ACCA DipIFR question papers and answers on IFRS 2 June 2014

ACCA DipIFR question papers and answers on IFRS 2 from June 2014

All questions on IFRS 2 Share based payments which have appeared in ACCA DipIFR from June 2014 have been indexed here. The answers are based on the standards prevalent at the exam point in time.

This is a topic which has come in almost every second exam and is a hot favourite with the examiners.

For the benefit of the readers, we have put the following sequentially to help them understand better

  • Question - Relevant portion of the exam pertaining to the standard has been recreated
  • Answer - Answers as shared by the ACCA Examination team which was required for the question
  • Examiners Feedback - Feedback on answers given by the students for that exam, this is a critical part of learning as students can learn from mistakes which other students did

Question

Delta is an entity which prepares financial statements to 31 March each year. During the year ended 31 March 2014 the following events affected Delta:
(a) On 1 April 2012, Delta had granted share appreciation rights to 200 senior executives. Each executive will receive 2,000 rights on 31 March 2015 provided he or she continues to be employed by Delta at that date. On 1 April 2012, the directors estimated that all the executives would remain employed by Delta for the three-year period ending on 31 March 2015. However, 10 executives left in the year ended 31 March 2013 and at 31 March 2013 the directors believed that a further 10 executives would leave in the following two years. Five executives actually left in the year ended 31 March 2014 and the directors now believe that seven more directors will leave in the year ended 31 March 2015. Since 1 April 2012, the fair value of the share appreciation rights has fluctuated as follows:
Date        Fair value of one right $
1 April 2012      1·60
31 March 2013 1·80
31 March 2014 1·74

 

Answer

Under the principles of IFRS 2 – Share-based Payment – the granting of share appreciation rights (SARs) to executives is a cash-settled share-based payment.  Cash-settled share-based payments create a liability in the statement of the financial position as they will ultimately be redeemed in cash. The liability is recognised based on the fair value of the SAR at the reporting date and the expected number of rights which will vest. 


Under the principles of IFRS 2 this liability is built up over the vesting period. Therefore the liability at 31 March 2014 would be $412,960 (2000 x (200 – 10 – 5 – 7) x $1·74 x 2/3). Since the rights are not exercisable until after 31 March 2015, the liability would be shown as a non-current liability. 

The liability at 31 March 2013 would have been $216,000 (2,000 x (200 – 10 – 10) x $1·80 x 1/3).  The charge to profit or loss would be $196,960 – the difference between the closing liability ($412,960) and the opening liability ($216,000). This charge would be shown as an operating cost.

Examiners feedback

Roughly half the candidates answering this part did so from the perspective that the transaction with the executives was equity settled, rather than cash settled. This produced two inevitable errors:
x Using the fair value of the right at the grant date rather than the latest fair value when computing the cost.
x Crediting equity rather than liabilities when debiting the cost to profit or loss.
The treatment of the vesting condition (a non-market service condition) was, on the whole, handled well by candidates so that, even those who made the errors previously described, were able to gain partial credit in this part.

 

Question

You are the financial controller of Omega, a listed entity which prepares consolidated financial statements in accordance with International Financial Reporting Standards (IFRS). The managing director, who is not an accountant, has recently been appointed. She formerly worked for Rival, one of Omega’s key competitors. She has reviewed the financial statements of Omega for the year ended 30 September 2014 and has prepared a series of queries relating to those statements:

‘The notes to our financial statements refer to equity settled share-based payments relating to the granting of share options. When I joined Omega, I was granted share options but I can only exercise those options if I achieve certain
performance targets in my first three years as managing director. I know that other directors are also granted similar option arrangements. I don’t see why they affect the financial statements when the options are granted though, because no cash is involved unless the options are exercised. Please explain to me exactly what is meant by an ‘equity settled share-based payment’. Please also explain how, and when, equity settled share-based payments affect the financial statements of entities that grant them to their employees. I would like to know how such ‘payments’ are measured, over what period the ‘payments’ are recognised, and exactly what accounting entries are involved.’

 Answer

An equity settled share-based payment transaction is one in which an entity receives goods or services in exchange for a right over its equity instruments. Where the payments involve the granting of share options, IFRS 2 – Share-based Payment – requires that the payments are measured at the fair value of the options at the grant date. No change is made to this measurement when the fair value changes after the grant date.  Unless the entity has traded options which have exactly the same terms and conditions as those granted to employees (unlikely), then fair value is estimated using an option pricing model. 


