IAS 37 PROVISIONS, CONTINGENT LIABILITIES AND CONTINGENT ASSETS

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1 IAS 37 PROVISIONS, CONTINGENT LIABILITIES AND CONTINGENT ASSETS - Anand Banka BASIC CONCEPTS Liability Present obligation Past event Which will result in outflow Obligating event Legal or constructive obligation Provisions Uncertain timing or amount 1

2 BASIC CONCEPTS Contingent liability Possible obligation Present obligation but outflow not probable Not reliably measurable Onerous contract Obligations exceed economic benefits PROVISION VS. REVENUE Customer Loyalty Program Bad Debts Warranties Cash discount if paid 45 days Dealer discounts escalation clause 2

3 RECOGNITION Provision Present obligation (Legal or Constructive) Probable outflow of resources Reliable estimate can be made Contingent Liability Not recognized Disclosed Contingent Assets Not recognized Disclosed only when probable LEGAL OR CONSTRUCTIVE OBLIGATION Legal Obligation Constructive Obligation Contract t Established pattern of past practices Law/ Act/ Legislation Published Policies Creation of valid expectations 3

4 CASE STUDY Which of the following does not lead to recognising a provision? There is a legal or constructive obligation There is a probable outflow of resources There is a general risks of future losses The amount can be estimated reliably CASE STUDY Case filed by customer on September 15 Year end December 31 Whether provision required? 4

5 CASE STUDY Government planning to declare a land as forest land The Company has a warehouse on that land Whether provision required? MEASUREMENT Best estimate Judgment Expected value Present value, if material Future events 5

6 CASE STUDY Warranty on products Manufacturing defects repaired for free Minor defects in all 1 mio Major defects in all 4 mio Past experience 75% - no defects 20% - minor defects 5% - major defects Expected value = 75% * NIL + 20% * 1 mio + 5% * 4 mio CASE STUDY Dismantling cost A new technology to be launched after 3 years Existing cost: 10 lacs Cost as per new technology: 7 lacs 6

7 CASE STUDY 2009 Provision for advertisement = Actual expense for advertisement = 70 Bonus given to salesman based on 2009 sales = 20 Can the company setoff the provision against this expense and reverse the remaining 10? REIMBURSEMENTS Separate asset Expense may be net of reimbursements 7

8 ONEROUS CONTRACTS Unavoidable costs > Economic benefits Example: - Company X enters into a contract to lease a warehouse for Rs. 10,000 a month Contract cancellable within 2 years only on payment of Rs. 1 Lakhs Company stops using the warehouse after one year RESTRUCTURING Sale or termination of a line of business Closure of business at a location Relocation Changes in management structure e.g. eliminating a layer of management 8

9 CONSTRUCTIVE OBLIGATION Detailed formal plan including identification of Business concerned Locations Approximate number of employees Expenditure involved Timing of implementation of the plan Raised a valid expectation by making an announcement CASE STUDY XP oil company limited No laws/ legislations l regarding contamination Company announces environmental policy for clean up Whether provision required? 9

10 CASE STUDY Manufacturer Purchaser Contract Price: 100 mio Cost of the project: 70 mio Penalty of 50 mio if not delivered on time SUMMARY Asset Virtually certain (>=90%) Recognize Contingent Asset Probable (> = 50%) Possible (< = 50%) Remote (< = 10%) Disclose No Disclosure No Disclosure Liability Virtually Certain Probable (reliably measurable) Recognize Recognize Contingent Liability Probable bl disclose Possible disclose Remote do not disclose 10

11 DECISION TREE Start Present Obligation as a result of an obligating event? No No Possible Obligation No No Yes Yes Yes Probable outflow No No Remote? Yes Yes Yes No Reliable estimate No No (rare) Yes Yes Provide Disclose Contingent liability Do nothing 11

12 QUESTION # 1 The company introduced a new car model two months before the reporting date. This model, in accordance with company policy which applies to all cars sold by the company, is guaranteed for a period of 12 months, whereby the company covers the costs of repairs for any defects. By the reporting date and the date when the financial statements are prepared, no claims have been received concerning this model. QUESTION # 2 A famous actor, who bought a specially designed version of the A170 model from the company last year, had an accident with a deer five days before the reporting date. The car was completely destroyed and the actor was badly hurt. A few days ago, the company received notification that the actor had filed a lawsuit against the company, alleging that the brakes which were guaranteed to last for two years, had failed and caused his accident. He claims Rs. 50L for the replacement of the car and another Rs.20L for medical and hospital bills and compensation for revenue lost during the week he spent in the hospital. The company reviewed the situation with its legal advisor who recommended that the company contest the case and strongly believes that the company will not be required to pay anything based on similar cases in the past. 12

