Preface

Accounting for employee transactions with a choice of settlement involves understanding the classification of liability and equity components based on IFRS 2 and related standards like IAS 37 and IAS 19 Employee Benefits.

The valuation of compound financial instruments for employee transactions considers the fair value of cash and equity alternatives, ensuring compliance with share-based payment accounting and disclosure requirements under IFRS 2.

Complex arrangements with non-share-based cash alternatives require careful handling of vesting periods, cancellations, and the reclassification of liabilities to equity, aligned with IFRS accounting standards.

If either the entity or the employee has a choice of settlement, then the transaction is accounted for at least in part as cash-settled if the entity will or can be required to settle in cash or other assets.  The following flowchart illustrates the effect on the accounting of the choice of settlement.

General Approach:

If the manner of settlement is not a choice within the control of the entity or the employee but depends on an external event (e.g., an IPO or a change in control), the classification should be determined using an approach based on IAS 37 Provisions, Contingent Liabilities, and Contingent Assets.

Employee’s Choice of Settlement

When the employee has the choice of settlement, the entity grants a compound financial instrument, including both a liability and an equity component. At the measurement date, the fair value of the compound instrument (the value of services to be received) is the sum of the values of the liability component and the equity component.

1. Liability Component: Measured first, equating to the fair value of the liability under the cash alternative.
2. Equity Component: Measured next by subtracting the fair value of the cash alternative from the fair value of the equity alternative. Any positive difference represents the fair value of the equity component.

If the fair value of the cash and equity alternatives are the same, the equity component’s grant-date fair value is zero. If extra value is granted for choosing the equity alternative, the equity component will have a residual value.

Complex Valuation Scenarios

When the fair values of the cash and equity alternatives differ, the compound instrument’s fair value will generally exceed the individual fair values of either alternative. Despite this complexity, the equity component is determined by first valuing the cash alternative for the liability component and then valuing the equity component by accounting for the forfeiture of the cash alternative.

Subsequent Accounting for Components Until Settlement

• Separate Accounting: The liability component follows the requirements for cash-settled share-based payments, while the equity component follows the requirements for equity-settled share-based payments if it has a recognized value.
• Cash Settlement: If the employee chooses cash settlement, the cash payment settles the liability. The equity component remains in equity.
• Equity Settlement: If the employee chooses equity settlement, the liability is transferred to equity as consideration for issuing the equity instruments.

Different Settlement Dates

Determining the grant date and vesting period for transactions with subsequent settlement choices can be challenging. The vesting periods for the two components should be determined separately. Choosing one alternative before the end of the vesting period of the other should be treated as a cancellation of the second alternative.

Non-Share-Based Cash Alternative

An arrangement that provides the employee with a choice of two mutually exclusive settlement alternatives, where only one is accounted for under IFRS 2, should be treated analogously to a share-based payment. The liability for the cash alternative, which is not share-based, embodies the liability component of a compound instrument and should be measured and remeasured according to the appropriate standard (e.g., IAS 19 Employee Benefits). Any incremental fair value of the equity-settled share-based payment over the initial value of the liability component is accounted for as an equity component. The disclosure requirements of IFRS 2 should apply to both elements.

If the choice for a cash alternative is sacrificed, the liability is reclassified to equity. If the cash alternative is exercised, the equity component is treated as canceled because the equity right was surrendered to receive the cash alternative.

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