and

b) may start before the service period on the condition that the commencement date of the performance target is not substantially before the commencement of the service period.

A performance target is defined by reference to:

a) the entity’s own operations (or activities) or the operations or activities of another entity in the same group (ie a non- market condition); or

b) the price (or value) of the entity’s equity instruments or the equity instruments of another entity in the same group (including shares and share options) (ie a market condition).

A performance target might relate either to the performance of the entity as a whole or to some part of the entity (or part of the group), such as a division or an individual employee.

Considering the above guidance,

• the award that vests in instalments will be treated as four different tranches because each tranche has a different vesting period with different fair values.
• IPO condition will be a non–vesting condition and factored in the grant date fair value of tranches 1 to 3 as the service period is not as long as the duration of the IPO condition. However, for tranche 4, the service and performance conditions are for the same duration, therefore the IPO Condition will be treated as a non–market performance condition and not factored into the grant date fair value but factored into the number of awards that will vest for tranche 4.

View point

IPO condition is a non-vesting condition for Tranche 1 to 3 and non-market vesting condition for Tranche 4. The impact of treating the IPO condition differently results in an expense being recognized for the first three tranches regardless of the IPO condition being met, so long as the service condition is met, as the likelihood of not meeting the IPO condition is factored into the grant date fair value. In contrast for tranche 4 if the IPO condition is not met but the service condition is met, no expense will be recognized as the non–market performance condition has not been met.