13 QUESTION # 3 The company purchased a batch of goods from its supplier, which contained some defective items. The batch was then sold unopened to one of the company s customers. The company was informed, prior to the issuance of its financial statements, that this customer won its claim for the defective product delivered Rs. 3 L. However, under the terms of the company s agreement with its supplier, the cost of any defect is recoverable from the supplier including along with penalty and an add-on (penalty) of 12%. The supplier has already indicated that it will reimburse Rs. 3.36L to the company. No provision had been recognised as it was believed that no obligation was incurred. Anand Banka anand.banka@talatiandtalati.com Mob:

14 IAS 12 INCOME TAXES - Anand Banka SCOPE Income tax = Current tax + Deferred tax 1

15 RECOGNITION OF CURRENT TAX On the basis of computation of tax Tax for the year = expense Tax payable = liability Tax paid but recoverable = asset MEASUREMENT OF CURRENT TAX Applicable tax rate for that type of income 1. General rate 2. Specific rates (e.g. capital gains tax rate) 2

16 RACK YOUR BRAINS!!! What is deferred tax? Why is it required? UNDERSTANDING DEFERRED TAX Library X purchases books costing Rs. 100 million having a useful life of 2 years As per the tax laws, 100% depreciation is allowed in the first year itself Profit before depreciation and tax was Rs. 200 million 3

17 UNDERSTANDING DEFERRED TAX Year 1 Year 2 Profit before depreciation and tax 200,000, ,000,000 Depreciation (100,000,000/2) (50,000,000) (50,000,000) Profit before tax 150,000, ,000,000 Profit as per taxation laws 100,000, ,000,000 Current tax expense (30% of tax profits) (30,000,000) (60,000,000) Effective tax rate 20% 40% Profit after tax 120,000,000 90,000,000 WHY DEFERRED TAX? Fundamental Accounting Assumptions Going concern Consistency Accrual 4

18 WHY DEFERRED TAX? Year 1 Year 2 Profit before depreciation and tax 200,000, ,000,000 Depreciation (100,000,000/2) (50,000,000) (50,000,000) Profit before tax 150,000, ,000,000 Profit as per taxation laws 100,000, ,000,000 Current tax expense (30% of tax profits) (30,000,000) (60,000,000) Deferred tax (15,000,000) 15,000,000 Profit after tax 105,000, ,000,000 BALANCE SHEET METHOD The Balance Sheet Liability method is based on the following principles: Asset recorded in the financials will be realised for at least its carrying amount in the form of future economic benefits, in future periods that will give rise to amounts used in determination of tax 5

19 IMPORTANT TERMS Timing differences are the differences between taxable income and accounting income for a period that originate in one period and are capable of reversal in one or more subsequent periods Temporary Difference is a difference between the carrying amount of an asset or liability and its tax base Balance Sheet method Tax Base is the amount that will be deductible for tax purposes. If the economic benefits will not be taxable, the tax base of the asset is equal to its carrying amount TAX BASE CASE STUDY Cost of Machine = 100 Depreciation rate as per books = 10% Depreciation rate as per tax = 20% Tax Base after 1 year =? 6

20 TAX BASE CASE STUDIES Interest receivable = 100 (taxed on cash basis) Trade receivable = 100 (related revenue taxed) Penalties payable = 100 (not allowable as an expense) IMPORTANT TERMS Taxable temporary differences are temporary differences that will result in taxable amounts in determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled Deductible temporary differences are temporary differences that will result in amounts that are deductible in determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled 7

21 SHORTCUT BV of Assets > Tax Base BV of Assets < Tax Base BV of Liability < Tax Base BV of Liability < Tax Base DTL DTA DTL DTA CASE STUDY PPE original cost = 100 Useful life = 10 yrs, depreciation = 10% Tax depreciation = 20% Year 1: Book Value = 90 Tax Base = 80 Taxable Temporary Difference = 10 8

22 CASE STUDY Interest receivable = 100 Tax Base = 0 Taxable Temporary Difference = 100 CASE STUDY Warranty Provision = 100 Tax Base = 0 Deductible Temporary Difference = 100 9

23 SUMMARY Book Value vs. Tax base = Temporary differences Deductible Taxable MEASUREMENT OF DEFERRED TAX Applicable tax rate Based on expected manner of recovery Use normal tax rate Sale/ disposal capital gains Rate enacted or substantively enacted by end of the reporting period No Discounting 10

