 Hello and welcome to the session. This is Professor Farhad and the session would look at share based payment. This topic is covered an international accounting course, the CPA exam as well as the ACCA exam. Please connect with me on LinkedIn if you haven't done so. YouTube is where you would need to subscribe. This is my channel. I have over 1500 plus accounting, auditing and tax lectures. Please like my lectures if you like them. Share them, put them in playlists. Let the world know about them. If they're benefiting you, it means they might benefit other people. Share the wealth. This is my Instagram account as I'm trying to grow my Instagram. Please follow me on Instagram. This is my Facebook and this is my website on my website. If you like the channel, you would like to support the channel. I do have a donation button. Please feel free to support the channel also on my website. You can find offers for my subscribers right now. Backer CPA review is offering $1000 off of their backer bundle CPA exam, which is the gold standard in CPA preparation. All four parts of the exam. Also, you will have unlimited access as long as you need it. You'll have access to it, which is that's very unusual that backer does give this option, but it is available now. Also, if you are not studying for your CPA exam now, if you are still a college student, backer CPA prep course would allow you to supplement your college studies with thousands of multiple choice questions, exercises and simulations, as well as hundreds of hours by backer faculty lectures. Let's talk about share based payment, which is covered in IFRS 2. Let's look at the big picture first. What is the big picture? The big picture is when you, when the company, let's assume this is the company, this is the company, the entity, when the company wants to purchase something, they pay cash. So we'll give cash and we'll buy what we need to buy. And the other party provide the goods or services. That's generally speaking, how transaction are settled. Guess what? Sometime rather than giving cash, maybe we don't have cash. Maybe we have cash would like to preserve the cash we want to pay with some sort of an equity instrument, equity instrument, give them stocks. Give them stock appreciation, right? Give stock options to our employees. So this is what we are dealing with here. So rather than paying with cash for goods and services, we're going to be paying with some sort of an equity instrument. So IFRS 2, which is the share based payment sets out measurement principle, how do we measure the transaction and specific requirement for the three type of share based payment transaction? The first one is equity settled share based payment transaction. What is equity settled? It means the entity received the goods or services as a consideration for equity instrument of the entity, including stock options granted to employee. Simply put, we receive the goods. We give something other than cash. So we don't give cash. We give something other than cash. We could give stock options. For example, we can pay our employees with stock option. Another form of share based payment is cash settled share based transaction. Notice this is equity settled. It means you're going to pay them actually with equity. Here you're going to pay them with cash. Now the cash is based on some equity measurement. So basically entity acquire goods or services by incurring liabilities to the supplier. Obviously, yes, we incur a liability of those goods or services for the amount that are based on the price of the entity shares or other equity of the entity, which is share appreciation, right? Simply put, I'm going to pay you based on my stock price. So I'm going to give you, I'm going to give you 100 share appreciation, right? 100 shares and depending how much the share is, when the time is due, I will pay you if the share is $5. I will have to end up paying you $500. Okay? That's the second option. The third shared based payment plan is a choice of share based payment. What does that mean? It means you could either settle it in cash or you can settle it in equity. So terms of the arrangement provide either the entity or the supplier. So either the entity can choose the form of the payment or the supplier with a choice, whether the entity settled the transaction in cash or issuing stocks. So simply put, the entity can have that option or the supplier can have that option. And what's the option? So we have the entity here, the company and the entity said, we're going to settle it in cash or we're going to settle this when equity or that option is given to the supplier and the supplier says, I want to be paid in cash or the supplier say, I'm going to settle it in equity. Okay. So though and we're going to look at each one of those, you know, one, two, three in detail, that's the purpose of the lesson, but this is just an introduction. So AFRS two applies to share based transaction with both employees and non employees and require the entity to recognize all share based transaction and its financial statements. No exception. Simply put, the share based transaction, they could be between you and your employees or between you and outside party non employees. We're going to be using the fair value approach. What does he what does it mean the fair value? It means we're going to record the transaction based on the fair value. Now, in some situation, we're going to be using these transactions are recognized at the fair value of the goods and services obtained. In another situation, we're going to base the fair value on the equity of the instrument awarded or granted. So simply put, what does that mean? So sometime and we're going to look at each situation separately. Sometimes we use this is the equity instrument. Sometimes we look at the equity instrument, the fair value of the equity instrument, and we record the transaction based on the fair value of the equity instrument. Other times and other situation, we're going