The first step in accounting for such payments is to estimate the total expected cost of the share-based payment.  This estimate takes account of any conditions attaching to the options vesting (the employees becoming unconditionally entitled to exercise them) other than market conditions (those based on the future share
price, which are taken account of in estimating the fair value of the option at the grant date).  The total expected cost is recognised in the financial statements over the vesting period (i.e. the period from the grant date to the vesting date). 
In the case of options granted to employees, the debit entry would be recorded as remuneration expense. Normally this would mean the debit entry being shown in the statement of profit or loss but in theory the debit entry could be an asset depending on the work of the employee involved. 


The credit entry is taken to equity. IFRS 2 is silent as to which component of equity this should be – normally it would be to an option reserve.
The above treatment is unaffected by whether or not employees subsequently exercise vested options. If they do, then the entity debits cash and credits equity with the cash proceeds.

Feedback

Answers were generally of a satisfactory standard but a significant minority of candidates wasted time by making references to cash settled share based payments. These were not part of the requirement so, whilst the comments were in many cases correct, they did not score marks. Once again the message here is that candidates must focus carefully on the exact requirements of each question.

Question 1 (6 marks)

IFRS 2 – Share-based Payment – defines a share-based payment transaction as one in which an entity receives goods or services from a third party (including an employee) in a share-based payment arrangement. A share-based payment arrangement is an agreement between an entity and a third party which entitles the third party to receive either:
– Equity instruments of the entity (equity-settled share-based payments); or
– Cash or other assets based on the price of equity instruments of the entity (cash-settled share-based payments).
Share-based payment arrangements are often subject to vesting conditions which must be satisfied over a vesting period.
Required:
For both cash-settled AND equity-settled share-based payment arrangements, explain:
(i) The basis on which the arrangements should be measured;
(ii) The criteria which are used to allocate the total value of the arrangement to individual accounting periods;
(iii) The accounting entries (debit and credit) required during the vesting period.

Question 2 (9 marks)

Kappa prepares financial statements to 31 March each year. The following share-based payment arrangements were in force during the year ended 31 March 2015:
(i) On 1 April 2013, Kappa granted options to 500 employees to subscribe for 400 shares each in Kappa on 31 March 2017, providing the employees still worked for Kappa at that time. On 1 April 2013, the fair value of each option was $1·50.
In the year ended 31 March 2014, ten of these employees left Kappa and at 31 March 2014, Kappa expected that 20 more would leave in the three-year period from 1 April 2014 to 31 March 2017. Kappa’s results for the year ended 31 March 2014 were below expectations and at 31 March 2014 the fair value of each option had fallen to 25 cents. Therefore, on 1 April 2014 Kappa amended the exercise price of the original options. This amendment caused the fair value of these options to rise from 25 cents to $1·45. During the year ended 31 March 2015, five of the employees left and at 31 March 2015, Kappa expected that ten more would leave in the two-year period from 1 April 2015 to 31 March 2017. The results of Kappa for the year ended 31 March 2015 were much improved and at 31 March 2015, the fair value of a re-priced option was $1·60.

Question 3 (5marks)

On 1 April 2013, Kappa granted share appreciation rights to 50 senior employees. The number of rights to which each employee becomes entitled depends on the cumulative profit of Kappa for the three years ended 31 March 2016:
– 1,000 rights per employee are awarded if the cumulative profit for the three-year period is below $500,000.
– 1,500 rights per employee are awarded if the cumulative profit for the three-year period is between $500,000 and $1 million.
– 2,000 rights per employee are awarded if the cumulative profit for the three-year period exceeds $1 million.
On 1 April 2013, Kappa expected that the cumulative profits for the three-year period would be $800,000. After the disappointing financial results for the year ended 31 March 2014, this estimate was revised at that time to $450,000. However, given the improvement in results for the year ended 31 March 2015, the
estimate was revised again at 31 March 2015 to $1,100,000.

On 1 April 2013, the fair value of one share appreciation right was $1·10. This estimate was revised to $0·90 at 31 March 2014 and to $1·20 at 31 March 2015. All the senior employees are expected to remain employed by Kappa for the relevant three-year period. The rights are exercisable on 30 June 2016.

 Answer 1

For equity-settled share-based payment arrangements, the transaction should be measured based on the fair value of the goods or services received, or to be received.  Where the third party is an employee, ‘fair value’ should be based on the fair value of the equity instruments granted, measured at the grant date.
For cash-settled share-based payment arrangements, the transaction should be measured based on the fair value of the liability at each reporting date. 
(ii) The amount recognised should take account of all vesting conditions other than (in the case of equity-settled share-based payment arrangements) market conditions (which are reflected in the measurement of the fair value of the instruments granted). 
(iii) For both types of arrangement, the debit entry will normally be to profit or loss unless the relevant expense would qualify for recognition as an asset. 
For an equity-settled share-based payment arrangement, the credit entry would be recognised in equity, either as share capital or (more commonly) as an option reserve. 
For cash-settled share-based payment arrangements, the credit entry would be recognised as a liability.