24 SUMMARY Book Value vs. Tax base = Temporary differences Deductible Taxable Tax rate applicable SPECIFIC ISSUES Revaluation of Assets Business Combination Consolidation Undistributed Profits Land Foreign Currency Translation Reserve (FCTR) 11

25 REVALUATION OF ASSETS WDV as per book as well as tax = 100 Remaining useful life = 5 years i.e. 20% p.a. Tax depreciation rate = 20% Revalued Amount = 150 Taxable Temporary Difference = 50 Reversal on Sale Excess depreciation every year ACCOUNTING ENTRY Revaluation Reserve A/c Dr. 15 (50 * 30%) To DTL A/c 15 12

26 BUSINESS COMBINATION Company A buys Company B for Rs. 1,500 Book value of assets of B = 1,000 Fair value of assets of B = 1,200 Goodwill = 1,500 1,200 = 300 Taxable temporary difference = 1,200 1,000 = 200 DTL = 200 * 30% = 60 Goodwill = = 360 ACCOUNTING ENTRY Goodwill A/c Dr. 60 (200 * 30%) To DTL A/c 60 13

27 CONSOLIDATION Company X (Holding) Cost to X = 60 Sold to Y = 100 Company Y (Subsidiary) Consolidated Accounts Stock = 100 Unrealised Gain = (40) Net Stock = 60 Tax Base for Y = 100 ACCOUNTING ENTRY DTA A/c Dr. 12 (40 * 30%) To P&L A/c 12 14

28 LAND Land is a non-depreciable asset As per Income Tax Act, land is eligible for indexation benefit Tax base of land > Carrying amount of land FCTR Holding Company Subsidiary Company Net Assets Rs. 7,000 Net Assets $ 50 Consolidated Company Net Assets Rs. 9,500 FCTR Rs. 300 DTL on 30% = 90 15

29 ACCOUNTING ENTRY FCTR A/c Dr. 90 (300 * 30%) To DTL A/c 90 RECOGNITION OCI Equity Goodwill P&L If the item has been recognized in OCI If the item has been recognized in Equity If it arises on business combination All other cases 16

30 EXAMPLES OCI Revaluation of PPE (IAS 16) Intangibles (IAS 38) AFS (IAS 39) FCTR (IAS 21) Cash Flow Hedge (IAS 39) Equity Compound Financial Instruments (IAS 39) Adjustments to opening balance of retained earnings (IAS 8/ IFRS 1) Share Based Payments (IFRS 2) SUMMARY Book Value vs. Tax base = Temporary differences Deductible Taxable Tax rate applicable Profit or loss OCI / Equity Goodwill 17

31 RECOGNITION OF DEFERRED TAX ASSETS All Deferred Tax Assets Probable Certainty Taxable temporary differences Taxable profits CASE STUDY Company Deductible Tax DTA Forecasted DTA Temporary Rate profit recognized Difference A % 200 1,000? B % ? C % 200 (500)? 18

32 REASSESSMENT Unrecognized deferred tax assets Recognized deferred tax assets Anand Banka Mob:

33 IFRS 2/ IND-AS 102 SHARE BASED PAYMENTS -Anand Banka SCOPE Share-based payments Equity-settled share-based payments Cash-settled share-based payments Share-based payments with cash alternatives Entity receives goods/services as consideration for equity instruments. Entity receives goods/services by incurring a liability to transfer cash or other assets to the supplier for amounts that are based on the price (or value) of the entity s shares. Either entity or the counterparty has a choice to settle in equity instruments or in cash or other assets. e.g. Shares, Options against receipt of services from employees e.g. Share appreciation rights 1

34 EXAMPLES Company purchases 10 sacks of rice for 100 shares Company grants 100 ESOPs Company gives 100 shares for 10 years land lease Company gives 100 shares for advertisement in newspaper Company buys 10 sacks of rice for 100 shares worth (100 shares * share value on the date of delivery) ABC Ltd. obtains 60% of the equity of XYZ Ltd. by issuing equity shares SCOPE OUT Transactions with employee-shareholders (in capacity of shareholders) Transactions under business combination 2

35 CASE STUDY Employee holds 100 shares Entity grants ESOP of 100 more shares Whether share based payment? Entity declares bonus of 1:1 to all share holders Employee gets another 200 shares Whether share based payment? EXAMPLE Franco Ltd procures 75% of the shares of Macro Ltd. In the financial books of Franco Ltd, does this transaction qualify as a share based payment? Answer: This transaction is a procurement of shares, which h are financial i instruments. t Financial i instruments are outside the scope of share-based payment. Hence this transaction does not fall within the scope of share-based payment. 3

