Module 4 – Shareholders’ Equity

(Share Options Based on Performance Condition, Share Appreciation Rights

and Share Based Transactions with Cash Alternatives)

Learning Outcomes:
 Differentiate the difference of accounting treatments for share options based on performance conditions
 Account for share options based on performance conditions
 Account for share appreciation rights
 Account for compound financial instruments with the option given to employees

Core Value/Biblical Principles:

Hebrews 11:3

By faith we understand that the worlds were prepared by the word of God, so that what is seen was not made
out of things which are visible.
If options do not vest immediately, i.e., the employees or officers are still required to satisfy some vesting conditions,
the value of the share options is spread as compensation expense over the testing period.

There are several vesting conditions and business may be based on one or a combination of the following:

1. Service condition;
2. Performance condition;
- Non-market condition
- Market condition

Share Options that Vest based on Performance Condition

A grant of options might be conditional upon satisfying specified certain vesting conditions, other than remaining
on the entity’s employ for a minimum number of years. There might me performance conditions, such as achieving a
specified growth rate in terms of profits or gross revenue, or reaching a specified increase in market price of the entity’s
shares.

Accounting for performance-based share options depends on whether the options are based on market
performance features or non-market performance features. Non-market based performance conditions include vesting
based on achieving specific growth rate in revenue or in profits, achieving a specific increase in earnings per share, or
vesting based on non-financial targets. Examples of market based performance conditions are achieving a specific share
price of the entity’s equity instruments and achieivng a specified target share price relative to an index or market prices.

Irrespective of whether the performance condition is market based or non-market based, the fair value of
options used to measure compensation expense is determined at the date the options are granted. The determined fair
value at the date of grant shall be charged to compensation expense over the vesting period.

Non-Market Condition

When the grant of share options is based on non-market performance condition, the amount recognized for
services received during the vesting period shall be based on the number of share options expected to vest based on
number of employees that will complete the required service period and on the achievement of the non-market
condition.

The entity shall revise that estimate, when necessary, if subsequent information indicates that the number of
share options expected to vest differs from the previous estimates. On vesting date, the entity shall revise the estimate
to equal the number of equity instruments that ultimately vested. In effect, the same principle applies as in grant of
options that vest based on service condition: the total compensation expense over the vesting period shall be equal to
the fair value, measured at date of grant, of the share options that actually vest.

Example 1: Share Options that Vest Based on Revenue

To illustrate, assume that on December 31, 2020, B Company issued 2,000 share options to each of
the five key executives that will vest once revenues reach P100 million a year until December 31, 2023. The
options expire on January 1, 2024. The employee must still be in the employ of the company at the time the
share options vest. Based on the pricing model used by the company, the market value of the option on the
date of grant is P30.
 At the end of 2021, it is expected that none of the executives who have been granted the share
options will leave the company until 2024. It is also estimated that revenue of P100 million will be reached by
the year 2023. Thus, compensation expense of P100,000 will be recognized by the company. The following
entry shall be made on December 31, 2021 based on the estimate of the company.

2021

Dec 31 Compensation Expense 100,000

Share Options Outstanding 100,000

Number of Options Expected to vest 10,000

Multiply: FV of options at date of grant 30
Total fair value of the options 300,000
Number of years completed over the expected vesting
period 1/3
Compensation expense for 2021 100,000

If the total annual revenue during 2022 reached P100 million, the vesting of the share options accelerates and the remaining
compensation expense related to the 10,000 share options related to the 10,000 share options shall be recognized, as follows:

2022

Dec 31 Compensation Expense 200,000

Share Options Outstanding 200,000

Number of Options Expected to vest 10,000

Multiply: FV of options at date of grant 30
Total fair value of the options 300,000
Number of years completed over the expected vesting
period 3/3
Total compensation expense to be recognized 300,000
Less: Compensation expense previously recognized (100,000)
Compensation expense for 2022 200,000

If the P100 million annual revenue had not been reached by the end of the year 2022 but it is still expected that
the condition will be satisfied in the year 2023, the compensation expense recognized in 2022 will be P100,000 and the
remaining P100,000 will be recognized in 2023.

