BE AWARE: THIS SECTION IS SPECIFICALLY AIMED AT EQUITY-SETTLED SBP TRANSACTIONS ONLY! IT DOES NOT APPLY TO CASH-SETTLED SBP TRANSACTIONS! WHY?

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1 Share price PAT 2 BE AWAE: THIS SECTION IS SPECIFICALLY AIMED AT EQUITY-SETTLED SBP TANSACTIONS ONLY! IT DOES NOT APPLY TO CASH-SETTLED SBP TANSACTIONS! WHY? 1. Why would an entity want to modify an equity-settled SBP agreement? Consider the following scenario: The employees were granted share options on 1 January 20X4 on condition that they remain in service for 3 years. The options are exercisable on vesting date at an exercise price of 150 per share. The fair value per share at 1 January 20X4 was 170. The fair value of the share options at this date was 15 per option. The share price began to decrease during 20X4 and by the 31 December 20X4, the share price had dropped to 157 per share. The employees became concerned, disgruntled and de-motivated WHY? exercise price e-pricing the exercise price time What strategies could the entity put into place to change this? Page 1 of 26

2 The entity could adopt a number of strategies to deal with this issue. A few will be discussed below: 1. Do nothing 2. Keep all other conditions the same, but change the exercise price (EPICING: IFS 2 p 26, 27 & B43) 3. Keep all the other conditions the same, but extend the vesting period (IFS 2 B44c) 4. Add a cash alternative to the share options (IFS 2 p 30-33; IG example 9) 5. Cancel the share options and make a courtesy payment to employees (CANCELLATION & SETTLEMENT IFS 2 p 28) 6. Cancel the share options and issue a new EPLACEMENT (EPLACEMENT: IFS 2 p 28c) The underlying principle relating to modifications is that the entity shall recognise, as a minimum, the services received measured at the grant date fair value of the equity instruments granted, unless those equity instruments do not vest because of failure to satisfy a vesting condition (other than a market condition) that was specified at grant date (IFS 2 para 27). Again, this paragraph is congruent with the overall principle that the services received by the employee must be recognised. Example 14: MODIFICATION: Grant of share options that are subsequently repriced (adapted from IG example 7) Grant date Modification date Vesting date Incremental fair value Original option Y 1 Y 2 Y 3 On 1 January 20X4 Company A granted 100 share options to each of its 500 employees on condition that the employees remain in service for at least three years after the options were granted. The share options are exercisable at vesting date at 150 per share. On 1 January 20X4, the fair value of the shares was 170 per share and the fair value of the share options was 15 per option. By 31 December 20X4, Company A s share price had dropped to 157 per share and the fair value of the share options had decreased to 5 per option. On 1 January 20X5 Company A decided to reprice its share options by reducing the exercise price of the share options to 140 per option. The repriced share options also vest on 31 December 20X6. The fair value of the repriced options on 1 January 20X5 was 8 per option. Page 2 of 26

3 At the end of the vesting period, the share price was 155 per share. All vested options were exercised on 31 December 20X6. The table below depicts expectations of Company A during the vesting period: FV original FV new Employees resigned Total estimated employee resignations by vesting date Grant date End 20X End 20X End 20X6 28 You are required to: Prepare the journal entries to account for the equity-settled share based transaction over the full vesting period. Solution Yr 1 D EMPLOYEE EXPENSE C EQUITY (100 options x 390 employees x 15 x 1/3 years) Yr 2 D EMPLOYEE EXPENSE C EQUITY (100 options x 395 employees x 15 x 2/3 years) D EMPLOYEE EXPENSE C EQUITY (100 options x 395 employees x 3 x ½) Yr 3 D EMPLOYEE EXPENSE C EQUITY (100 options x 397 employees x 15) D EMPLOYEE EXPENSE C EQUITY (100 options x 397 employees x 3) Page 3 of 26

