Blog IFRS 2 Share Based Payments (advanced)

IFRS 2 Equity settled share-based payments and how to account for options issued as part of a business combination = equity settled share-based payments issued as replacement awards.

By Tom Clendon

This blog assumes that you are basically familiar with IFRS2 Share based payments and is looking at a twist, which is how to account for options issued in a business combination.

In a business combination the consideration paid by the acquiror for the controlling interest in the subsidiary must be recorded at the fair value of the consideration given. When the parent simply pays cash for the equity interest in the subsidiary then there are no complications or measurement issues.

However, where the subsidiary has previously issued share options (equity settled share-based payments) to its staff and by the acquisition date these have not vested, then the parent will have to buy out this equity interest as part of its purchase consideration. This can be done by the parent issuing new replacement options. The accounting challenge will then be to analyse the value of these new replacement options and split them between compensation for the pre combination interest and any post combination incentives.

Splitting the value between pre and post

The amount of the new replacement options that represent pre combination services are capitalised as part of the cost of the investment as they relate to a payment for an equity interest in the subsidiary.

The amount of the replacement options that is pre-acquisition will be the proportion of the value of the original options that has been completed.

Whilst the amount attributable to post combination services will be spread through the profit and loss as an expense over the vesting period because that will relate to future employee service.

But this is all best further explained and understood in a worked example.

Example Wang and Hiren

Wang has just acquired all the equity shares in issue of Hiren for $100 million paid in cash. As 100% of the shares were acquired there will be no non-controlling interest.

Three years ago, Hiren had granted equity settled share payment awards to its staff. These were due to vest after five years i.e. in two years’ time. Accordingly, in addition to paying $100 million cash for the shares, Wang issued replacement equity awards to the employees of Hiren with a fair value of $51 million and that will vest in two years after the date of the acquisition. At the date of the acquisition the fair value of the original share award issued by Hiren was $25 million.

The fair value of the net assets of Hiren at the date of acquisition was $70 million.

Required. Explain how Wang will account for the issue of the replacement share based payment awards. Calculate goodwill arising on the acquisition of Hiren.

Answer

Wang’s issue of the replacement equity share awards

When Wang issues those replacement equity awards with a fair value of $51 million to the employees of Hiren, in substance, it is partly buying out the employees’ equity interest in Hiren (the pre-acquisition element) and partly providing the employees’ with options in Wang – as a future reward in their capacity as employees of the Wang group (the post-acquisition element).

The element of the replacement equity award of $51 million that is pre-acquisition will be based on the value of the original options by the ratio that has been completed. $25 million x 3/5 = $15 million. This will be accounted for as part of the parent’s investment in the subsidiary. Dr Investment in Hiren $15 million Cr Other Components of Equity $15 million. As a result, goodwill will increase.

The post -acquisition element is therefore the balance. $51 million less $15 million = $36 million. This will then be spread through the profit and loss account of Wang over the two-year vesting period. In the first two years after the acquisition the annual entry is Dr PL $18 million and Cr Other Components of Equity.

Goodwill calculation

The goodwill that arises on the acquisition of Hiren will be the difference between the fair value of the consideration that Wang has paid for the controlling interest and the fair value of the net assets of Hiren acquired. In addition to the cash paid of $100 million for the shares, $15 million of the replacement awards also related to the purchase of an equity interest.

	$m
FV of the parent’s investment – the controlling interest (100%)
Cash paid	100
Equity-share based awards	15
	115
Less the fair value of the net assets at acquisition	(70)
Goodwill arising	45