Assuming instead, that the revenue condition was not satisfied up to end of 2023, the compensation expense
recorded in the previous years shall be reversed. The adjustment is treated as a change in accounting estimate affective
the compensation expense of the current period. Thus, in effect, on a cumulative basis, no compensation expense is
recorded as a result of the share options if the non-market condition has not been satisfied.
Example 2: Share Options that vest based on Profit

On January 1, 2020, ABC Corporation granted 100 share options to each of its 500 employees for the purchase
of the company’s ordinary share capital at P120 per share. The options are exercisable by employees who are in the
employ of the company until the exerccise of the options. The share options will vest as follows:

At the end of 2020, if earnings increase by 15%.

At the end of 2021, if earnings over two years (2020 and 2021) increase by an average of 12%.
At the end of 2022, if earnings over three years, (2020 through 2022) increase by an average of 10%.

On January 1, 2020, the fair value of each option is P24.

Actual and estimate of the entity’s earnings are as follows:

End of 2020: actual, 12%; estimated earnings in 2021, 12%.

End of 2021: actual, 10%; estimated earnings in 2022, 8%
End of 2022: actual, 11%

Actual and estimate of the employees who leave the company are as follows:

2020: 20 employees left; Additional employees expected to leave, 40

2021: 15 employees left; Additional employees expected to leave, 20
2022: 16 employees left.

Solution:

Actual and estimated number of employees:

Best estimate at the end of 2020: 500 – 20 ‒ 40 = 440

Best estimate at the end of 2021: 500 – (20 + 15) ‒ 20 = 445
Actual at the end of 2022: 500 – (20 + 15 + 16) = 449

Table to determined the best estimate of the vesting period at each reporting date

ACTUAL ACTUAL AVERAGE ESTIMATED AVERAGE

YEAR EXPECTED STATUS OF VESTING
EARNINGS EARNINGS EARNINGS
Did not vest; Expected to vest in
2020 12% ‒ (12% + 12%)/2 = 12% 2021
Did not vest; Expected to vest in
2021 10% (12% + 10%)/2 = 11% (12% + 10% + 8%)/3 = 10% 2022
2022 11% (12% + 10% + 11%)/3 = 11% Vested

At December 31, 2020, the options did not vest because the increase in earnings did not reach 12%; however, the
company still needs to estimate whether the options will vest at the end of 2021 or 2022. At December 31, 2020, it was
expected that earnings in 2021 would increase by 12%. Thus, average increase in earnings during 2020 and 2021 was
expected to be 12%, that is, actual increase in 2020 of 12% plus expected increase in 2021 of 12% divided by 2. At
December 31, 2020, the best estimate is, therefore, is that options would vest by the end of 2021; hence there are 2
years estimated in the vesting period.
The entry on December 31, 2020 is

2020
Dec 31 Compensation Expense 528,000
Share Options Outstanding 528,000

Best estimate of employees as of the year end 44

2020 0
10
Multiply: Number of options per employee 0
Total number of options 44,000
Multiply: Fair value of options 24
Total fair value of options 1,056,000
Number of completed years over vesting period 1/2
Compensation Expense for 2020 528,000

(At December 31, 2021 it was determined that options have not yet vested because the company did not achieve an
average increase in annual earnings for 2020 and 2021 of 12%. However, there is one last chance for vesting: if average
annual increase in earnings for years 2020, 2021 and 2022 would be at least be 10%. An estimate must be made by
December 31, 2021 if this condition would be met. Based on actual increase in earnings in 2020 and 2021 and expected
increase in earnings 2022, it was expected that the condition for vesting would be satisfied at the end of 2022. Thus, the
vesting period was expected to extend until the end of 2022.)

