IFRS 2 Share Based Payments

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This post is a technical one relating to IFRS 2 Share Based Payments. It explains how equity settled share-based payments accounted for when issued by the parent as replacement awards on the acquisition of a subsidiary?

This article assumes that you are basically familiar with IFRS 2 Share Based Payments as it looks at a twist, which is how to account for options issued in a business combination.

Business combinations and the issue of options

In a business combination, the consideration paid by the parent 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 – which will be accounted for as part of the investment in the subsidiary – and any post combination incentives – which will be spread through future profit and loss accounts as an expense.

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

Example: Rachel and Sindhu
Rachel has just acquired all the equity shares in issue of Sindhu for $100 million, paid in cash. As 100% of the shares were acquired there will be no non-controlling interest. Three years ago, Sindhu 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, Rachel issued replacement equity awards to the employees of Sindhu 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 Sindhu was $25 million. The fair value of the net assets of Sindhu at the date of acquisition was $70 million.  
Required. Explain how Rachel will account for the issue of the replacement share based payment awards. Calculate goodwill arising on the acquisition of Sindhu.  

Answer a)

Rachel’s issue of the replacement equity share awards

When Rachel issues those replacement equity awards with a fair value of $51 million to the employees of Sindhu, in substance, it is partly buying out the employees’ equity interest in Sindhu (the pre-acquisition element) and partly providing the employees’ with options in Rachel – as a future reward in their capacity as employees of the Rachel 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 Sindhu $15 million

Cr Equity – Other Components of Equity $15 million.

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 Rachel over the two-year vesting period. In the first two years after the acquisition the annual entry will be  

Dr P/L expense $18 million

Cr Equity – Other Components of Equity $18 million

Answer b)

Goodwill calculation

The goodwill that arises on the acquisition of Sindhu will be the difference between the fair value of the consideration that Rachel has paid for the controlling interest and the fair value of the net assets of Sindhu 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.

FV of the parent’s investment – the controlling interest (100%) 
Cash paid100
Equity-share based awards15
Less the fair value of the net assets at acquisition(70)
Goodwill arising45

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