36 IFRS 2 VS. IAS 32/39 Company E enters into a forward contract to buy certain quantity of steel at a price equal to 1000 of company E s ordinary shares. Company E can settle the contract net, but does not intend to do so (nor does it have a practice of doing so). This transaction would be with in the scope of IFRS 2. However, if company E had a practice of settling these contracts net, or did not intend to take physical delivery, then the forward contract would be within the scope of IAS 32 and IAS 39 RECOGNITION EQUITY (Equity settled transactions) Goods or Services received or acquired are recognised as Asset or Expense LIABILITY (cash settled transactions) 4

37 MEASUREMENT PRINCIPLES Measurement principles Equity-settled share-based payments Cash-settled share-based payments Non-employees Employees Goods/services are measured directly, based on fair value of goods/services received Goods/services are measured by reference to fair value of equity instruments granted Good/services are measured at the intrinsic value of the equity instruments Goods/services are measured at the fair value of the liability If not reliably measurable If not reliably measurable (only in very rare cases) DETERMINING THE FAIR VALUE OF EQUITY INSTRUMENTS GRANTED Fair Value Measure employee services indirectly, based on fair value of equity instruments granted Fair value of equity instruments measured at market price for instruments with similar terms and conditions (rarely available) If no market exists, fair value is estimated by applying an option pricing model If fair value is not measurable reliably (only in very rare cases), then services are measured at the intrinsic value of the equity instruments Date of measurement Fair value measured at grant date 5

38 CASE STUDY Company buys 100 sugarcane for 10 shares FV of Sugarcane = 10 per sugarcane Face value of shares = 10 Market value of shares = 50 SC = 1000 SC = 500 or 100 CASE STUDY Papa Ltd. is a parent entity of Beta Ltd. Papa Ltd. transfers its own equity instruments to the employees of Beta Ltd. 6

39 ESOP Grant date Vesting period Vesting date Exercise period Exercise date Exercise price ESOP Vesting period Vesting period - the period during which all the specified vesting conditions are to be satisfied Grant date Year 1 Year 2 Year 3 Vesting date Exercise date Time Grant date - the date at which the entity and the counter party have a shared understanding of the terms and conditions of the arrangement Vesting date the date when the vesting conditions for entitlement are satisfied Exercise date is the date when awards (e.g. options) are exercised. 7

40 CASE STUDY Company A agrees with its CEO to grant the CEO share options (to be vested immediately) on 31 May subject to ratification at the AGM. The company s year- end is 30 June and the AGM is held on 31 July. The share options are ratified at the AGM and are eventually issued on 30 September. Grant Date is May 31 July 30 September VESTING CONDITIONS The conditions that determine whether the entity receives the services Vesting conditions Service conditions Performance conditions Market conditions Non-market conditions To complete a specified e period of service To stay employed for 3 three years after grant date Related to the market price of the equity instrument Share price must increase by 15% Performance, but not market price related Revenue must increase by 10% 8

41 NON-VESTING CONDITIONS Non-vesting conditions are all requirements that do not represent service or performance conditions, but which have to be met in order for the counterparty to receive the share-based payment. share-based payment arrangements in which an employee has to provide funding during the vesting period, which is then used to exercise the options; scenarios in which the entity can discontinue the share-based payment plan at its own discretion Taken into account when estimating the fair value Similar to market based performance condition MEASUREMENT ILLUSTRATION (1) - PERFORMANCE CONDITIONS Vesting conditions: Three years continued employment (service condition) A performance condition (see next slide) Assumptions: 100 options granted on 1 January 2001 All employees remain in service over the vesting period of the optiono Grant date fair value of each option, 3.50 (excluding market conditions) Best estimate is that the performance condition is met 9

42 MEASUREMENT ILLUSTRATION (2) - PERFORMANCE CONDITIONS If market condition, e.g., share price hitting a specified level The estimated discount for market-based performance condition is Therefore grant date fair value of each option is 3.00 ( ) Total compensation cost is 300 Expense recognised: Market condition Year Year MEASUREMENT ILLUSTRATION (3) - PERFORMANCE CONDITIONS Now, assume that at the end of 2002 the best estimate becomes that the market condition will not be met (the target share price will not be reached). All service conditions are expected to be met Employee service cost of 300 is recognised even if the market condition is not met (as long as services are provided) Market condition Expense recognised: Year Year Year Total