to look at the situation differently. We're going to look at the fair value of what we received. And that's going to be the fair value of the transaction. Let's go ahead and get started. We have a list. We're going to start with number one, equity, settle, share based transaction. This is one of three, one of the three we're going to be covering. So again, this is share based payment transaction entered into by an entity that will be settled by the entities issuing equity are accounted for as equity transaction. Typically, what do we do is we debit either an asset or an expense depending on what we provided. So simply put, we debit an expense or asset depending what we obtained and we credit some sort of paid in capital and common stock. This is basically what it boils down to. So we issued stocks for something either an expense or an asset. Now we have to differentiate when we have those. We're going to differentiate between when we have equity settled share based payment to employees and to non employees. So we have to know, are we dealing with employees? It's treated differently than when we deal with non employees. Okay. So the next thing we're going to do, we're going to break section one into whether this share based payment to a non employee. We're going to start with non employee. Think of non employee as creditors. They don't have to be creditors. Anyone that's not an employee is non employee. I'm just going to think of it as creditors. This way you are familiar with like, okay, I'm buying goods and services from my creditors from my suppliers. Okay. Suppliers, not creditors suppliers. I meant to say. So you measure the transaction at the fair value of the goods receipt. That's the first thing you have to know. What does that mean? It means you are dealing with non employees. You would look at the goods that they gave you and you're going to use the fair value of those goods. Usually that's given. If the fair value of those good cannot be determined, then the fair value of the equity instrument of use. So if the fair value of the goods that they're selling you, we cannot determine the fair value. Then what we do is we use our fair value. One of them should be known. Okay. So if the fair value of the instrument is used of the equity instrument is used, the measurement date. So when do we measure it is the day the entity obtained the goods or the service. So when do we record the transaction? Well, we're going to look at when when when did we obtain the goods or the services at what day and based on that date will be the value of the transaction. If the goods or services are received on a number of dates over a period. So we received some goods here, some goods here, some goods here a different date. So it's going to be 11523215. Okay, guess what we're gonna for this transaction, we're gonna figure out what's the fair value of the instrument on that date, what's the fair value of the instrument on that date, what's the fair value of the instrument on that date. So it's pretty straight forward. Now under us gap under us gap. So let me just show you how you as gap work under us gap, we always start with the fair value of the instrument. So if we're giving equity to someone for giving equity, we always say the value of the transaction is the value of our equity. Now if you don't know the value of our equity, then we would look at the other party. But notice here, with the non employee, we look at the other party fair value. Okay, so the seller, the earlier, and the earlier of either the date at which a commitment for the performance is reached or when the performance is completed is used as a measurement date for determining the fair value of the instrument. So this is under gap when at the date that we measure the instrument. Okay. So this is important. Now we're gonna look at share based payment to employees. So again, share based payment, but employees are treated a little bit differently. It's measured at the fair value of the equity instrument on the grand date. So notice now we are giving stock options to our employees. What's what is the employee given us back? Well, services, they're working for the company. When we measure the when we measure the transaction, we use the equity instrument just like you as gap does. Okay, so the entity issuing stock option must estimate the number of option expected to vest. What does that mean? It means we might be given them 1000 options, but they don't all vest. Means we may end up vesting 600. Why? Because some employees leave. Maybe the options are not worth anything. So we have to know how much are they given them? And how much do we expect the vest to actually materialize? Okay. The product of the number of option expected to vest multiply by the fair value is the total compensation cost that will be recognized over the compensation expense simply put if we're given them 1000 options. And we expect the fair value of these options to be $10. So we have a compensation expense of 10,000. Now, when do we the when do we recognize those compensation expense over the vesting period? Let's assume the vesting period of two is two years, we're going to use the straight line for the simplicity. We're going to recognize 5000 of expense and 5000 expense. Now, maybe I should define what a stock option is because I'm just throwing this word out. What is a stock option? Let's assume you are hired by Amazon. It's assuming you are hired for Amazon. Amazon might give you stock options. What is stock options? For example, Amazon might say, I'm going to give you 1000 options to buy the stock at $2500. Okay, the stock right now is approximately 1700. Okay, so what is the option worth? It's worth zero. It's not worth anything. Why? Because the price right now is just 1700. Why would you buy? Why would you buy the stock price at 1500 if you can buy it at 1700? But what's the goal of the options? The goal of the option is if you work for the company and you work hard, you drive the