 Answer 2

The expected total cost of the arrangement at 31 March 2014 is 400 X $1·50 X (500 – 10 – 20) = $282,000. Therefore $70,500 ($282,000 X 1⁄4) would be credited to equity and debited to profit or loss for the year ended 31 March 2014. 


For the year ended 31 March 2015, the expected total cost of the originally granted options would be 400 X $1·50 X (500 – 10 – 5 – 10) = $285,000. 
The cumulative amount taken to profit or loss and recognised in equity at 31 March 2015 is $142,500. 
The additional cost of the repriced options must also be recognised over the three-year period to 31 March 2017.  The total additional cost is 400 X ($1·45 – $0·25) X 475 = $228,000.  Therefore the amount recognised in the year ended 31 March 2015 is $76,000 ($228,000 X 1/3). Therefore the total recognised in equity at 31 March 2015 is $218,500 ($142,500 + $76,000).

The amount recognised in equity would be shown as ‘other components of equity’. 1⁄2 And the charge to profit or loss for the year ended 31 March 2015 is $148,000 ($142,500 + $76,000 – $70,500).

The amount recognised in profit or loss would be shown as an employment expense.

 Answer 3

For the year ended 31 March 2014, the expected total cost will be 50 X 1,000 X $0·90 = $45,000.
The amount taken to profit or loss in the prior period, and recognised as a liability, will be $15,000 ($45,000 X 1/3). 
At 31 March 2015, the liability will be 50 X 2,000 X $1·20 X 2/3 = $80,000. 
Since the rights are exercisable on 30 June 2016, the liability will be non-current. 
The charge to profit or loss for the year ended 31 March 2015 will be $65,000 ($80,000 – $15,000). This will be included in employment expenses.

Feedback

Part (a) was answered well by most candidates. A minority of candidates lost marks by not addressing the questions specifically enough and writing about share based payments too generally. Some candidates repeated information about IFRS 2 that was given in the question. This clearly attracted no marks.

Candidates found part b(i) challenging on the whole. A reasonable number were able to compute the cost based on the initial share award, by basing the cost on the fair value of the option at the grant date and the expected numbers vesting based on the best estimate at the reporting date. However very few candidates were able to deal with the modification to the award that was necessary because of the fall in Kappa’s share price in the year ended 31 March 2014. It would appear that in general candidates had not studied this aspect of accounting for share based payments.


Answers to part b(ii) were on the whole satisfactory. Having said this, only a minority of candidates correctly identified the liability as non-current..

 

Question

Delta is an entity which prepares financial statements to 31 March each year. Each year the financial statements are authorised for issue on 20 May. The following events are relevant to the year ended 31 March 2016:

Event (a)

On 1 April 2014, Delta granted 2,000 employees 1,000 share options each. The options are due to vest on 31 March 2017 provided the relevant employees remain in employment over the three-year period ending on 31 March 2017.

On 1 April 2014, the directors of Delta estimated that 1,800 employees would qualify for the options on 31 March 2017. This estimate was amended to 1,850 employees on 31 March 2015, and further amended to 1,840 employees on 31 March 2016.

On 1 April 2014, the fair value of an option was $1·20. The fair value increased to $1·30 by 31 March 2015 but, due to challenging trading conditions, the fair value declined after 31 March 2015. On 30 September 2015, when the fair value of an option was 90 cents, the directors repriced the options and this caused the fair value to increase to $1·05. Trading conditions improved in the second half of the year and by 31 March 2016 the fair value of an option was $1·25. Any additional costs that have occurred as a result of the repricing of the options on 30 September 2015 should be spread over the remaining vesting period from 30 September 2015 to 31 March 2017.

Explain and show (where possible by quantifying amounts) how this  event would be reported in the financial statements of Delta for the year ended 31 March 2016.

 Answer

IFRS 2 – Share based Payments – requires that equity settled share based payments should be measured based on their fair value at the grant date, based on the number of options expected to vest based on estimates at the reporting date.

The cost should be spread over the vesting period – three years in this case.
This means that the charge to profit or loss in the year ended 31 March 2015 will be
$740,000

(1,850 x 1,000 x $1·20 x 1/3).
The credit entry will be to
equity, probably to an option reserve.

Based on the original arrangements, the cumulative balance in equity on 31 March 2016 will be $1,472,000 (1,840 x 1,000 x $1·20 x 2/3).

The impact of the repricing on 30 September 2015 is to charge the incremental increase in fair value over the remaining vesting period on the same basis as the original charge.