43 MEASUREMENT ILLUSTRATION (4) - PERFORMANCE CONDITIONS If non-market condition, e.g., certain revenue target must be met: Grant date fair value of each option is 3.50 Total expected compensation cost is 350 Allocate over service period based on best estimate of outcome Employee service cost is adjusted for any forfeiture Expected total compensation cost Accumulated attribution Expensed in prior period(s) Expense in current year (350/3)* (350/3)* MEASUREMENT ILLUSTRATION (5) - PERFORMANCE CONDITIONS Now, assume that at the end of 20X2 the best estimate becomes that only 50% of employees will meet the performance condition. All service conditions are expected to be met. Expected total compensation cost Accumulated attribution Expensed in prior period(s) Expense in current year (350/3)* (175/3)* (175/3)*3 Total

44 MEASUREMENT ILLUSTRATION (6) - PERFORMANCE CONDITIONS Comparison: A change in the expectation whether or not a performance condition will be met is ignored for market-conditions but recognised for non-market conditions. Market condition Non-market condition Expense recognised: Year Year Year Total MEASUREMENT ILLUSTRATION (7) - PERFORMANCE CONDITIONS Question: What if 50% of the employees left the company at the end of 2002? (assuming that this is split equally between employees that have fulfilled and have not fulfilled the performance condition) Market condition Non-market condition Expense recognised: Year Year Year Total

45 MEASUREMENT ILLUSTRATION (8) - PERFORMANCE CONDITIONS Question: What if only 80% of the 100 options ultimately are exercised? Answer: There are no subsequent adjustments after vesting date for equity-settled share-based payments! IFRS SUMMARY 13

46 RELOAD FEATURE For options with a reload feature, the reload feature shall not be taken into account when estimating the fair value of options granted at the measurement date. Instead, a reload option shall be accounted for as a new option grant, if and when a reload option is subsequently granted. AFTER VESTING DATE No change in equity Even if no options exercised Even if market conditions do not get fulfilled Transfer within equity allowed 14

47 CASE STUDY ESOP granted for 100 shares FV on the date of grant = 10 Vesting period = 2 years ACCOUNTING ENTRIES Year 1 Particulars Dr/ Cr Amount Share based payment expense A/c Dr 500 Option Reserve Cr 500 Year 2 Share based payment expense A/c Dr 500 Option Reserve Cr 500 Year end entries Option Reserve A/c Dr 1,000 Share Capital A/c Cr 100 Securities Premium A/c Cr

48 MODIFICATION Separate additional expense if modifications are beneficial to employee e.g. reduction in the exercise price or vesting period No reduction in expenses if modification is not beneficial to employee Minimum expense = original grant date fair value Decrease in exercise price Increase in vesting period Situationti Modification Increase in number of shares offered Shortening exercise period CANCELLATION To be accounted for on accelerated basis Payments made To the extent of FV deduct from equity Excess charge to P&L New equity instruments granted Accounted for as modification Beneficial accounted Non-beneficial ignored Non-vesting condition not met account for it as cancellation 16

49 CASE STUDY An entity grants an employee the opportunity to participate p in a plan in which the employee obtains share options if he agrees to save 25 per cent of his monthly salary of Rs.40,000 for a three-year period. The monthly payments are made by deduction from the employee s salary. The employee may use the accumulated savings to exercise his options at the end of three years, or take a refund of his contributions at any ypoint during the three-year period. The estimated annual expense for the share-based payment arrangement is Rs.12,000. After 18 months, the employee stops paying contributions to the plan and takes a refund of contributions paid to date of Rs.180,000. CASH SETTLED FV of the liability Each year end Difference to profit or loss 17

50 CASE STUDY Mona Ltd manufactures and sells utensils. It buys steel from Steelcraft Ltd. Steelcraft Ltd is to be paid amount equivalent to 1,500 shares of Mona Ltd on the date when the steel is to be delivered. Does this transaction qualify as a cashsettled share based payment transaction? Answer: This transaction involves purchase of goods. The amount of consideration is based on the value of the shares of Mona Ltd. Hence this qualifies as a cash-settled share based payment transaction. STOCK APPRECIATION RIGHTS (SAR) Stock Appreciation Rights (SAR) entitle the employees to claim cash payment to the extent of excess of market price of underlying shares on exercise date over the exercise price. Stock Appreciation Rights are not exercised if market price of underlying shares on exercise date is less than the exercise price. SAR is therefore a call option held by employees. The employer recognise the value of call as expense over the vesting period. 18

51 CASE STUDY Company grants share appreciation rights Current share value = 100 After one year = 110 After two years = 120 After third year = 130 CASH ALTERNATIVES Counter-party has the right to choose Accounted for as Compound Financial Instrument Debt portion accounted as cash settled Equity portion accounted as equity settled Entity has the right to choose Accounted for as Equity Settled Accounted for as Cash Settled, if present obligation Present obligation when settlement in equity has no commercial substance or based on past practice or stated policy 19

