The IASB’s recent Annual Improvements includes some important changes to IFRS 2
For my money, IFRS 2 Share-based payment is one of the more poorly expressed standards, in that it does a weak job of laying out its core principles, and all but encourages a reader to get lost in definitions and complexities, without really understanding the reason for it all: vesting conditions, non-vesting conditions, service conditions, performance conditions, market conditions, non-market-conditions – some of them affecting the initial measurement of the grant-date fair value, others not; some of them leading to subsequent adjustments to the expense, others not. IFRS 2 IG24 has a table summarizing how it all fits together, but it’s the kind of thing you could stare at for an hour and then forget as soon as you turn the page.
What’s IFRS 2 about?
If you can see through all those trees, IFRS 2 is built more clearly than old Canadian GAAP was on the assumption that since no one gets something for nothing, an entity issuing share-based payments must have received some form of economic resources in return for them. That’s why, more than Canadian GAAP did, IFRS emphasizes measuring the share-based instruments at the fair value of the goods or services received, unless that fair value can’t be measured reliably. It follows, in broad terms, that certain kinds of conditions (so-called vesting conditions) will (at least in theory) affect the economic resources to be received, for example by incentivizing the recipients to work harder or better. Other kinds of conditions though (non-vesting conditions) won’t affect the resources received: the conditions are beyond the control of the recipients, so they’ll put in the same amount and quality of work either way. In the first case, then, the outcome of the condition may result in revising the expense in the light of experience (by applying forfeiture-style accounting), but in the second case it doesn’t. A broad-based market condition, such as a target return on a share index, always falls into the second category, because it reflects the performance not only of an entity itself but that of other entities outside the group as well, and so is inherently beyond the control of any employee.
Of course, all of this assumes an extremely programmatic view of human behaviour, but that’s the executive compensation racket for you. Anyway, the IASB’s recent Annual Improvements to IFRSs: 2010-2012 cycle attempts to clear this up a bit, by providing some new definitions and cleaning up some of the old ones, and adding some explanatory language (the amendments apply prospectively to share-based payment transactions for which the grant date is on or after July 1, 2014). After implementing the improvements, IFRS 2 now specifies that vesting conditions are either “service conditions” or “performance conditions”, and provides definitions for each of those.
Types of vesting conditions
Service conditions are the more straightforward of the two: either an employee completes the specified period of service and provides the expected economic resources to the entity, or he or she doesn’t. Performance conditions are trickier, and this area provides the meat of the new amendments. For example, IFRS 2 now specifies that the period of achieving the performance targets attaching to an award can’t stretch beyond the defined service period. The IASB ties this back to the basic notion that “An entity shall recognize the goods or services received or acquired in a share-based payment transaction when it obtains the goods or as the services are received”. That is: of course entities can attach any terms they like to their awards, but if a particular award vests based on (say) a three year service period and on achieving a specified level of sales in the year after that, then IFRS 2 recognizes the cost of the services received solely over that three year period, and the sales target effectively becomes irrelevant for accounting purposes (perhaps reflecting that it wouldn’t seem to be a particularly rational set of conditions from the point of view of incentivizing and recognizing performance). On the other hand, if the specified level of sales has to be reached within the three year service period, and isn’t met, then forfeiture-style accounting is applied, resulting in a cumulative net expense of zero, and reflecting that the services envisaged in return for the award were never met.
Up to now, there’s also been some uncertainty over what kinds of things can be considered as performance conditions – in particular, whether it depends on being able to demonstrate that the item for which performance is being measured is actually influenced by the employee. The amendments clarify this by stating “that the link between the employee’s service/performance against a given performance target is management’s responsibility” – that is, if it’s good enough for management, it’s good enough for IFRS 2. They also clear up another area of uncertainty, on the accounting consequences for awards that fail to vest because an employee is involuntarily terminated, by specifying the following: “If the counterparty, regardless of the reason, ceases to provide service during the vesting period, it has failed to satisfy the (service) condition.” In other words, that is, forfeiture-style accounting applies here too.
If that still sounds little clearer than mud, it’s at least better than it was. They don’t call them improvements for nothing!
The opinions expressed are solely those of the author