Replacement award on termination of employment
On 1 January 2012, an executive is granted the right to 10,000 free shares on condition of remaining in service until 31 December 2014. The fair value of the award at grant date is £2.00 per share.
On 31 December 2013, the executive’s employment is terminated and he therefore loses his right to any shares. However, as ex gratia (voluntary) compensation, the remuneration committee awards him 6,667 shares vesting immediately. At 31 December 2013, the share price was £4.00, and the fair value of the original award was £3.60 per share. (This is lower than the current share price because the holder of a share is entitled to receive any dividends paid during 2014, whereas the holder of an unvested right to a share is not – see 8.5.4 below).
This raises the question of how the ex gratia award of 6,667 shares should be accounted for. In our view, the starting point for any analysis is whether the entity, as a matter of accounting policy (pending finalisation of the IASB’s proposed clarification), accounts for the lapse of an award on termination of employment by the entity as a forfeiture or as a cancellation (see 7.4.1.A and 7.4.1.B above).
The factors to be considered in determining the grant date in such cases are discussed further at 5.3.9 above. For the purposes of this Example, it is assumed that the replacement award is treated as having been granted on 31 December 2013 rather than 1 January 2012.
If the lapse is treated as a forfeiture, the entity:
- reverses the cost already booked for the award of £13,333 (10,000 shares × £2 × 2/3); and
- recognises the cost of the ex gratia award (at the fair value at that award’s grant date) of £26,668 (6,667 shares × £4)
This results in a net charge on termination of £13,335.
If the lapse is currently treated as a cancellation, the entity:
- accelerates the cost not yet booked for the original award of £6,667 (10,000 shares × £2 = £20,000, less £13,333 already recognised – see above); and
- treats the ex gratia award as a replacement award. The fair value of the replacement award of £26,668 (6,667 shares × £4 – see above) is compared to the fair value of the original award of £36,000 (10,000 shares × £3.60). Since the fair value of the replacement award is less than that of the original award, there is no incremental cost required to be recorded under IFRS 2.
This results in a net charge on termination of £6,667.
Some support a third analysis which argues that, of the original award of 10,000 shares:
- 3,333 are forfeited, giving rise to a reversal of expense previously charged of £4,444 (3,333 shares × £2 × 2/3);
- 6,667 have their terms modified, by changing the vesting period from one year (as at 31 December 2013) to immediate vesting. A service period is a non-market vesting condition which is not factored into the fair value of the award. Thus, it is argued that although the modification clearly enhances the ‘real’ value of the award, it has no effect on its value for the purposes of IFRS 2 (see 7.3.1.C above). Therefore there is no incremental cost required to be recorded under IFRS 2, and the entity simply accelerates the cost (based on the original grant date fair value) not yet recognised for the awards of £4,444 (6,667 shares × £2 = £13,334, less the amount already recognised of £8,890 [6,667 shares × £2 × 2/3]).
This results in no profit or loss arising on the termination of employment. We do not believe that this approach is appropriate. Whilst the service period is not directly factored into the fair value of the award, the life of an award is one of the inputs to the fair value and a reduction in the life could therefore affect the fair value. The approach above therefore relies on the change of vesting date having no effect on the fair value. In addition to this, in our view, the award must be considered as either forfeited and replaced as a whole, or as cancelled and replaced as a whole. An approach that treats some part of the award as forfeited and some as modified effectively treats the original award as 10,000 awards of one share rather than what we regard as its true economic substance of one award of 10,000 shares.