stock price up more than 2500 and for every dollar above 2500, you make a thousand dollar profit. So that's that's how the stock options work. So the company will have to estimate how many options will be exercised times the fair value of those options. And this is going to be the total compensation expense. Okay, costs should be revised throughout the vesting period with corresponding adjustment to compensation expense. So what happens sometime, some employees leave. So what's going to happen, compensation expense will go down. As compensation expense is recognized, it's offset by an increase in additional paid in capital. What does that mean? It means when you recognize stock options, you're going to debit an expense. Initially, and you're going to credit capital or an equity account. Simply put, an equity account goes up because you credit that capital. Expense is an equity account that's going to go down. You might be saying that doesn't make any sense. Yes, yes, it does. Simply put, you are showing the expense on the income statement. Although the overall equity is the same because you recorded an expense and you offset it with capital, but you still have to show it. I know it doesn't make any sense because there is really no expense to the company until you exercise. That's the truth. Because if you never exercise, if they gave you those options and the stock price never went above 2500, it's like a tree fallen into the forest. No one cares. Nothing happened. Nevertheless, you still have to debit an expense. You record an expense and you credit a capital. So it does hit your income statement, but at the same time, you increase your equity. Now, how would you expense the options? You have two options. You could use a straight line, which I showed you earlier, or you could use straight line, or you can amortize the expense, the compensation expense, and trenches, that means in pieces. Same as USGAP. Most of the time, we use the straight line method. When I teach it, I always teach it using the straight line method. Now, if you are looking for this and just like, I need more about stock options, go to my chapter 16, Intermediate Accounting, and you have a whole thing about stock options in case, you know, you felt, you know, this is not enough for me about stock options. Okay? Let's take a look at an example to see how this work. Let's assume a corporation grants stock options with a fair value of 100,000. Grant means they give their employees the option to buy, and the value of this option is 100,000. Okay? How did we come up with 100,000? It's given to you. They told you it's worth 100,000. 50% of the 50% vest at the end of year one and 50% at the end of year two. In other words, you have to work two years for this company. Under IFRS, compensation cost associated with the first branch is fully allocated to expense in year one. Simply put, we have 100,000, 50% and 50%. That's the best thing. Under IFRS, for year one, we're gonna vest this 100% and we're gonna vest 50% of year two. Okay? 50% of year two. As a result, the amount of compensation expense in year one is 75,000, which is 50,000 plus 50% of year two. 50,000 times 50%. And the amount of compensation expense to be recognized in year two is 25,000. So year one, we're gonna debit expense 75,000, credit equity or capital 75,000. Year two, the expense is debited 25 and capital is credited 25. Okay? The same pattern of compensation recognition would be acceptable under USGAP, which is we could use, you could use this for USGAP or under USGAP, we can go ahead and use the straight line and expense 50,000 and 50,000. Okay? Let's take a look now at the cash settled share-based transaction. Now they are cash settled. Remember cash settle means when we settle them and this is the second type of share-based we've been talking about equity-based now, we're gonna settle it using cash. So rather than issuing stocks, we're gonna go ahead and give you cash. Okay? So here's what happened. An entity might provide employee with stock appreciation, right, in which they are entitled to receive cash payment when the entity stock price increase above a predetermined level. What does that mean? It means they will tell you right now the stock price is $20. That's the current price. They will tell you if the stock price reaches $30, guess what? We're gonna give you value of 100 shares. Simply put, you have $3,000 in your pocket. Okay? So they're gonna, they're not gonna give you 100 shares. They are not gonna give you 100 shares. They're gonna give you $3,000 in cash. That's what they're gonna give you. Okay? So this type of transaction would result in the recognition of liability. Why? Because they have to pay you cash. They don't have to issue stocks for you and it would be an expense. We'll debit an expense, credit the liability. How is the liability measured? It's measured at the fair value of the share appreciation right using an option price and model. Simply put, option price and model means aka in accounting given to you. It's gonna be given to you. We don't have to worry about this. So, and it means sometime the option price and model goes up, sometime it goes down and you have to adjust that liability up or down. Under US GAAP, we're gonna look at how we treat it under US GAAP. Until the liability is settled, it must be remeasured at each balance sheet date with the change reflected in net income. So, remember, I told you $3,000 if the stock price go to $40, now I owe you $4,000. Well, I owe you more. I have an additional $1,000. Under US GAAP, certain cash-settled share-based transactions are classified as equity. These transactions must be classified liability under IFRS. So under US GAAP, they say what you're doing is really this is an equity transaction under IFRS. It says this is a liability. The third type of settlement is the choice of settlement. Either you can choose of settlement. It means you can either get it in cash or get it in stocks or equity. Allow