4 D BANK C STATED CAPITAL (100 options x 397 employees x 140) Example 15: Modification of vesting conditions (Adapted from IG example 8) Company A granted share options to 18 members of its sales team on 1 January 20X3 on condition that they sell more than units of product X over 3 years. The fair value of the options at grant date was 15 per option. On 1 July 20X4, the sales target was increased to units of product X. At this date, the fair value of the original options was 18 and the fair value of the modified options was 10. By the end of 20X5, the entity had only sold units and the share options were therefore forfeited. At the end of 20X3 and 20X4, Company A had expected all the employees to remain in service for the full vesting period. However, 6 employees resigned during 20X5. You are required to: Prepare the journal entries (if any) required to account for the SBP during the vesting period. 1. Would the journal entries change if the entity sold units instead of the units? 2. What would the journal entries be if the entity had sold units instead of the units? Page 4 of 26

5 Although the shares were forfeited because a vesting condition (non-market vesting condition) was not met (only units sold instead of units), the underlying principle of modifications is that the entity must recognise, as a minimum, the services received measured at the grant date fair value of the equity instruments granted, unless the equity instruments are forfeited because of failure to satisfy a vesting condition that was specified at grant date (at grant date the condition was to sell a minimum of units). Example 16: MODIFICATION: Grant of shares with a cash-alternative added (IG example 9) Company A granted shares to an employee conditional upon 3 years of service. At grant date, the share price was 33, but it dropped to 25 by the end of year 2. At this date, Company A added a cash alternative to the grant where the employee could choose whether to receive the shares or cash to the value of the shares on vesting date. The share price is 22 on vesting date. You are required to: Prepare journal entries for the 3 years. Solution: Before commencing ask yourself; What would the value of the share alternative have been at grant date if the SBP had a cash alternative to commence with (with the same fair value as at modification date)? At grant date the share price was 33 per share (this is the fair value of the total instrument). The liability at the modification date is 25 per share. The value of the equity component (residual) is therefore 8 per share. Journals Yr 1 D EMPLOYEE EXPENSE C EQUITY ( x 33 x 1/3 years) Yr 2 D EMPLOYEE EXPENSE C EQUITY ( x 33 x 2/3 years) (prior year expense) D EQUITY C LIABILITY ( options x 25 x 2/3 years) Page 5 of 26

6 As a cash alternative was added, this creates an obligation to settle in cash. The liability at this date must be calculated with reference to its fair value at year end (25). The recognition of the liability is done by reducing the equity previously raised. The equity at this date (after recognition of the liability) should theoretically be: 8 x x 2/3 = , which it is ( ). Yr 3 D EMPLOYEE EXPENSE C EQUITY C LIABILITY EQUITY: 8 x options (prior year equity) LIABILITY: 22 x options = Example 17: MODIFICATION: Cancellation and settlement of equity settled instrument Company A agreed to issue 20 options to 30 employees at 1 January 20X6. The options vest after 3 years. The fair value of the options at grant date was 10 per option. As the share price and the fair value of the options began to decrease, the directors of the company decided to cancel the options and instead make a cash settlement of 9 per option to the employees on 31 December 20X7. At 31 December 20X7, the fair value of each of the options was 8. You are required to: Prepare the journal entries that Company A would be required to process for the years ending December 20X6 and 20X7. Solution: 31 Dec 20X6 Dr Employee expense Cr Equity options x 30 employees x 10 x 1/3 31 Dec 20X7 Dr Employee expense Cr Equity options x 30 employees x Accelerated vesting, para 28a Dr Equity Cr Liability epurchase of equity (maximum repurchase at fair value of equity para 28b) : 20 options x 30 employees x 8 Page 6 of 26

