04 May 2020
During this period of economic uncertainty, when cash is limited, entities may seek to incentivise employees using non-cash benefits such as share-based payments. As well as this, existing share-based payment schemes may vest based on conditions such as employment continuity or KPI achievement which may be impacted by the current economic volatility.
Share-based payments is a complex area of accountancy and this memo does not cover the basic principles of how they are recognised under FRS 102. This article considers some areas that may be of greater complexity or judgement during the coronavirus pandemic.
What does FRS 102 say?
FRS 102 (Chapter 26) covers two types of share-based payments for goods or services received:
- Equity settled share-based payments; or
- Cash settled share-based payments.
The entity should recognise a share-based payment (as either equity or liability) when it receives the goods or services.
Most typically, share-based payments relate to services given to entities by employees. In this case, the standard states that fair value must be measured by reference to the fair value of the equity instruments granted measured at the grant date.
There is a three-tier measurement hierarchy for the fair value of share-based payments.
- If an observable market price is available for the equity instruments granted, that price should be used.
- If an observable market price is not available, the fair value of equity instruments granted should be measured using entity-speciﬁc observable market data such as: a) a recent transaction in the entity’s shares; or b) a recent independent fair valuation of the entity or its principal assets.
- If an observable market price is not available and obtaining a reliable measurement of fair value under (2) is impracticable, the fair value of the shares should be indirectly measured using a valuation method that uses market data to estimate the price of those equity instruments on the grant date in an arm’s length transaction between knowledgeable, willing parties.
Practical impact and interpretation for preparers
Measurement and recognition of share-based payments during coronavirus
With the economic impact of coronavirus, if an entity grants new share-based payments, they will need to apply careful consideration for the determination of the fair value of their equity instruments; carefully considering both micro and macro-economic conditions that are changing daily.
If the entity uses the first tier of the measurement hierarchy, they will need to consider the daily fluctuations in the markets as a result of the pandemic.
If the entity uses the second tier, they may find it difficult to obtain relevant data – recent transactions are unlikely to still be a good proxy of value given the rapidly-changing situation and an independent valuation at a point in time will quickly become outdated.
If the entity uses the third tier of the measurement hierarchy, they may find it difficult to use current market data to reliably measure the fair value during such a time of uncertainty. This is because any fair value assumptions used in a model will likely be subject to a high level of variability and complexity. For example, the commonly used Black-Scholes model uses volatility as an input, and although data will be available, the higher volatility will imply a higher valuation which may be surprising.
Recognition of historic share-based payments during reporting dates falling during coronavirus
Entities may also want to consult with an employment law specialist as to whether furloughing an employee would impact vesting periods relating to employee service length. In the United Kingdom, many share option schemes are EMI schemes and a key condition is continuing employment. A furlough of an employee might disqualify the employee from EMI and the impact on the accounts may be that the charge is no longer required in the accounts.
Share-based payment schemes include performance conditions which may have been deemed probable in the past. If a performance condition exists that impacts vesting (such as a growth in EBITDA target) and it becomes not probable this might trigger a reversal of previously recognised expense in relation to the share-based payment.
If entities modify existing share-based payment schemes (eg because they are now out of the money) the accounting may change and it is possible that additional compensation expense might arise as a result of these modifications.
Prepare a board paper that clearly documents the entity’s approach to share based payments issued during the year. This should include, as a minimum:
- an explanation of the scheme;
- a determination of whether it is an equity settled share-based payment scheme or a cash settled share-based payment scheme;
- a high-level summary of the quantum of the scheme including number of participants and length;
- a clear explanation of which level of measurement hierarchy has been applied and why;
- an explanation of key judgements and estimates applied in determining fair value, with supporting evidence enclosed where appropriate; and
- documentation of what experts have been liaised with.
Don’t rely on an HMRC approved tax value. It is rarely appropriate for accounting purposes as they are prepared on a different valuation basis. In some cases, the work performed for a HMRC approved tax valuation can be extended and used to derive an accounting valuation.
Review furloughed staff for employees who hold EMI schemes and seek further advice on the validity of these options as this may impact the charge recognised in the accounts and the related disclosures.
Review the basis of accounting for existing share-based payment schemes and consider if any performance conditions exist which are now deemed not probable and the subsequent impact on accounting.
The accounting and tax consequences of any proposed modifications of existing share-based payment arrangements should also be reviewed and considered before making any modifications.