the entity to choose between equity settlement and cash settlement. So you could either get once it's mature, once it's due, you could either settle it in equity or settle it in cash. Give them cash or give them equity. The entity must treat the transaction as a cash-settled share-based payment. If it only has a present obligation to settle in cash. If it has to be settled in cash, then it becomes a cash. Otherwise, the entity will treat it as an equity transaction. Okay, so simply put, they'll decide. Now, assume that this is the entity deciding. Now, when the terms of the share-based transaction allow the supplier, now the supplier decides, the supplier tells you I want it to be settled in cash or I want it to be settled in equity. Okay, when they have the allowed to choose, when they are allowed to choose between equity settlement or cash settlement, the entity has issued a compound financial statement, not a financial statement, a compound financial instrument. In other words, we have two financial instruments. We have a debt and we have equity. So now we account for the transaction as two instruments. We owe them money, which is debt, and we could also owe them equity. Okay, the debt component, how do we determine the debt component? The debt component must be re-measured at fair value at each balance sheet date, with a change in fair value reflected in their income. So the debt value could go up, the debt value could go down. We have to report that gain or loss in their income. If the supplier of service is going to choose to receive settlement in cash, the cash payment is applied against the debt component. Obviously, that means I have to settle it in cash. So I'll have to pay you cash. This is how it's going to be settled. The equity component remain in equity. If the supplier choose to receive settlement in equity, the debt is transferred to equity. Basically, we remove the debt, we debit the debt, and we credit equity. The best way to illustrate this is to actually work an example. Let's take a look at this example to see how this all works together. So we have a company on January 1st issued 100 stock options with an exercise price of 18 to five employees, which is a total 500 options. What does that mean? It means the employees, they can buy the stock at any time at $18. So if you receive those options, you can buy the stock at $18, which is you're going to have to pay $1800, but you can buy at $18, whether the price is $50 or the price is $100. So you're giving them the option to buy it. Now, the employee can choose to settle the option either in shares of stock, so they can get the shares, or they can settle it in cash. In cash means they would receive cash, and the cash value would equal to the intrinsic value of the option on the vested date. Now, what is the intrinsic value? Remember, you can buy the exercise price, this is the exercise price, is $18. This option is worthless to you unless the stock price is above $18. If the stock price is $15, this option is worthless. It means it's worth nothing. Why? Because I can buy the stock at $15, why would I pay $18? When is this option worth something to you when it's above $18? If the stock is $25, guess what? The difference between the exercise and the current price is $7. This is called the intrinsic value. This is the intrinsic value of the stock. Now, the stock is worth something, intrinsic value. The intrinsic value is $7, so you can either settle it in intrinsic value or you can buy the stock at $18. The option vests on December 2nd, year 2, after the employees has completed two years of service. So, when do you qualify? You have to put two years worth of service for you to be able to exercise it. Now, the company will recognize the expense over two years, okay, but you have to wait two years in order to be able to exercise. So, when employee resigned in year one, okay, when employee resigned in year one and the company continued to assume an overall furniture rate of 20%. So, the company expect only four employees would remain, because if you don't put the two years, simply put, for you to get the options, you have to work year one, you have to work year two. After you put those two years worth of work, remember we had five employees, after you put those two years, the option will vest. Guess what? One of the employees left, so we have four employees now, okay, because if you leave before the before you put the time, you don't get the options. So, when they give you the options, you have to make sure you're aware of the date. The date, you're aware of the vesting date. The vesting date means after that date you can exercise the options. As expected, four employees vest on December 31st year two. And the exercise, and the exercise, and their stock options, obviously, they all vest. The share price and the fair value is as followed. So, here's what happened. When we granted the options, the share price was 20%. The fair value of the cash settlement consideration alternative as 10%. December 31st year one, the share price was 26%. The fair value cash settlement alternative is 12%. In other words, we'll give you $12. If it vest today, December 31st, the share price is 30%. And the fair value of the cash settlement is 12%. And this is perfect because, you know, you can buy it for 30%. The option is 18%. So, you'll have $12. So, this is like perfect value. Okay, now the question is how much would the company incur an expense? Because, remember, the company granted those options, granted 500 options to their employees. And each option, they can buy at $18. However, the fair value, the fair value of the stock option will not be known, okay, until the end of the year. So, at the end of the year, we have to figure out what's the fair value cash settlement. In other words, if we have to settle this option today, and this is will be given, this will be given, this will be given, this will be given. What we're saying is the fair value is $11. If we