52 CASE STUDIES CASE I The following particulars in respect of stock options granted by a company are available: Grant date April 1, 2006 Number of employees covered 525 Number of options granted per employee 100 Vesting condition: continuous employment for 3 years Exercise per share(rs.) 125 Market price per share on grant date (Rs.) 149 Vesting Date March 31, 2009 Exercise date March 31, 2010 Fair value of option per share on grant date (Rs.) 30 20

53 Position on Estimated annual rate of departure 2% Number of employees left=15 Position on Estimated annual rate of departure 3% Number of employees left=10 Position on Number of employees left=8 Number of employees entitled to exercise option = 492 Position on Number of employees exercising the option = 480 Number of employees not exercising the option = 12 Compute expenses to recognise in each year by (i) fair value method (ii) intrinsic Value method and show important accounts in books of the Company by both of the methods. 21

54 SOLUTION Year Fair value of option per share=rs.30 Number of shares expected to be vest under the scheme = (525 X 0.98 X0.98X 0.98) X 100 = 49,400 Fair value = 49,400 X Rs. 30 = Rs 14, 82,000 Vesting period = 3 years Value of option recognized as expense in = Rs. 14, 82,000/3 = Rs.4, 94,000. Year Fair value of option per share = Rs.30 Number of shares expected to be vest under the scheme = (525 15) X 0.97 X 0.97) X 100 = 47,986 Fair value = 47,986 X Rs. 30 = Rs 14, 39,580 Vesting period = 3 years Numbers of years expired = 2 Years Cumulative value of option to recognize as expense in and = (Rs. 14,39,580/3) X 2 = Rs.9,59,720 Value of option recognised as expense in = Rs. 9,59,720 Rs. 4,94,000 = Rs. 4,65,720 22

55 Year Fair value of option per share=rs.30 Number of shares actually vested under the scheme = 492 X 100 = 49,200 Fair value = 49,200 X Rs. 30 = Rs 14, 76,000 Vesting period = 3 years Cumulative value of option to recognize as expense in 3 years = Rs. 14,76,000 Value of option recognised as expense in = Rs. 14,76,000 Rs. 9,59,720 = Rs. 5,16,280 Year Fair value of option per share=rs.30 Number of shares not subscribed = ( ) X 100 = 1, 200 Value of option forfeited = 1,200 X 30 = Rs. 36,000 Employees Compensation A/c. Year Rs Year Rs To ESOP o/s A/c 4,94, By P/L A/c 4,94,000 4,94,000 4,94, To ESOP o/s A/c 4,65, By P/L A/c 4,65,720 4,65,720 4,65, To ESOP o/s A/c 5,16, By P/L A/c 5,16,280 5,16,280 5,16,280 23

56 ESOP OUTSTANDING A/C Year Rs Year Rs To Balance c/d 4,94, By Emp Comp A/c 4,94,000 4,94,000 4,94, To Balance c/d 9,59, By Bal b/d 4,94,000 By Emp Comp A/c 4,65,720 9,59,720 9,59, To Balance c/d 14,76, By Bal b/d 9,59,720 By Emp Com A/c 5,16,280 14,76,000 14,76, To Gen Res (1,200 X 30) To sh Capital (48,000 X 100) To Sec premium (48,000 X 55) 36, By Bal b/d (49,200 X 30) 14,76,000 48,00,000 By bank 60,00,000 (48,000 X 125) 26,40,000 74,76,000 74,76,000 Note: Securities Premium Rs. Exercise Price received per share 125 Value of service received per share 30 Consideration received per share 155 Less: Nominal value per share 100 Securities premium per share 55 24

57 Intrinsic Value method Year Intrinsic value of option per share = Rs.149 Rs. 125= Rs 24 Number of shares expected to be vest under the scheme = (525 X 0.98 X0.98X 0.98) X 100 = 49,400 Intrinsic value = 49,400 X Rs. 24 = Rs 11,85,600 Vesting period = 3 years Value of option recognized as expense in = Rs. 11,85,600/3 = Rs.3,95,200 Year Intrinsic value of option per share = Rs.149 Rs. 125= Rs 24 Number of shares expected to be vest under the scheme = (525 15) X 0.97 X 0.97) X 100 = 47,986 Intrinsic value = 47,986 X Rs. 24 = Rs 11,51,664 Vesting period = 3 years Numbers of years expired = 2 Years Cumulative value of option to recognize as expense in and = (Rs. 11,51,664/3) X 2 = Rs.7,67,776 Value of option recognised as expense in = Rs. 7,67,776 Rs.3,95,200 = Rs. 3,72,576 25

