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Share-based Payment

Date recorded:

The Boards discussed various convergence issues arising from the projects.

Classification of share-based payment arrangements as liabilities or equity

There are some differences between the classification of contracts on own shares as liabilities and equity differs under the proposals in ED 2 and the revised IAS 32 Financial Instruments: Disclosure and Presentation. Except for arrangements with cash alternatives (which the IASB will discuss later), the IASB has agreed to retain the differences between ED 2 and IAS 32, pending the outcome of the Board's concepts project, which includes reviewing the distinction between liabilities and equity.

The FASB recently considered the debt/equity classification in FAS 123, which differs from that applied in FAS 150 Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. The FASB agreed that the exposure draft to revise FAS 123 should incorporate the debt/equity distinction applied in FAS 150. The FASB also has a project to review the definitions of liabilities and equity in its conceptual framework.

The debt/equity distinction applied in IAS 32 is not the same as that applied in FAS 150. For example, the debt/equity classification in IAS 32 does not consider whether the financial instrument is indexed to the entity's own shares, unlike the debt/equity distinction in FAS 150.

Ultimately, therefore, convergence of the definitions of liabilities and equity in the two Boards' conceptual frameworks should enable convergence in the standards on share-based payment (equity-based compensation).

Transactions with parties other than employees

The IASB standard on share-based payment will deal with both transactions with employees and with parties other than employees. The FASB has recently decided to defer consideration of the treatment of transactions with parties other than employees until the second phase of its equity-based compensation project, to enable it to focus on developing an.exposure draft on employee transactions. In the interim, existing guidance in FAS 123 and EITF 96-18 Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services will continue to apply.

The IASB deliberations of transactions with parties other than employees have not concluded at the time of writing these notes. However, it seems likely that there will be differences between the IFRS and current US GAAP. Whether those differences will remain depends on outcome of the FASB deliberations in the second phase of its equity-based compensation project. If the FASB decides on an approach that differs from that applied in the IFRS, the IASB will consider whether to revise the IFRS.

The IASB and FASB staff recommend that after the FASB has completed its project to revise US GAAP on accounting for equity-based compensation, including the requirements relating to both employees and parties other than employees, the IASB and FASB consider undertaking a convergence project with the objective of eliminating all remaining differences between international and US standards.

The Boards agreed with the staff recommendations.

Tax effects of share-based payment transactions

ED 2 proposed that all tax effects of share-based payment transactions should be recognised in the income statement. This differs from the approach taken in FAS 123, which requires any realised tax benefits in excess of the tax benefits on the total amount of remuneration expense recognised to be credited direct to equity as additional paid-in capital. Conversely, if the tax deduction is less than the total expense recognised for accounting purposes, under FAS 123 the write-off of the related deferred tax asset in excess of the benefits of the tax deduction is recognised in the income statement, except to the extent that there is remaining additional paid-in capital from excess tax deductions from previous share-based payment transactions.

Recently, both Boards reconsidered this issue. The IASB agreed to retain the approach proposed in ED 2, while the FASB agreed to retain the approach applied in FAS 123. In essence, the two Boards have reached different conclusions about the transaction(s) or event(s) to which the tax effects relate:

The IASB view is that the tax effects relate to an income statement item, remuneration expense, and therefore all of the tax effects should be recognised in the income statement.

The FASB view is that the tax effects relate to both an income statement item and an equity item, and therefore the tax effects should be allocated between the income statement and equity.

The IASB and FASB voted on who could accept:

  • All to the income statement.
  • A split between equity and the income statement.

A majority could accept the split approach. A further vote of IASB members indicated a majority could accept the split approach.

In addition to discussing these two views, the Boards will also discuss a related issue, concerning the allocation method that should be applied where the tax effects should be allocated between the income statement and equity.

The IASB staff has developed an alternative allocation method from that applied in FAS 123, under which all tax benefits are recognised in the income statement, except for, and to the extent that, any tax benefits arise from the application of a later measurement date for tax purposes, which are recognised in equity. For example:

A share option has $2 intrinsic value, $4 time value (= $6 fair value) at grant date. The tax deduction is based on the intrinsic value at exercise date, which is $8. The tax rate is 40%.

Tax benefits received: $8 x 0.40 = $3.20

Tax benefits credited to equity: $(8 - 2) x 0.40 = $2.40

Tax benefits credited to the income statement: $(3.20 - 2.40) = $0.80 (or $2 x 0.40)

Note: in the above example, the option has an intrinsic value of $2 at grant date. However, for options granted at-the-money, with no intrinsic value, all tax benefits will be credited to equity.

In developing this alternative allocation method, the following issues arose:

  • The treatment of tax shortfalls, that is, when the tax deduction turns out to be less than the recognised expense.
  • How to calculate the deferred tax asset between the period in which the expense is recognised and the period in which a tax deduction is made.
In considering the first issue, the IASB staff identified three alternative approaches:
  • Recognise the shortfall in the income statement, so that the total amount of tax benefits recognised in the income statement does not, in the end, exceed the total tax benefits ultimately received.
  • Recognise the shortfall in equity, to ensure symmetry between the treatment of excess tax benefits and shortfalls.
  • Recognise the shortfall in equity, but only to the extent that excess tax benefits on other share-based payment transactions were recognised in equity.

The IASB staff developed an allocation method that applies the approach in the first bullet above, and the FASB staff developed an allocation method that applies the approach in the second bullet.

An indicative vote indicated 10 in favour of any reversals going through the income statement and 11 in favour of equity.

It was agreed that the staff should develop the positions for consideration at future meetings of the respective Boards.

In considering how to calculate the deferred tax asset between the period in which the expense is recognised and the period in which a tax deduction is made, the allocation methods developed by the IASB and FASB staff would both require the recognition of a deferred tax asset that is based on a current estimate of the future tax deduction. However, the allocation method developed by the IASB staff limits the deferred tax asset to the tax benefits relating to the cumulative recognised expense, so that a deferred tax asset is not recognised for the portion of the expected future tax benefits that relates to an equity item. The allocation method developed by the FASB staff does not include this limitation.

This issue will be included in the paper to be prepared by the staff and redebated by the Boards.

Reload features

ED 2 proposed that for options with a reload feature, the reload feature should be taken into account, where practicable, when an entity measures the fair value of the options granted. However, if the reload feature is not taken into account in the measurement of the fair value of the options granted, then the reload option granted should be accounted for as a new option grant. In contrast, FAS 123 requires that, in all cases, the reload feature should not be included in the grant date valuation and therefore all reload options granted should be accounted for as a new option grant.

The IASB recently agreed to retain the proposal in ED 2, while the FASB recently agreed to retain the approach in FAS 123.

The IASB and FASB staff believe there are a number of alternative approaches to this issue: Incorporate the fair value impact of a reload feature at grant date into the estimate of the grant's fair value unless it is not deemed practicable (ED 2 approach) Treat all reload grants as new awards (FAS 123 approach) Treat reload grants dependent on non-market-based performance conditions as new grants and incorporate the fair value impact of a reload feature dependent on market-based conditions into the award's grant-date fair value

The IASB staff supports the first approach. One FASB staff member supports this approach while another supports approach the second approach.

It was noted that FASB members considered practicality and simplicity in reaching their view. The majority of IASB members agreed to move to the FAS 123 approach.

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