have to settle it today, the fair value is $11. We're not going to settle it, okay? But if we have to do it, we have to pay $11. Well, okay, if we have to pay $11 and we have 500 options, well, we have $5,500 in cost. Now, we're assuming, how many would assume all 500 options are exercised? But that's not true. We're only going only 80% because one employee left. We expect one employee to leave, whether they left or not, but this is what we can assume. So, basically, what we're going to have to do is we only have an expense of $4,400 as of the end of year one. At the end of the year one, we have $4,400. And we're going to take this $4,400 and spread it over two years. So, every year we're going to create an expense of $2,200. So, let's see. So, this is the computation that I just made. Now, we're going to debit compensation expense for $2,200. We're going to credit share-based payment liability $2,200. Now, under U.S. GAP, we usually credit capital, but this is how do we do it under IFRS. So, year one, this is the entry for year one. We recognize $2,000 of expense and $2,200 of liability. Now, again, for U.S. GAP, we have credited some sort of a capital account, some sort of a capital account. Okay? I told you earlier we offset it to capital under IFRS. We offset to liability. At December 31st, year one, the fair value of each option equal to $12, which is the share price was $30. The exercise price is $18. It means right now, right now any employee can make $12, can make $12 from this trade. Okay? Now, you might be saying, why was it 12-year-one? How did you compute this? It's given to you. It's given to you. But year two, once at best, now you could just compare the share price to the exercise price. So, the fair value of the liability, if we have $12 intrinsic value times 500 option, that's $6,000. But remember, we're only going to get 80% of the $6,000. We're responsible for 80%. Therefore, the expense is $4,800. Okay? So, the amount to be recognized as compensation expense in year two is $4,800 in total for the whole option minus we recognize $2,200. So, we have to recognize $2,600. Simply put, we debit compensation expense $2,600. Credit, share-based liability $2,600. You might be saying, why didn't we go $2,200 year one, $2,200 year two? What happened is the stock price went up. The stock price, let me show you, the stock price went from, weight went from $26. The stock price, the stock price went from $26 to $30. So, the stock price went up. As the stock price went up, the fair value of the cash settlement went up. It means we have more expenses. In year one, we had $2,200, but the value of the option in year two becomes in total, becomes in total $4,800 of which we recognize $2,200 in year one. So, we have to recognize the remaining which is $2,600 in year two. So, this is what we do before they actually come to exercise and in other words, before the executives comes to exercise. Now, we're going to look at the exercise. So, this is what the company, so this is year one compensation expense for the company. This is year two. So, the company already recorded their expense. Okay? Now, let's see what's going to happen when the executives come to the company and they either, they ask for the cash or they ask or they want to exercise their option. Okay? Accounting for exercise for the stock option under the two settlement alternative is S follow. The first thing we're going to look at is cash settlement. Let's look at the cash settlement. Simply put, the cash settlement, remember we have, we already recorded share payment based liability. Let me just do this on the previous slide so this way you can see it. Share payment based liability, 2200, 2600. Well, guess what? If we need to reduce the liability, we have to debit the liability, 4800, to make it go down to zero and credit cash. So, the cash, so the cash, so the cash settlement is pretty easy. We debit the share based liability, share based, share based liability, share payment, I should say share based liability, 4800, we credit cash 4800. Now, the executives, they may not want the cash, they actually want to settle it in equity. In other words, they want to buy the stock, they want to buy the stock. Well, if they want to buy the stock, they have to pay money, they have to pay cash. How much cash will they have to pay? Well, there are 400 options, they have to pay 18 dollars in cash. So, they have to pay the company 4700, with debit cash 7200. Then, we have to remove this share based liability. So, we're going to debit share payment based liability 4800. This stock has a par value of 1, therefore, we credit common stock 400, and anything left is a pick or paid in capital, which is 11600. So, this is if the transaction was settled in equity. Simply put, the executives will have to pay us cash, we remove the liability that we created as we were recording the expense, we credit common stock, and we credit additional paid in capital. Why did we credit common stock 400? It's the number of shares, this is how much you credit common stock times the par value, and anything left, this is a plug figure. Now, under US GAAP, once again, under US GAAP, we will not have a liability, we will not have this account, we have an equity account, we will have an equity account. Okay? We will have an equity account. Remember, US GAAP will have equity account, we'll consider this as equity transaction, IFRS will consider it a liability transaction. So, simply put, let me clarify one point, because I kind of spoke about earlier here, let me just, I just want to make sure. Okay? As compensation expenses recognize, it's offset by an additional paid in capital, this is US GAAP. Okay? All right. If you have any questions, any comments about this topic, please email me. If you happen to visit my website for additional lectures, please consider donating. If you're studying for your CPA exam, as always, study hard, it's worth it. Good luck, and see you on the other side of success.