2021

Dec 31 Compensation Expense 184,000

Share Options Outstanding 184,000

44
Best estimate of employees as of the year end 2021 5
10
Multiply: Number of options per employee 0
Total number of options 44,500
Multiply: Fair value of options 24
Total fair value of options 1,068,000
Number of completed years over vesting period 2/3
Cumulative compensation expense that should be
recognized 712,000
Less : Compensation expense previously recognized (528,000)
Compensation expense in 2021 184,000
2022

Dec 31 Compensation Expense 365,600

Share Options Outstanding 365,600

44
Actual employees as of the year end 2022 9
10
Multiply: Number of options per employee 0
Total number of options 44,900
Multiply: Fair value of options 24
Total fair value of options 1,077,600
Number of completed years over vesting period 3/3
Cumulative compensation expense that should be
recognized 1,077,600
Less : Compensation expense previously recognized (712,000)
Compensation expense in 2022 365,600

Market Condition

If the grant of share options is based on market performance features, the best estimate of the length of vesting
period is made at the date of grant, while the number of employees expected to be entitled to the options shall be
estimated at each reporting date. Compensation expense is recorded at the end of each vesting year, irrespective of
whether that market condition is satisfied.

To illustrate, assume the following information:

On January 1, 2020, X Corporation issued 3,000 share options to its key employees that will vest once its share
price equals P90. Each employee who received the options is required to be employed with the company at the time the
condition is met in order to receive the options. The share options will expire in three years. On the date of grant, it is
expected that the market condition will be satisfied in 3 years. Based on the pricing model used by the company, the
market value of the share option on the date of grant is P25.

The total compensation expense that will be recognized over the three-year period is P75,000 if all the
employees satisfied the required service condition. At the end of each year in the expected vesting period, compensation
expense of P25,000 will be recognized, irrespective of whether the condition of reaching P90 share price is satisfied.

The entries at the end of 2020, 2021, and 2022 are as follows:

2020
Dec 31 Compensation Expense 25,000
Share Options Outstanding 25,000

2021
Dec 31 Compensation Expense 25,000
Share Options Outstanding 25,000

2022
Dec 31 Compensation Expense 25,000
Share Options Outstanding 25,000
 The above entries are made irrespective of whether the market price of the company reached P90
before the expiration of the option. That is so, as the market price of the company is dependent on many
factors not wholly based on the performance of the employees or the entity. The amount of compensation
expense recorded over the vesting period is adjusted only by the number of options that will vest because the
employee leaves the company before the vesting date. It seems that what IFRS 2 considers is that an
expense shall be appropriately recorded for each vesting year on account of services received by the
enterprise from its employees.

When there is acceleration to the vesting period because the targeted market price is reached before
the end of the three-year period in the foregoing example, the compensation expense is accordingly adjusted.
If the market price of the share reached P90 in 2021 in the foregoing illustration, the compensation expense
in 2021 will be adjusted to P50,000, computed as follows:

Total value of the options, January 1, 2020 (3,000 x P25) 75,000

Less: Compensation Expense recognized in 2020 as a result of the option grant (25,000)
Compensation Expense recognized in 2021 50,000

Share Appreciation Rights

Incentives for impressive performance of the company may also be granted to key employees in the
form of cash based on the increase in the market value of the company’s shares from the date of grant.
These are called share appreciation rights. Share appreciation rights (SARs) are examples of cash-settled
share-based payment transactions. IFRS 2 requires that the value of the services received and the liability
incurred be measured at the fair value of the liability.

Until the liability is settled, the entity shall remeasure the fair value of the liability at each reporting
date and at the date of settlement, with any changes in fair value recognized in profit or loss for the period
(paragraph 30, IFRS 2).

Example 1: Number of share appreciation rights is based on number of employees, use of fair value method

On January 1, 2020, Company D grants 100 cash share appreciation rights to each of its 400 employees, on the
condition that the employees remain in its employ at least until December 31, 2022.

The number of employees who left during 2020 and the estimated number of employees still expected to leave until
December 31, 2022 as estimated at the end of 2020 and 2021 are follows:

2020: 20 employees left; 35 employees expected to leave until December 31, 2022
2021: 15 employees left: revised estimate, 15 employees expected to leave until December 31, 2022
2022: 10 employees left

The entity estimates the fair values of the SARs at end of each year as follows:

2020 ‒ P12.40
2021 ‒ P15.20
2022 ‒ P16.40
2023 ‒ P18.00
2024 ‒ P21.00
The market values of the ordinary share are available on the following dates:

January 1, 2020 ‒ P60.00

December 31, 2020 ‒ P71.00
December 31, 2021 ‒ P74.00
December 31, 2022 ‒ P76.40
December 31, 2023 ‒ P78.00
December 31, 2024 ‒ P81.00

All share appreciation rights were exercised on December 31, 2024.

Solution:

Number of employees expected to stay until December 31, 2022, as estimated at the end of each year:

2020: 400 – 20 – 35 = 345

2021: 400 – 20 – 15 – 15 = 350
2022: 400 – 20 – 15 – 10 = 355

The vesting years are 2020, 2021, and 2022. At the end of each of these vesting years, the entry is

Compensation Expense xx
Share Appreciation Rights (SARs) payable xx

SARs are measured at fair value at the end of each reporting period. The compensation expense for each year in the
vesting period is computed as follows:

2020: 345 x 100 x P12.40 x 1/3 = P142,600

2021: (350 x 100 x P15.20 x 2/3) ‒ 142,600 = P212, 067
2022: (355 x 100 x P16.40) ‒ 354,667 = P227,533

After the vesting date (December 31, 2022), until the share appreciation rights are exercised, the SARs are remeasured
at each reporting date at fair value. Thus, as a result of remeasurement, additional compensation expense shall be
recognized in 2023, as follows:

2023: Total fair value of the SARs (355 x 100 x P18) P639,000
Less: Previous fair value (355 x 100 x P16.40)
Which equals cumulative compensation expense
previously recognized 582,200
Compensation expense for 2023 P 56,800

At the date of exercise, the employees are to be paid an amount equal to the intrinsic value.

2024: Intrinsic value at the date of exercise (35,500 x P21) P745,500

Less: Previous fair value 639,000
Compensation expense for 2024 P106,500
The following are the entries relating to the share appreciation rights from January 1, 2020 through December 31, 2024:

2020
Jan 1 Memo. Granted 100 cash share appreciation rights to each of the 400 employees, on the condition that
the employees remain in its employ at least until December 31, 2024.

Dec. 31 Compensation expense 142,600

Share Appreciation Rights Payable 142,600

2021
Dec. 31 Compensation expense 212,067
Share Appreciation Rights Payable 212,067

2022
Dec. 31 Compensation expense 227,533
Share Appreciation Rights Payable 227,533

2023
Dec. 31 Compensation expense 56,800
Share Appreciation Rights Payable 56,800

2024
Dec. 31 Compensation expense 106,500
Share Appreciation Rights Payable 106,500

Dec. 31 Share Appreciation Rights Payable 745,500

Cash 745,500

Example 2: Number of share appreciation rights is based on level of revenue

Company Z issued share appreciation rights to its Chief Executive Officer on January 1, 2020. The share
appreciation rights may be exercised beginning January 1, 2023 provided that the officer is still in the employ of the
company at the date of exercise. Each right provides for a cash payment equal to the amount the share price of
Company Z exceeds P50. The equivalent number of shares of share appreciation rights will be based on the level of sales
of the company during the year 2022, as follows:

Level of Sales Equivalent share granted

P250 million - P400 million 10,000
Above P400 million - P750 million 15,000
Above P750 million 20,000

The level of sales actually achieved by the enterprise and the share price at the end of each year are:

Yea Level of sales Share price, end of year

r
2020 P350 million P74
2021 P410 million 85
2022 P760 million 95
The following are the entries at the end of each year during the vesting period, 2020, 2021 and 2022. (Note: The actual
level of sales in 2020 and in 2021 is used as the estimate of the level of sales in 2022, for the purpose of determining
the number of share appreciation rights expected to vest. Alternatively, the enterprise at the end of each year may make
a projection of the 2022 level of sales.)

2020
Dec 31 Compensation Expense 80,000
Share Appreciation Rights Payable 80,000

Increase in share price (P74 - P50) 24

Number of shares based on sales 10,000
Total amount of appreciation rights 240,000
Divided by number of years in vesting period 3
Compensation Expense in 2020 80,000

2021
Dec 31 Compensation Expense 270,000
Share Appreciation Rights Payable 270,000

Increase in share price (P85 - P50) 35

Number of shares based on sales 15,000
Total amount of appreciation rights 525,000
Multiplied by the number of years completed over the total vesting period 2/3
Cumulative compensation expense (2020 - 2021) 350,000
Less: Compensation expense recognized in 2020 80,000
Compensation expense for 2021 270,000

2022
Dec 31 Compensation Expense 550,000
Share Appreciation Rights Payable 550,000

Increase in share price (P95 - P50) 45

Number of shares based on sales 20,000
Total amount of appreciation rights 900,000
Multiplied by the number of years completed over the total vesting period 3/3
Cumulative compensation expense (2020 - 2022) 900,000
Less: Compensation expense recognized in 2020 and 2021 350,000
Compensation expense for 2022 550,000

Assuming that the share appreciation rights are exercised on January 1, 2023, the entry for the settlement is

2023
Jan. 1 Share Appreciation Rights payable 900,000
Cash 900,000
Similar to Example 1, until the share appreciation rights are settled, the entity shall adjust at each reporting date and at
settlement date, through the compensation expense account, any change in the value of the share appreciation rights.

Assuming that the share appreciation rights are still unexercised at December 31, 2023, and that the fair value
of the share appreciation rights is already P1,000,000, an entry is made to adjust the Share Appreciation Rights Payable
from P900,000 to P1,000,000. The change in fair value of the share appreciation rights is an adjustment to the current
year compensation expense.

2023
Dec 31 Compensation Expense 100,000
Share Appreciation Rights Payable 100,000

Share Based Transactions with Cash Alternatives

In other instances, as part of its remuneration package, an entity provides a choice of whether the additional
benefits provided to employees are to be settled in the form of cash or in the form of equity instruments. In such
instances, the entity shall determine whether it has a present obligation to settle in cash. The entity has a present
obligation to settle in cash if the choice of settlement in equity instruments has no commercial substance. An example of
this instance when the entity has a past practice or a stated policy of settling in cash, or when the entity is legally
prohibited from issuing shares. (Paragraph 41, IFRS 2)

If the entity has a present obligation to settle in cash, it shall account for the transaction as a cash-settled share
based payment transaction illustrated in the previous section (Share Appreciation Rights Payable).

If the entity has no present obligation to settle in cash, the entity shall account for the transaction as an equity-
settled share based payment transaction, applying the principles applied in share options. If at the date of settlement,
the entity settles in cash, the cash payment shall be accounted for as a repurchase of an equity instrument. If the
settlement price is lower than the amount previously recorded in equity, the excess shall remain in equity but may be
transferred from one equity component to another. If the settlement price is higher than the amount previously recorded
in equity, the excess of the settlement price is recorded as additional expense. (Based on par 42 and 42, IFRS 2).

Some share-based payment arrangements permit the employees to choose whether to receive cash or equity
instruments, that is, the choice is given to the employees. In this situation, a compound financial instrument has been
granted. The total value of the compound financial instrument has to be bifurcated into its debt component and equity
component. The residual approach is applied. The debt component is deducted from the total value of the compound
financial instrument at the date of grant to determine the value assigned to the equity component.

Fair value of the compound financial instrument xx

Less: fair value of the debt component at the date of
grant xx
Value assigned to equity component, at the date of grant xx

The residual approach is used merely to measure the value of the equity component at the date of grant. Such
assigned value is not subsequently adjusted, unless there is a change in the estimate of the share appreciation rights
expected to vest. The value of the debt, however is measured at fair value and is subject to adjustment at the end of
each reporting date and at the date of settlement.
At each reporting date, the entry during the vesting period, the entry is

Compensation Expense xx
SARs Payable (based on FV at year-end) xx
Share Options Outstanding (based on fair value at date of grant) xx

Illustration:

On January 1, 2020, an entity granted to its chief operations officer the right to choose either 5,000 ordinary
shares or to receive cash payment equal to 4,000 shares. The grant is conditional upon completion of two years of
service. The entity estimates that the value of the share alternative at the date of grant is P60 per share. Par value per
share is P40.

The fair values per share at January 1, 2020, December 31, 2020, and December 31, 2021 are P65, P68, and
P72, respectively. The officer exercised his rights on June 30, 2022 when the market price of each share is P75.

Solution:

The fair value of the equity component is measured at the date of grant, January 1, 2020:

Fair value of the equity alternative (5,000 x P60) 300,000

Less: Fair value of the debt component (4,000 x P65) 260,000
Fair value of the equity component 40,000

Fair value of the liability:

December 31, 2020 272,000
December 31, 2021 288,000
June 30, 2022 300,000

The following are the entries for the years 2020 through 2022 as a result of the foregoing:

2020
Dec. 31 Compensation Expense 156,000
Share Options Outstanding (40,000/2) 20,000
Share Appreciation Rights payable (272,000/2) 136,000

2021
Dec. 31 Compensation Expense 172,000
Share Options Outstanding (40,000-20,000) 20,000
Share Appreciation Rights payable (288,000 – 136,000) 152,000

2022
Jun 30 Compensation Expense 12,000
Share Appreciation Rights payable (300,000 – 288,000) 12,000
After the above entries, the balances of the debt and equity are as follows:

Share Appreciation Rights Payable P300,000

Share Options Outstanding 40,000

The balance of the debt is the fair value at the date of settlement, while the balance of the equity is the fair value at the
date of grant.

If the officer chooses the cash settlement, the transaction is recorded as:

June 30 Share Appreciation Rights Payable 300,000

Share Options Outstanding 40,000
Cash 300,000
Share Premium from Unexercised Share Options 40,000

If the officer, on the other hand, opted for the equity alternative, the settlement is recorded as

June 30 Share Appreciation Rights Payable 300,000

Share Options Outstanding 40,000
Ordinary Share Capital (5,000 x 40) 200,000
Share Premium – Ordinary Share 140,000

In cases when the option with cash alternative is granted to more than one employee, the number of options expected to
vest is considered to determine the amount of compensation expense recorded and the credits to debt and equity during
the vesting period.

SUMMARY

 Share appreciation rights are examples of cash-settled share-based transaction. IFRS 2 requires that the value of
the services received and the liability incurred shall be measured at the fair value of the liability. The value of the
services received from the employees shall be recognized as expense over the years in which the related
services are received. Until the liability is settled, the entity shall re-measure the fair value of the liability at each
reporting date and at the date of settlement, with any changes in fair value recognized in profit or loss for the
period.
 When share-based payment transactions provide for cash alternatives, the entity shall determine whether it has
a present obligation to settle in cash. If the entity has a present obligation to settle in cash, it shall account for
the transaction as cash-settled share-based transaction. If no such obligation exists, it shall account for the
transaction as an equity settled share-based payment transaction.
 In share-based payment arrangements with employees where employees are given the choice to receive cash or
equity instruments, a compound financial instrument has been granted. The entity shall split the instrument into
its debt component and equity component, using the residual approach. The equity component shall be
measured initially and at each reporting date at the fair value at the date of grant. The liability component shall
be measured at each reporting date at its fair value, with change in fair value taken to profit or loss. When the
employees choose the cash settlement, the amount previously taken in equity shall remain in equity, canceling
the liability at the amount of cash settlement. When the employees choose the equity settlement, the amount
previously recognized as debt transferred to equity.

REFERENCE

Intermediate Accounting Vol. 3, 2015 ed., Nenita S. Robles, Patricia M. Empleo