International Financial Reporting Standard 2 mandates measuring the cost of the scheme at fair value and amortising it over the vesting period.
A few years ago, employee stock option schemes, or ESOPs as they are popularly known, were one of the stellar ways for compensating employees. Much has happened since, and we now have Share Purchase Plans, Optional Stock Plans and Restricted Stock Awards all variants of the original scheme but with subtle changes that can cause a conundrum in accounting.
The International Financial Reporting Standard (IFRS) 2 on share-based payments appears to have kept pace with the law and has a solution for any issue that could come up. In substance, IFRS 2, whose scope stretches beyond employees to include share barter transactions with outsiders too, mandates measuring the cost of the scheme at fair value and amortising it over the vesting period.
The fact that we are moving from an era of International Accounting Standards to an era of International Financial Reporting Standards suffices to conclude that the focus is going to shift from mere accounting to financial reporting.
Reverse or write-off?
Under IFRS 2, vesting conditions need to be satisfied for the share-based scheme to be successful. A few minimum vesting conditions are that the employee should continue to remain in service for a specified period or specified performance targets by the entity are to be met. However, in case there is a failure to meet the vesting condition, two different methods of accounting treatment are prescribed under IFRS 2.
In case the failure is because of the employer, it is treated as an acceleration of vesting and all unamortised costs relating to the options are consumed in the income statement immediately. However, in case the failure originated from the employee, IFRS 2 is silent. An amendment has been proposed to IFRS 2 to ensure that employee cancellations are also treated on a par with employer cancellation and recognised in the profit and loss account in the year in which the cancellation occurs.
There is also a certain degree of confusion about the vesting conditions themselves. By definition, these ensure that the counter-party pays for the instruments issued service and performance conditions set on an employee could be the simplest example.
The issue arose as to whether the standard should stick to these as vesting conditions or look at others too regular plan contributions over a defined period or an initial grant in a matching share scheme, for instance.
It concluded that it would not be necessary to consider the latter as vesting conditions owing to the sheer accounting imbroglios it can unfold and also because of the fact that the only conditions that ensure that the counter-party provides the services required to pay for the equity instruments granted are either the service conditions themselves, or the conditions that directly affect the services rendered.
In case the amendments proposed are accepted, IFRS 2 would be consistent with SFAS 123 share-based payment which would eliminate one area of reconciliation between US GAAP and IFRS.
We appear to have gone into a silent mode as far as issuing new standards are concerned, or amending already issued standards to ensure that they match the IFRS or IAS requirements. We have an early mover advantage since we have modelled our standards on IAS and all we need to do is a bit of tweaking.
We have a Guidance Note on Stock Option Plans and Financial Instruments it provides alternative modes of treatment instead of mandating fair value as IFRS 2 and 7 dictate.
Mohan R. Lavi
(The author is a Hyderabad-based chartered accountant.)