7 Dr Employee expense 600 Cr Liability 600 Additional benefit given to the employees (20 options x 30 employees x 9) Example 18: MODIFICATION: Cancellation and settlement of SBP with a cash alternative On 1 January 20X6, Co. B granted an employee the right to receive either phantom shares (i.e. cash equivalent to the value of the shares) or shares, on condition that she provides 3 years of service. The share price was 50 at grant date and 40 at 31 December 20X6. During 20X7, the share price continued to deteriorate. Consequently, the directors of the company decided to cancel the SBP agreement with the employee on 31 December 20X7 and instead make a cash settlement of 25 per phantom share granted. At 31 December 20X7, the share price was 22. Assume that the share price is a good estimation of the fair value of the shares. You are required to: Prepare the journal entries that Company B would be required to process for the years ending December 20X6 and 20X7. Solution: 31 Dec 20X6 Dr Employee expense Cr Equity (1 200 x 8.33 x 1/3) Cr Liability (1 000 x 40 x 1/3) Dec 20X7 Dr Employee expense Cr Equity (1 200 shares x 8.33) Accelerated vesting, para 28a Dr Employee expense Cr Liability (1 000 x 25) e-measurement of liability as per para 28b Dr Liability Cr Bank Settlement of liability Page 7 of 26

8 In the above example, the settlement of the share based payment transaction is not recognised as a repurchase of equity but merely as a re-measurement of a liability (through profit or loss). This is because a liability component has already been recognised in a cash-alternative SBP transaction and merely requires re-measurement. Furthermore, this treatment is consistent with the fact that MODIFICATIONS are only applicable to EQUITY-SETTLED share based payments and NOT to cash-settled share based payments, reason being that the liability in a cash-settled transaction is always re-measured to reflect the amount that the entity expects to pay. Example 19: MODIFICATION: Issue of a replacement award (IFS 2 para 28(c) & para B 43(a)) Grant date Modification/ eplacement Original Vesting Modified Vesting Incremental fair value Original option Y 1 Y 2 Y 3 Y 4 On 1 August 20X3 Company Z issued 500 share options with a 3 year vesting period to each of its 5 directors. The options had a strike price of 10 per share. The FV of the options at grant date was 40 per option. By 1 August 20X5, the FV of the options had reduced to 8 per option. On 1 August 20X5 the company cancelled the original options and issued 500 new options to the same 5 employees with a 2 year remaining vesting period. The strike price of the new options was 3 per share and the FV of the new share options on 1 August 20X5 was 30 per option. All employees were expected to remain in service throughout the vesting period. You are required to: 1. Calculate the cumulative employee expense if the new options were considered to be replacement awards. 2. Calculate the cumulative employee expense if the new options were NOT considered to be replacement awards. Page 8 of 26

9 3. Prepare the journal entries required to recognise the share based payment transaction for the years ended 31 December 20X3; 20X4; 20X5 and 20X6. Assume that the new awards were regarded as replacement awards. Solution Part 3 31 Dec 20X3 Dr Employee expense Cr Equity options x 5 employees x 40 x 5/36 months 31 Dec 20X4 Dr Employee expense Cr Equity (500 options x 5 employees x 40 x 17/36 months) Dec 20X5 Dr Employee expense Cr Equity (500 options x 5 employees x 40 x 29/36 months) Dr Employee expense Cr Equity Incremental FV increase is recognised from modification date to modified vesting date (500 options x 5 employees x 22 x 5/24 months) 31 Dec 20X6 Dr Employee expense Cr Equity Original grant date FV recognised up until original vesting date (500 options x 5 employees x 40 x 36/36 months) Dr Employee expense Cr Equity (500 options x 5 employees x 22 x 17/24 months) IFS 2 para B43(a) IFS 2 para B43(a) Take note that if the modified vesting date was earlier than the original vesting date, then the original grant date FV would have been recognised up to the earlier modified date in terms of para B43(c). This would be treated as a change in estimate. Page 9 of 26

