I seldom need to dive into the intricacies of IFRS 2, and find that when I do, many of the concepts have invariably grown fuzzy. since the last time. I previously summed it up this way:
- 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.
The IASB made some changes a few years ago to specify, among other things, that vesting conditions are either “service conditions” or “performance conditions” and to provide further elaboration. Against that backdrop, CPA Canada’s IFRS Discussion Group recently discussed the following fact pattern:
- Many entities include non-market performance conditions in their share-based payment arrangements. A non-market performance condition might be an EBITDA (earnings before interest, tax, depreciation and amortization) target required to be met for the award to vest. However, the adoption of a new accounting standard may bring into question whether the non-market performance conditions are still appropriate given the effect the new accounting standard would have on such conditions. For example:
- (a) Net income may decrease under IFRS 9 Financial Instruments when applying the expected loss model for certain financial assets.
- (b) The timing of revenue recognition may be earlier or later under IFRS 15 Revenue from Contracts with Customers.
- (c) EBITDA may increase subsequent to the adoption of IFRS 16 Leases.
- Entities may decide to modify their share-based payment arrangements to take into consideration the effect of the new accounting standard. For example, an entity might increase the EBITDA target to ensure such target considers the effect of adopting IFRS 16.
The group generally thought that if the share-based payment arrangement already specified how to account for a change in non-performance market conditions, then the change wouldn’t constitute a modification to the plan (they thought this would be unusual though). The group also agreed that if a modification does exist, and it increases the total fair value of the arrangement or is otherwise beneficial to the employee, then an accounting impact arises. But it’s not entirely clear how exactly to make this assessment.
For example, suppose a current award contains (in addition to a service condition) a vesting condition that the entity achieve cumulative EBITDA exceeding $1,000 over a 3-year period. The entity expects a new accounting standard to add an estimated $300 to expected EBITDA over that timeline, so it raises the amount of the performance condition accordingly, or maybe by a somewhat different amount. You might conclude that since the new EBITDA target is higher than the old one, then the modification plainly isn’t beneficial to the employee. On the other hand, looking only at the absolute amount of the change in the target may not provide a full picture of what the adjustment represents. Perhaps some modifications to vesting conditions could or should be bifurcated into a neutral portion that solely seeks to respond to a change in accounting standards, and an employee-specific portion which may or may not be beneficial to them, depending on the facts.
The group didn’t reach a single view on this. The report sums up:
- Group members noted that the adoption of IFRS 16 may be triggering entities to revisit non-market performance measures in their share-based payment arrangements because of the standard’s effect on key metrics like EBITDA. However, some entities may build such changes into their next series of awards so that a modification to outstanding awards is not triggered. The Group noted that this issue has been discussed globally, with strong views held on both sides.
Again, the key conceptual question is whether a particular change to a plan affects the economic resources to be received from the underlying recipient, for example by incentivizing the individual to work harder or better. Obviously, this all depends on a somewhat abstract and programmatic view of human behaviour in the first place, and that may get pushed almost to absurdity in concluding that a particular tweak to the targets within a plan has a quantifiable impact on how the underlying individual behaves. Still, as we just learned, strong views exist on the topic, so beware!
The opinions expressed are solely those of the author