58 Year Intrinsic value of option per share = Rs.149 Rs. 125= Rs 24 Number of shares actually vested under the scheme = 492 X 100 = 49,200 Intrinsic value = 49,200 X Rs. 24 = Rs 11,80,800 Vesting period = 3 years Cumulative value of option to recognize as expense in 3 years = Rs. 11,80,800 Value of option recognised as expense in = Rs. 11,80,800 Rs. 7,67,776 = Rs. 4,13,024 Year Intrinsic value of option per share = Rs.149 Rs. 125= Rs 24 Number of shares not subscribed = ( ) X 100 = 1, 200 Value of option forfeited = 1,200 X 24 = Rs. 28,800 Employee s Compensation A/c. Year Rs Year Rs To ESOP o/s A/c 3,95, By P/L A/c 3,95,200 3,95,200 3,95, To ESOP o/s A/c 3,72, By P/L A/c 3,72,576 3,72,576 3,72, To ESOP o/s A/c 4,13, By P/L A/c 4,13,024 4,13,024 4,13,024 26

59 ESOP OUTSTANDING A/C Year Rs Year Rs To Balance c/d 3,95, By Emp Comp A/c 3,95,200 3,95,200 3,95, To Balance c/d 7,67, By Bal b/d 3,95,200 By Emp Comp A/c 3,72,576 7,67,776 7,67, To Balance c/d 11,80, By Bal b/d 7,67,776 By Emp Com A/c 4,13,024 11,80,800 11,80, To Gen Res (1,200 X 24) To sh Capital (48,000 X 100) To Sec premium (48,000 X 49) 28, By Bal b/d (49,200 X 24) 11,80,800 48,00,000 By bank 60,00,000 (48,000 X 125) 23,52,000 71,80,800 71,80,800 Note: Securities Premium Rs. Exercise Price received per share 125 Value of service received per share 24 Consideration received per share 149 Less: Nominal value per share 100 Securities premium per share 49 27

60 CASE II. The following particulars in respect of stock options granted by a company are available Grant date April Number of employees covered 500 Number of options granted per 100 employee Fair value of option per share on grant 25 date (Rs.) The vesting period shall be determined d as below: a) If the company earns Rs.120 crore or above after taxes in , the options will vest on b) If condition (a) is not satisfied but the company. Earns Rs. 250 crores or above after taxes in aggregate in and , the options will vest on c) If conditions (a) and (b) are not satisfied but the company. Earns Rs. 400 crores or above after taxes in aggregate in , and , the options will vest on Position on a) The company earned Rs 115 crore after taxes in b) The company expects to earn Rs 140 crores in after taxes c) Expected vesting date: March 31, 2008 d) No. of employees expected to be entitled to option =

61 Position on a) The company earned Rs 130 crore after taxes in b) The company expects to earn Rs 160 crores in after taxes c) Expected vesting date: March 31, 2009 d) No. of employees expected to be entitled to option = 465 Position on a) The company earned Rs. 165 crore after taxes in b) No. of employees on whom the option actually vested = 450 Compute expenses to recognize in each year SOLUTION Year Fair value of option per share=rs.25 Number of shares expected to be vest under the scheme = 474 X 100 = 47,400 Fair value = 47,400 X Rs. 25 = Rs 11,85,000 Vesting period = 2 years Value of option recognized as expense in = Rs. 11,85,000/2 = Rs.5,92,500 29

62 Year Fair value of option per share=rs.25 Number of shares expected to be vest under the scheme = 465 X 100 = 46,500 Fair value = 46,500 X Rs. 25 = Rs 11,62,500 Expected vesting period = 3 years Cumulative value of option to recognize as expense in and = (Rs. 11,62,500/3) X 2 = Rs.7,75,000 Value of option recognised as expense in = Rs. 5,92,500 Value of option recognised as expense in = Rs. 7,75,000 Rs 5,92,500 = Rs. 1,82,500 Year Fair value of option per share=rs.25 Number of shares actually vested under the scheme = 450 X 100 = 45,000 Fair value = 45,000 X Rs. 25 = Rs 11,25,000 Vesting period = 3 years Cumulative value of option to recognize as expense in 3 years = Rs. 11,25,000 Value of option recognised as expense in and = Rs. 7,75,000 Value of option recognised as expense in = Rs 11,25,000 Rs 7,75,000 = Rs 3,50,000 30

