Discretionary investment by employee of cash bonus into shares with discretionary 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. 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. Any shares received under this part of the arrangement are fully vested.
If the employee elects to receive shares, the entity has the discretion, but not the obligation, to award additional shares (‘matching shares’) – in this case 200 shares – 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).
It is in our view necessary, as discussed in Example 32.58 above, to consider whether the entity’s discretion to make an award of matching shares is real or not, this being a matter for judgement in the light of individual facts and circumstances.
If it is determined that the entity is effectively obliged to match any share award taken by the employee, then the award should be analysed as giving the employee the choice of settlement between:
- at 1 January 2014: cash of £500, subject to performance in the year ended 31 December 2013; or
- at 1 January 2014 shares with a value of £500 at 1 January 2014 subject to performance in the year ended 31 December 2013; and, at 31 December 2015: the same number of shares again subject to (i) performance in the year ended 31 December 2013 and (ii) service during the three years ended 31 December 2015.
In this case the grant date (and therefore measurement date) of all the equity awards would be taken as 1 January 2013. As regards the award due on 1 January 2014, this would be split into its equity and liability components, and in this case the equity component would have a value of zero (since the two components are essentially worth the same). Thus the entity would accrue a liability over the year to 31 December 2013. The matching share award would be expensed over the three years ending on 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, 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].
As in Example 32.60 above, there is an argument that IFRS 2 could be read as requiring an election by the employee for cash at the end of 2013 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.
If it is concluded that the entity has genuine discretion to make a matching award, the analysis is somewhat different.
The portion of the annual award that may be taken in shares should be analysed as giving the employee the choice, at 1 January 2014, between cash of £500 and shares worth £500 (the number of shares being determined by reference to the share price at that date). This would be split into its equity and liability components, and in this case the equity component would have a value of zero (since the two components are essentially worth the same). Thus the entity would accrue a liability over the year to 31 December 2013. If the employee elected to receive shares, this would be transferred to equity.
Any matching share award would be treated as being made on, and measured as at, 1 January 2014. The cost would be recognised over the two years ended 31 December 2015.
The discussion in 8.10 above is relevant to the valuation of the matching equity award.
If, in Examples 32.57 to 32.61 above, the employee had to retain his original holding of shares in addition to completing a further period of service in order for the matching award to vest, the requirement to retain the original shares would be treated as a non-vesting condition and taken into account in the grant date fair value of the matching award (see 6.4 above).