10 If you recall, the probability of a non-vesting condition being met is included as part of the fair value of the equity instrument at grant date. The consequence of this is that a non-vesting condition has no further impact on the recognition of the employee expense. In other words, the recognition of the employee expense is based only on the performance of the vesting conditions (other than market conditions). Furthermore, whether the non-vesting condition is met or not does not impact the recognition of the employee expense over the full vesting period. It must be emphasized however that IFS 2 para 21 is really referring to those non-vesting conditions in which neither the entity nor the counterparty have the ability to choose whether or not the non-vesting condition can be met. An example of such a vesting condition would be the benchmark petrol price must not exceed US$500 per barrel. Paragraph 28A stipulates that if an entity or counterparty has a choice of whether or not to meet a non-vesting condition, the entity shall treat the entity s or counterparty s failure to meet that nonvesting condition during the vesting period as a cancellation. In this instance, the employee expense is still fully recognised, however, it is accelerated to the date of cancellation. An example of such a condition would be where an employee is required to set a certain amount of his monthly salary aside into a certain share fund in order to later have the funds to settle the exercise price of the share options. Explain why, in your opinion, the failure to meet a non-vesting condition in this instance, should be treated as a cancellation? For a comprehensive example, refer to IG example 9A. Page 10 of 26

11 To review at home: AT THIS POINT IN THE LECTUES YOU SHOULD HAVE GAINED THE FOLLOWING ADDITIONAL UNDESTANDING 1. Explain what a cash-settled transaction is and the underlying principle for measuring these transactions. 2. Explain what a cash-alternative is and how it is different to offering employees a choice at grant date to settle in shares or cash. 3. Explain with reasons how you would determine the value of the equity and liability components of a share based transaction with a cash alternative. 4. In your own words, describe the underlying principle governing the accounting for modifications of equity-settled share based transactions. 5. Describe the ways in which equity-settled share based payments can be modified and the appropriate accounting treatment for each. 6. Explain why the modifications section of IFS 2 is specific only to equity-settled transactions and not to cash-settled transactions. 7. Briefly explain why the failure to meet a non-vesting condition where the entity or the counterparty has the choice on whether to meet the conditions or not, is treated as a cancellation. Page 11 of 26

12 PAT 3 The IFS 2 implications of share based payments within group transactions are discussed in IFS 2 para 43A 43D & B45 B61 and in IFS 3 para 52(b); B56 to B62B. PAENT SUB A SUB B eceives goods/services efer to IFS 2 p 43A & 43B Settles the transaction efer to IFS 2 p 43C Questions to ask? 1. What awards are granted by Sub B? Sub A s equity instruments? O 2. Does Sub A have the obligation to settle the SBP? Questions to ask? 1. What awards are granted by Sub B? Sub B s equity instruments? 1. How would the transaction depicted by the diagram above be recognised in the separate financial statements of subsidiaries A and B? 2. How would the transaction depicted by the diagram above be recognised in the consolidated financial statements? Page 12 of 26

13 Example 20 You are required to state whether the following transactions will be accounted for as equity-settled or cash-settled in the separate financial records of the subsidiary and in the consolidated financial statements. Separate (S) Separate (H) Consolidated Transaction Equity/Cash-settled Equity/Cash-settled Equity/Cash-settled 1 Parent (H) grants S s employees options to H s shares : (See IFS 2 para B50; B52(a); B53) Not S s shares, but also no obligation to settle. Therefore equity-settled. H s shares, thus equity-settled. 2 Parent (H) grants S s employees options to S s shares: (See IFS 2 para B50) (IFS 2 p B50) H s (part of group) shares, thus equitysettled. (IFS 2 p B50) 3 S grants its own employees options to H s shares: (See IFS 2 para B52(b); B55) 4 Parent (H) grants S s employees share appreciation rights over S s shares. (See IFS 2 para B56(a); B57) 5 Parent (H) grants S s employees share appreciation rights over H s shares. (See IFS 2 para B56(b); B57) Page 13 of 26

14 Example 21: Parent company issues options over its own shares to employees of subsidiary company On 1 July 20x0 a parent company (HCo) issued options over of its own shares to employees of its subsidiary (SCo). The fair value of the options at grant date was 1 per option. The options are exercisable between 1 July 20x2 and 1 July 20x3 at 1.50 each and will vest if the employees remain in the employ of SCo for two years from grant date. All the employees remained and were expected to remain in the employ of S Co until vesting date. All the options were exercised on 1 October 20x2. The H Co group financial year ends on 31 December. You are required to: Prepare the journal entries to recognise this share based payment for the financial years ended 31 December 20X0; 20X1 and 20X2 in the financial statements of: 1. The subsidiary company (SCo) 2. The parent company (HCo) 3. The consolidated financial statements of HCo. Solution: SEPAATE FINANCIALS OF SUBSIDIAY In the separate financial statements of the subsidiary this SBP is treated as equity-settled. WHY? 20x0 Dec 31 Employee expense 750 Equity (contributed by parent) 750 Value of options granted by parent company (3 000 options x 1 x 6/24) 20x1 Dec 31 Employee expense Equity (contributed by parent) Value of options granted by parent company expensed 20x2 June 30 Employee expense 750 Equity (contributed by parent) 750 Value of options granted by parent company expensed Page 14 of 26

15 SEPAATE FINANCIALS OF PAENT In the separate financial statements of the parent this SBP is treated as equity-settled. WHY? 20x0 Dec 31 Investment in SCo 750 Equity 750 Value of options granted to subsidiary employees (3 000 options x 1 x 6/24) 20x1 Dec 31 Investment in SCo Equity Value of options granted to subsidiary employees 20x2 June 30 Investment in SCo 750 Equity 750 Value of options granted to subsidiary employees 20x2 Oct 1 Bank Stated Capital options exercised (3000 x 1.50) GOUP FINANCIALS OF PAENT In the consolidated financials this SBP is treated as equity-settled. WHY? The inter-company journal entries between the parent and the subsidiary must be reversed in order to achieve this purpose. 20x0 Dec 31 Equity (contributed by parent) 750 Investment in SCo 750 eversal of inter-company transactions on consolidation 20x1 Dec 31 Equity (contributed by parent) Investment in SCo eversal of inter-company transactions on consolidation Page 15 of 26

16 20x2 June 30 Equity (contributed by parent) 750 Investment in SCo 750 eversal of inter-company transactions on consolidation Example 22: Cash-settled share-based instrument issued by parent company to employees of subsidiary company On 1 July 20X0 the parent company (HCo) issued share appreciation rights (SAs) to employees of its subsidiary (SCo). The SA s vest and are exercisable on 30 June 20X2. The employees are entitled to receive cash equivalent to the value of shares in HCo at the date on which the right is exercised. All employees were expected to remain (and remained) in service for the fully two-year vesting period. The fair value of the SA s is as follows: Date Fair value per SA 1 July 20X Dec 20X Dec 20X June 20X The financial year end of all entities in the group is 31 December. You are required to: Prepare the journal entries to recognise this share based payment for the financial years ending 31 December 20X0; 20X1 and 20X2 in the financial statements of: 1. The subsidiary company (SCo) 2. The parent company (HCo) 3. The consolidated financial statements of HCo. Page 16 of 26

17 Solution SEPAATE FINANCIALS OF SUBSIDIAY In the separate financial statements of the subsidiary this SBP is treated as equity-settled. WHY? 20x0 Dec 31 Employee expense 750 Equity (contributed by parent) 750 Value of options granted by parent company (3 000 options x 1 x 6/24) 20x1 Dec 31 Employee expense Equity (contributed by parent) Value of options granted by parent company expensed 20x2 June 30 Employee expense 750 Equity (contributed by parent) 750 Value of options granted by parent company expensed SEPAATE FINANCIALS OF PAENT In the separate financial statements of the parent this SBP is treated as cash-settled. WHY? 20x0 Dec 31 Investment in SCo Liability Value of SA s granted to subsidiary employees (3 000 options x 1.80 x 6/24) 20x1 Dec 31 Investment in SCo Liability Value of SA s granted to subsidiary employees (3 000 options x 2.70 x 18/24) x2 June 30 Investment in SCo Liability Value of SA s granted to subsidiary employees (3 000 options x 2.90) Page 17 of 26

18 20x2 June 30 Liability Bank SAs paid out at intrinsic value (2.90) GOUP FINANCIALS OF PAENT In the consolidated financials this SBP is treated as cash-settled. WHY? The inter-company journal entries between the parent and the subsidiary must be reversed in order to achieve this purpose. 20x0 Dec 31 Equity (contributed by parent) 750 Employee expense 600 Investment in SCo eversal of inter-company transactions on consolidation. From a group perspective, the SBP is cash-settled; hence the employee expense should mirror the measurement of the liability. 20x1 Dec 31 Equity (contributed by parent) Employee expense Investment in SCo eversal of inter-company transactions on consolidation. From a group perspective, the SBP is cash-settled; hence the employee expense should mirror the measurement of the liability. 20x2 June 30 Equity (contributed by parent) 750 Employee expense Investment in SCo eversal of inter-company transactions on consolidation. From a group perspective, the SBP is cash-settled; hence the employee expense should mirror the measurement of the liability. Page 18 of 26

19 By this I mean Equity instruments issued on acquisition of a subsidiary. There are three SBP scenarios that could occur/exist at acquisition date pertaining to the subsidiarys employees. These are listed as follows: 1. The parent replaces the existing or vested awards of the subsidiary to their employees. This occurs only when there is a contractual or legal obligation to replace these awards (IFS3 para B56 to B62). 2. The parent does not grant any awards to the employees of the subsidiary. However, at acquisition date the subsidiary has an existing equity-settled share based transaction with its employees (IFS 3 para B62A and B62B). 3. The parent grants awards to the employees of the subsidiaries, but these are not replacement awards (IFS 2 para 43A to 43D as discussed in section above). In this section, we will be reviewing the scenarios posed under points 1 and 2 above. EPLACEMENT AWADS If a parent replaces either existing awards or unexercised awards that have vested, they are in fact making an additional payment at acquisition. Do you agree? What we need to establish is whether the payment is being made for past services (i.e. services that the subsidiary s employees rendered before acquisition date) or for future services (IFS 3 para 51 & 52). Why is this important? ACQUISITION DATE H EPLACES S s AWADS PAST SEVICE FUTUE SEVICE GANT DATE S granted awards to its employees. Market-based measure (B57) FV of original instrument FV of new instrument VESTING DATE Page 19 of 26

20 1. How will this transaction be recognised in the separate financial statements of the subsidiary and the parent? 2. How will this transaction be recognised in the consolidated financial statements? Example 23: Parent replaces subsidiary awards at acquisition: Original vesting period is completed before acquisition and there are no future services required of the employees (IFS 3 IE63 to IE64). AC (parent) acquired 100% of TC on 1 July 20X5 for 915 when the stated capital of TC was 100, the retained earnings was 815 and the equity relating to share based payments was 86. At acquisition date, AC issued replacement awards to TC s employees with a market based measure of 110. The market based measure of TC s awards was 100 at acquisition date. No post combination service is required of TC s employees and the awards had vested by acquisition date. The original vesting period was 4 years which ended on 30 June 20X5. The grant date fair value of TC s awards was 86. You are required to: 1. Calculate the portion of the market based measure of AC s awards that relate to pre- & postcombination services. 2. Prepare the journal entries that are required at acquisition date in the separate records of the subsidiary and the parent, as well as on consolidation. TC (SUB) D Employee expense C Equity (contribution by parent) Subsidiary: treated as a modification per IFS 2 (see IFS 3, B56) AC (PAENT) D Investment in S Co. (100 pre + 10 post ) C Equity of parent Parent: treated as a grant of equity instruments per IFS GOUP D Share capital D etained earnings D Equity (Share based payment reserve of subsidiary) D Goodwill C Investment in S Co. ( ) Group: Business combination entry Page 20 of 26

21 D Equity (contribution by parent) C Investment in S Co. Group: reversal of post-combination inter-company transaction Example 24: Parent replaces subsidiary awards at acquisition: Original vesting period is completed before acquisition and additional future service is required from the employees (IFS 3 IE 65 to IE 67). HCo (parent) acquired 100% of SCo (subsidiary) on 1 July 20X6 for 915 when the stated capital of SCo was 100, the retained earnings was 815 and the equity relating to share based payments was 86. At acquisition date, HCo issued replacement awards to SCo s employees with a market based measure of 100. The terms of the replacement awards are that the employees of S provide one additional year of service. SCo s awards had originally been granted on 1 July 20X0 and vested on 30 June 20X4. The grant date fair value of SCo awards was 86. The market based measure of SCo s awards was 100 at acquisition date. You are required to: 1. Calculate the portion of the market based measure of HCo s awards that relate to pre- & post- combination services. 2. Prepare the journal entries that are required for the year ended 31 December 20X6 in the separate records of the subsidiary and the parent, as well as on consolidation. SCo (SUB) Original awards vested in 20X4. No additional entries are required in 20X6 as incremental value of awards is nil. ( ) Subsidiary: treated as a modification per IFS 2 (see IFS 3, B56) HCo (PAENT) D Investment in S Co. (80 pre + 10 post ) C Equity of parent Parent: treated as a grant of equity instruments per IFS 2. Pre: 100 x 4/5 years= 80 (relates to acquiree award ) Post: = 20 x 6/12 months to 31 Dec 20X Page 21 of 26

22 GOUP D Share capital D etained earnings D Equity (Share based payment reserve of subsidiary) D Bargain purchase gain C Investment in S Co. ( ) Group: Business combination entry D Employee expense C Investment in S Co. Group: Additional post-combination service (20 x 6/12 months) from the perspective of the group and reversal of parent s investment in subsidiary What is a market-based measure? 2. If the expected number of employees changed at acquisition, how would this impact the calculation of the pre- and post- combination services? The market based measure of the subsidiary s awards is a measure of the unexercised awards (eg share options) held only by existing employees of SCo. Any employees that had resigned from SCo before acquisition date were not legible for the awards. Furthermore, those awards in SCo that had already been exercised could, for obvious reasons, not be replaced (once the option is exercised, it no longer exists). Example 25: Parent replaces subsidiary awards at acquisition: Original vesting period is NOT yet completed at acquisition and additional future services are required from the employees (ADAPTED FOM IFS 3 IE 68 to IE 69). ABC (parent) acquired 100% of X Ltd (subsidiary) on 1 July 20X6 for 915 when the stated capital of X Ltd was 100, the retained earnings was 815 and the equity relating to share based payments was 43. At acquisition date, HCo issued replacement awards to SCo s employees with a market based measure of 110. The terms of the replacement awards are that the employees of S provide only one year of service from acquisition date. SCo s awards had originally been granted on 1 July 20X4 and had an original vesting period of 4 years. The grant date fair value of SCo awards was 86. The market based measure of SCo awards was 100 at acquisition date. Page 22 of 26

23 You are required to: 1. Calculate the portion of the market based measure of HCo awards that relate to pre- & postcombination services. 2. Prepare the journal entries that are required for the year ended 31 December 20X6 in the separate records of the subsidiary and the parent, as well as on consolidation. SCo (SUB) D Employee expense C Equity Subsidiary: treated as a modification per IFS 2 (see IFS 3, B56) Original awards: emaining grant date fair value of 43 over remaining 1 year (x 6/12 months) 43 x 6/12 months (IFS 2 para B43c) eplacement awards (incremental value = = 10 x 6/12 months) HCo (PAENT) D Investment in S Co. (50 pre + 30 post ) C Equity of parent Parent: treated as a grant of equity instruments per IFS 2. Pre: 100 x 2/4 years= 50 (relates to acquiree award ) Post: = 60 x 6/12 months to 31 Dec 20X GOUP D Share capital D etained earnings D Equity (Share based payment reserve of subsidiary) D Goodwill C Investment in S Co. ( ) Group: Business combination entry Dr Equity (contribution from parent) D Employee expense C Investment in S Co Group: eversal of inter-company transactions. Furthermore, from a group perspective the employee expense should relate only to the post-acquisition service i.e. 60/2 = 30 (made up of 26.5 employee expense from sub pro-forma) = Page 23 of 26

24 AWADS EXISTING AT DATE OF ACQUISTION THAT AE NOT EPLACED BY PAENT COMPANY IFS 3 para B62A and B62B IFS 3 para B62A and B62B explain that the equity raised by an acquiree (subsidiary) in respect of a SBP award that has not been replaced by the acquirer (parent) should be re-measured to its market-based measure and disclosed as a different type of equity, i.e. as non-controlling interests. These other non-controlling interests do not represent a present ownership interest of the acquiree s identifiable net assets as mentioned in IFS 3 para 19. Instead they represent potential, future ownership interest and must be re-measured to their market-based measure. IFS 3 para B62B states that the market-based measure of unvested share-based payment transactions is allocated to the non-controlling interest on the basis of the ratio of the portion of the vesting period completed to the greater of the total vesting period and the original vesting period of the share-based payment transaction. The balance is allocated to post-combination service. Example 26: Unreplaced awards at acquisition date (illustrating IFS 3 para B62A and B62B) SC granted the chief financial officer share options valued at a total of 180 on 1 January 20X0 on condition that she remains in service for three years. On 31 December 20X1 HC acquired 80% of the issued share capital of SC for 828. HC did not replace these options on acquisition. HC has elected to measure non-controlling interest in SC at their proportionate share of the identifiable net asset fair values at acquisition date. The equity of SC on 31 December 20X1 consisted of: Stated capital 100 etained earnings 815 Option holders equity 120 The market based measure of the share options at 31 December 20X1 was 270. You are required to: 1. Prepare the journal entries required in the separate financials of S relating to these options for the years ended 31 December 20X0 through to 20X2. 2. Prepare the consolidated journal entries required in the separate financials of S relating to these options for the years ended 31 December 20X1 and 20X2. Page 24 of 26

25 Solution SEPAATE FINANCIALS OF SUBSIDIAY 20x0 Dec 31 Employee expense 60 Equity 60 Value of options granted by subsidiary (SC) (180 x 1/3) 20x1 Dec 31 Employee expense 60 Equity 60 Value of options granted by subsidiary (SC) (180 x 1/3) 20x2 Dec 31 Employee expense 60 Equity 60 Value of options granted by subsidiary (SC) (180 x 1/3) GOUP FINANCIALS OF PAENT 20x1 Dec 31 Dr Stated Capital 100 Dr etained earnings 815 Dr Equity (share options) 120 Dr Goodwill 180 Cr Investment 828 Cr Non-controlling interest (IFS 1 p 19) 207 Cr Other non-controlling interest 180 Acquisition journal. Other NCI = 270 x 2/3 20x2 Dec 31 Dr Equity 60 Dr Employee expense 30 Cr Other non-controlling interest 90 eversal of post-acquisition equity arising in SC. On consolidation the equity of S represent other shareholders of SC, hence non-controlling interest. Furthermore, the acquisition date is deemed to be the new grant date from a group perspective. The employee expense should therefore be based on the market-based measure at acquisition date and not on the grant date FV. Page 25 of 26

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