Cancellation and settlement – basic accounting treatment
At the start of year 1 an entity grants an executive 30,000 options on condition that she remain in employment for three years. Each option is determined to have a fair value of $10.
At the end of year 1, the executive is still in employment and the entity charges an IFRS 2 expense of $100,000 (30,000 × $10 × 1/3). At the end of year 2, the executive is still in employment. However, the entity’s share price has suffered a decline which the entity does not expect to have reversed by the end of year 3, such that the options, while still ‘in the money’ now have a fair value of only $6. Moreover, the entity is under pressure from major shareholders to end option schemes with no performance criteria other than continuing employment.
Accordingly, the entity cancels the options and in compensation pays the executive $6.50 per option cancelled, a total payment of $195,000 (30,000 options × $6.50).
IFRS 2 first requires the entity to record a cost as if the options had vested immediately. The total cumulative cost for the award must be $300,000 (300 options × $10). $100,000 was recognised in year 1, so that an additional cost of $200,000 is recognised.
As regards the compensation payment, the fair value of the awards cancelled is $180,000 (30,000 options × $6.00). Accordingly, $180,000 of the payment is accounted for as a deduction from equity, with the remaining payment in excess of fair value, $15,000, charged to profit or loss.
The net effect of this is that an award that ultimately results in a cash payment to the executive of only $195,000 (i.e. $6.50 per option) has resulted in a total charge to profit or loss of $315,000 (i.e. $10.50 per option, representing $10 grant date fair value + $6.50 compensation payment – $6.00 cancellation date fair value).