Award with market condition and fixed vesting period
At the beginning of year 1, an entity grants to 100 employees 1,000 share options each, conditional upon the employees remaining in the entity’s employment until the end of year 3. However, the share options cannot be exercised unless the share price has increased from €50 at the beginning of year 1 to more than €65 at the end of year 3.
If the share price is above €65 at the end of year 3, the share options can be exercised at any time during the next seven years, i.e. by the end of year 10. The entity applies a binomial option pricing model (see 8 below), which takes into account the possibility that the share price will exceed €65 at the end of year 3 (and hence the share options become exercisable) and the possibility that the share price will not exceed €65 at the end of year 3 (and hence the options will be forfeited). It estimates the fair value of the share options with this market condition to be €24 per option.
IFRS 2 requires the entity to recognise the services received from a counterparty who satisfies all other vesting conditions (e.g. services received from an employee who remains in service for the specified service period), irrespective of whether that market condition is satisfied. It makes no difference whether the share price target is achieved, since the possibility that the share price target might not be achieved has already been taken into account when estimating the fair value of the share options at grant date. However, the options are subject to another condition (i.e. continuous employment) and the cost recognised should be adjusted to reflect the ongoing best estimate of employee retention.
By the end of the first year, seven employees have left and the entity expects that a total of 20 employees will leave by the end of year 3, so that 80 employees will have satisfied all conditions other than the market condition (i.e. continuous employment).
By the end of the second year, a further five employees have left. The entity now expects only three more employees will leave during year 3, and therefore expects that a total of 15 employees will have left during the three year period, so that 85 employees will have satisfied all conditions other than the market condition.
By the end of year 3, a further seven employees have left. Hence, 19 employees have left during the three year period, and 81 employees remain. However, the share price is only €60, so that the options cannot be exercised. Nevertheless, as all conditions other than the market condition have been satisfied, a cumulative cost is recorded as if the options had fully vested in 81 employees.