Share-based compensation is accounted for under IFRS 2 Share-Based Payment.
There are two primary items that are covered under share-based compensation:
- share options (stock options)
- share appreciation rights (phantom stock options)
Share-based compensation can refer to compensation that gives the right to either shares or cash. The key is that the compensation is based on the performance of the entity’s shares.
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Share Options
Share options (stock options) provide an employee the right to purchase shares in a company at a pre-established price for a specified period of time.
Recognition
The timing of the recognition of share options is dependent on when the options vest. Options are deemed to have vested on the date that the option may first be exercised.
For example, if share options are granted on January 25, 2021, and they can be exercised on January 25, 2023, they are said to vest on January 25, 2023. The period between January 25, 2021, and January 25, 2023, is thus referred to as the vesting period.
If the option vests on the same day that it is granted, it is assumed that the option is compensation for services already provided. The option is then recognized immediately.
In most cases, there will be a period between the grant date and the exercise/vesting date. If this is the case, it is assumed that the option is compensation for services provided throughout the vesting period (the period between the grant date and the exercise date), and the compensation is recognized in line with that assumption.
The remainder of this article will assume that there is a vesting period (that is, that options cannot be exercised on the same day they are granted).
Journal entry for vesting of stock options
As the option is earned in the periods in which the employee performs the service (over the vesting period), compensation expense is recorded for the proportionate amount of the fair value of the option. The offset to this is a credit to equity.
| Account | ||
|---|---|---|
| Compensation expense | $100,000 | |
| Contributed surplus — share options | $100,000 |
If an entity anticipates that a percentage of options will not vest, the amount earned is multiplied by the percentage expected to vest. Employees who leave prior to an option vesting forfeit the option.
Measurement
Options are measured using an option-pricing model. The pricing model determines the fair value of an option based on factors such as time until expiration, market value of the share, volatility of the share price, expected dividends and the risk-free interest rate.
The fair value of options must be measured at the grant date. No journal entry is required at this time, as the option has not yet been earned.
This measurement is used for the remainder of the life of the option. Employee share options are not subsequently revalued for changes in any of the factors impacting their initial measurement.
Derecognition
Share options are derecognized for two reasons:
- The option is redeemed.
- The option expires.
Journal entry for the redemption of stock options
If an option is redeemed, the entity receives cash and the value of the option is moved from contributed surplus to common shares.
| Account | ||
|---|---|---|
| Cash | $250,000 | |
| Contributed surplus — share options | $100,000 | |
| Common shares | $350,000 |
Journal entry for the expiration of stock options
If the option expires (that is, the employee doesn’t exercise it), the entity makes a journal entry to move the option from contributed surplus — share options to contributed surplus — expired share options.
| Account | ||
|---|---|---|
| Contributed surplus — share options | $100,000 | |
| Contributed surplus — expired share options | $100,000 |
Share Appreciation Rights
Share appreciation rights (SARs) have much the same purpose as share options in that they allow the employee to profit when the market price of the company’s shares improves. The key difference between SARs and share options is that employees do not pay an option price to obtain the benefit. Employees simply redeem them.
SARs can be settled in equity or in cash. Cash-settled SARs are the most common and will be addressed first.
Recognition
The timing of the recognition of SARs is similar to that of options. The SARs are recorded in line with when they are earned, which is usually over a vesting period.
Journal entry for settlement of stock appreciation rights
When the SARs are to be settled in cash, the credit is no longer to equity; instead, it establishes a liability.
| Account | ||
|---|---|---|
| Compensation expense | $100,000 | |
| SAR liability | $100,000 |
If an entity anticipates that a percentage of SARs will not vest, the amount earned is multiplied by the percentage expected to vest.
Measurement
SARs are measured at fair value using an option-pricing model. As the amount of compensation that will ultimately be paid out by the entity changes based on the current market price of the shares, the SARs are revalued using current information at each reporting date.
Derecognition
SARs are derecognized for two reasons:
- The SARs are redeemed.
- The SARs expire.
Journal entry for the redemption of stock appreciation rights
If a SAR is redeemed, the entity makes a cash payout and removes the liability from its financial statements.
| Account | ||
|---|---|---|
| SAR liability | $100,000 | |
| Cash | $100,000 |
Journal entry for the expiration of stock appreciation rights
If the SAR expires, no payout occurs. The liability is removed and the compensation expense is reversed.
| Account | ||
|---|---|---|
| SAR liability | $100,000 | |
| Compensation expense | $100,000 |
Examples of Journal Entries for Share-Based Compensation
Stark Industries Inc. grants 5,000 options on January 1, 2022, to the company’s management. The following information relates to the options:
- The fair value of the options granted was $100,000.
- The options vest one year after the grant date, on December 31, 2022.
- 100% of the options vest.
- The options expire on December 31, 2023.
- The options have an exercise price of $12 per share.
- On January 1, 2023, 3,000 options are exercised. The remainder of the options are not exercised at the expiration date.
Grant Date: January 1, 2022
No entry is required.
Vesting Date: December 31, 2022
| Account | ||
|---|---|---|
| Compensation expense | $100,000 | |
| Contributed surplus – share options | $100,000 |
$100,000 [fair value] × 12/12 months [time period] × 100% [% vested] = $100,000
Exercise Date: January 1, 2023
| Account | ||
|---|---|---|
| Cash | $36,000 | |
| Contributed surplus – share options | $60,000 | |
| Common shares | $96,000 |
The employee exercising the stock options pays $36,000 to Stark Industries (3,000 options × $12 exercise price = $36,000)
The proportion of the fair value of the options exercised is removed from contributed surplus ($100,000 × 3,000/5,000 options = $60,000)
Expiration Date: December 31, 2023
| Account | ||
|---|---|---|
| Contributed surplus – share options | $40,000 | |
| Contributed surplus – expired share options | $40,000 |
The proportion of the fair value of the options expired is transferred to an expired share options contributed surplus account ($100,000 × 2,000/5,000 options = $40,000)