63 CASE III. Rahul Ltd has offered share options of 200 shares to each of its 1,000 employees. The vesting condition is that the employees need to remain in continuous employment for next 5 years. The estimate t fair value of each share up to is Rs30. The entity estimates that 25% of the employees will leave the organization during the 5 year period. Determine the amount to be recognized in the financial statements SOLUTION Step-1: Fair value on grant date = 200 X 1,000 X 30 = 6,000,000 Step-2: Cumulative charge to statement of comprehensive income: Year1: 6,000,000 X 75% X (1/5) = 900,000 Year2: 6,000,000 X 75% X (2/5) = 1,800,000 Year3: 6,000,000 X 75% X (3/5) = 2,700, Year4: 6,000,000 X 75% X (4/5) = 3,600,000 Year5: 6,000,000 X 75% X (5/5) = 4,500,000 31

64 Step 3: expense for the period: Amount calculated in 2- Amount charged in previous period Year 1: 900,000-0 = 900,000 Year 2 : 1,8000, ,000 = 900,000 Year 3: 2,700,000-1,800,000 = 900,000 Year 4: 3, 6000,000 2,700,000 = 900,000 Year 5: 4,500,000-3,600,000 = 900,000 CASE IV. Pretty Ltd offers 200 shares at Rs 30 to each of its 1000 staff if they stay with them for 3 years. At the end of the first year, 15 employees leave and the entity estimates t that t 25 % will have left at the end of the vesting period. During the second year a further 15 employees leave and the entity revises its estimate of total departures over the vesting period from 25% to 27%. During the third year a further 15 employees leave the entity. Determine the amount to be recognized in the financial statements 32

65 SOLUTION Step 1 - Fair value on grant date: 200 X 1,000 X 30 =6,000,000 Step 2 - Cumulative charge to Statement of comprehensive income: Year 1: 6,000,000 X 75% X (1/3) = 1,500,000 Year2: 6,000,000X 000X 73% X (2/3) = 2,920, Year3: 5,730,000(955X 30X 200) X(3/3) =5,730,000 Step 3- Expense for the period: Amount calculated in 2 Amount charged in previous period Year 1: 1,500,000-0 =1,500,000 Year 2: 2,920,000 1,500,000 = 1,420,000 Year 3: 5,730,000-2,920,000 = 2,810,000 33

66 CASE V. On 1 October 2005, Sanjay LTD granted 100 employees options to purchase 100 shares in the entity. The options vest on 1 October 2007 for those employees who remain employed by the entity until that date. The options allow the employees to purchase the shares for Rs. 9 per share. The market price of the shares was Rs9 on 1 October 2005 and Rs9.5 on 1 Oct The market values of options was Rs3 on 1 Oct 2005 and Rs3.60 on 1 Oct 2006.On 1 Oct 2005, the directors estimated that 10% of the relevant employees would leave in each of the years ended 30 sep 2006 and 30 sep 2007 respectively. It turned out that 2% of the relevant employees left in the year ended 30 sep 2006 and directors now believe that a further 6% will leave in the year ended 30 sep SOLUTION This transaction is an example of an equity-settled share-based payment transaction that is accounted for in accordance with IFRS 2 share-based payment. Such transactions ti are measured using the, market value of the, relevant equity instrument on the grant date. In this case, the relevant market value is Rs.3 (market value of the share option on 1 October 2005). The cost of the grant is taken to statement of comprehensive income over the two-year vesting period. Where the grant is subject to future employment or future conditions then the latest known estimates of the extent of performance are used to determine the total cost. This means that, in this case, the total charge to the statement of comprehensive income will be: 100 X 92 X 3 = Rs. 27,600. In the year ended 30 September 2006, 1/2 of this amount, i.e. Rs. 14,700, is debited to income as an operating cost and credited to equity. 34

67 CASE VI. On 1 April 2004 Saurav limited granted 50 executives call options to purchase up to 1000 shares each on 1 April The options only vest if the executives are still employed on 1 April Personnel estimate that 95% of executives will remain for the 2 year period and exercise their options in full: i. The option price is Rs10 per share ii. The market value of each share was Rs15 on 1 April 2004 and Rs18 31 st March It is Rs19 on 31 st March iii. The market value of share option was Rs3 on 1 April 2004 and Rs2.20 on 31 st march It is Rs on 31 st March on State where in the statement of financial position and where in the statement of comprehensive income the relevant amounts will be presented. Where appropriate, you should justify your treatment with reference to the relevant international financial reporting standards. SOLUTION The market value of a Share options on 1April 2004 was Rs. 3 and so the market value of a Share options is Rs.3 X 50 X 1,000 X 95% = Rs. 142,500 Since the share option is based on service over a two-year period then the charge to income for the current year is ½ i.e. Rs. 71,250. An equivalent amount will be credited to equity and will be included in the future proceeds of issue of the shares, assuming the options are exercised 35

68 Anand Banka Mob: