prepare any necessary entries in e s consolidated financial statements for the years 613378

Discretionary investment by employee of cash bonus into shares with mandatory matching award by employer

On 1 January 2013 an employee is told that he is to participate in a bonus scheme which will pay £1,000 if certain performance criteria are met for the year ended 31 December 2013. The bonus will be paid on 1 January 2014. 50% will be paid in cash and the employee will be permitted, but not required, to invest the remaining 50% in as many shares as are worth £500 at 1 January 2014. Thus, if the share price were £2.50, the employee could choose to receive either (a) £1,000 or (b) £500 cash and 200 shares.

If the employee elects to reinvest the bonus in shares, the shares are not fully vested unless the employee remains in service until 31 December 2015. However, if the employee elects to receive 50% of the bonus in shares, the entity is required to award an equal number of additional shares (‘matching shares’), in this case 200 shares, also conditional upon the employee remaining in service until 31 December 2015. The award of any matching shares will be made on 1 January 2014.

The 50% of the bonus automatically paid in cash is outside the scope of IFRS 2 and within that of IAS 19 (see Chapter 33).

The 50% of the bonus that may be invested in shares falls within the scope of IFRS 2 as a share-based payment transaction in which the terms of the arrangement provide the counterparty with the choice of settlement. This is the case even though the value of the alternative award is always £500 and does not depend on the share price (see 10.4 above).

The mandatory nature of the matching shares means that the award is a share-based payment transaction, entered into on (and therefore measured as at) 1 January 2013, in which the terms of the arrangement provide the counterparty with a choice of settlement between:

• at 1 January 2014: cash of £500, subject to performance in the year ended 31 December 2013; or
• at 31 December 2015: shares with a value of £1,000 as at 1 January 2014, subject to:

(i) performance in the year ended 31 December 2013; and

(ii) service during the three years ended 31 December 2015.

The equity component as calculated in accordance with IFRS 2 will have a value in excess of zero (see 10.1.2 above). The measurement date of the equity component is 1 January 2013. However, as discussed at 10.1.3.A above, IFRS 2 does not specify how to deal with a transaction where the counterparty has the choice of equity- or cash-settlement but the liability and equity components have different vesting periods. In our view it is appropriate to recognise the liability and equity components independently over their different vesting periods, i.e. in this case:

• for the liability component (i.e. the fair value of the cash alternative), the year ended 31 December 2013;
• for the equity component (i.e. the excess of the total fair value of the award over the fair value of the cash alternative), the three years ended 31 December 2015.

Thus, at the end of the year ended 31 December 2013, the entity will have recorded:

• as a liability, the cost of the portion of the annual award that the employee may take in cash or equity;
• in equity, one-third of the cost of the matching award.

If the employee decides to take shares, the entity would simply transfer the amount recorded as a liability to equity and recognise the remaining cost of the matching shares over the following two years.

If, however, the employee elects to take cash, the position is more complicated. Clearly, the main accounting entry is to reduce the liability, with a corresponding reduction in cash, when the liability is settled. However, this raises the question of what is to be done with the one-third cost for the matching award already recognised in equity.

In our view, by electing to receive cash, the employee has effectively failed to exercise his option to receive additional equity at the end of 2015. This should therefore be accounted for as a failure to exercise (see 6.1.3 and 10.1.3 above), so that the amount already recognised in equity would not be reversed, but no further cost would be recognised. [IFRS 2.40].

There is an argument that IFRS 2 could be read as requiring an election by the employee for cash at the end of 2012 to be treated as a cancellation of the matching award, due to the employee’s failure to fulfil a non-vesting condition (i.e. not taking the cash alternative) for the matching award – see 3.2 and 6.4 above. This would require the remaining two-thirds of the matching award not yet recognised to be recognised immediately, resulting in an expense for an award that does not actually crystallise. Another view – which we prefer – would be that the requirement of paragraph 38 of IFRS 2 to ‘account separately’ for the liability and equity components of a transaction offering the employee alternative methods of settlement (see 10.1.3 above) suggests that not taking the cash alternative should not be considered as a non-vesting condition for the equity alternative.