Therefore the additional credit to equity in respect of the repricing will be $92,000 (1,840 x 1,000 x {$1·05 – $0·90} x 6/18).

This means the closing balance in equity will be $1,564,000 ($1,472,000 + $92,000).
The charge to profit or loss in the year ended 31 March 2016 will be
$824,000 ($1,564,000 –

$740,000). This will be shown as an employment expense under operating costs.

Feedback

This question for 9 marks based on IFRS 2 – Share-based Payments - was generally satisfactory answered.
Many candidates wrote that equity settled share based payment arrangement should be measured using the fair value of an option on the grant date based on the number of options expected to vest according to estimates at the reporting date and earned two marks. Many forgot to mention that the cost should be spread over the vesting period (three years), to correctly calculate the charge to P/L for the year and mention that the credit entry should be to other components of equity (option reserve).
Still it was not a problem for well-prepared candidates to score at least two thirds of marks. Candidates found it difficult to deal with the re-pricing on 30 September 2015. Candidates sometimes charged the incremental increase in fair value over the remaining vesting period on the same basis as the original charge. This means that the additional credit to equity in respect of the 
re-pricing of one option will be based on the increase in its fair value ($1·05 – $0·90) and the number of months in the reporting period related to the remaining period of 18 months (6/18). This ratio was correctly calculated only a few candidates.

Some candidates used the term “option reserve” without stating that this is equity and failed to score any mark because “reserve” may well refer to liability.

As for the employment expense not all the candidates wrote that these should be charged to P/L under operating costs. Mentioning “other comprehensive income” is not correct because there are P/L and OCI at the same time. Mentioning provision or reserve cost is not correct either.

Question

You are the financial controller of Omega, a listed entity which prepares consolidated financial statements in accordance with International Financial Reporting Standards (IFRS). One of your assistants, a trainee accountant, is involved in the preparation of the consolidated financial statements for the year ended 31 March 2017. She is also involved in the preparation of the individual financial statements for the entities in the group. She has sent you an email with the following queries:

I’m not sure whether we need to make any entries in respect of the equity settled share-based payment scheme we started on 1 April 2016. I believe we granted options to 1,000 employees to purchase 100 shares in Omega for a fixed price. The options vest on 31 March 2021 subject to two conditions. The first vesting condition is that the employees remain employed by Omega throughout the five-year period up to the date of vesting. Best estimates are that 900 of the 1,000 will stay for that period – only 25 left in the year ended 31 March 2017. The other condition is that the Omega share price on 31 March 2021 should be at least $10. The share price on 31 March 2017 was only $8·50 so it doesn’t look like this condition is satisfied yet. I’ve also noticed that the fair value of one share option was $1 on 1 April 2016, rising to $1·05 on 31 March 2017. Do we need any accounting entries and, if so, what should they be?

Provide answers to the the query raised by the trainee accountant. Your answer should refer to relevant provisions of International Financial Reporting Standards.

 Answer

Under the provisions of IFRS 2 Share-based Payment, this arrangement is an equity settled share-based
payment. 1

IFRS 2 regulates the treatment of vesting conditions based on whether they are market based or
non-market based. 1

A market based vesting condition is taken into account by reflecting it in the measurement of the fair value of the option. It does not need to be considered subsequently as to do so would result in double-counting. Therefore the condition relating to the share price can be ignored after the fair value of $1 is determined. 

A non-market condition is taken into account by reflecting it in the calculation of the number of options ultimately expected to vest. In this case, that number would be 90,000 (900 x 100). 

The cost of the arrangement is recognised over the vesting period, based on the fair value of the option at the grant date.

The amount recognised for the year ended 31 March 2017 would be $18,000 (90,000 x $1 x 1/5). 

This amount is recognised as an employment cost (probably in profit or loss) and a corresponding credit

to equit

Feedback

Answers to part (c) were generally good. Having said this, two errors were relatively common:

  • 􏰒  Basing the accounting charge on the number of employees at the year-end rather than the expected

    number of employees at the vesting date.

  • 􏰒  Basing the accounting charge on the share price at the year-end rather than the option price at the grant

    date.

Question

It has become increasingly common for entities to use share-based payment methods and the most common example is to grant employees share options as part of a remuneration package. These options often vest at the end of a specified period, and are subject to vesting conditions. IFRS 2 – Share-based Payment – has been issued to provide financial reporting guidance for entities which engage in this type of transaction.

Required:

  1. (i)  Explain how share options granted to employees with a future vesting date and subject to vesting conditions should be recognised and measured in the financial statements of the employing entity. Your explanation need only include the treatment of non-market based vesting conditions. (6 marks)

  2. (ii)  Explain what would be the changes to your answer if instead the entity granted share appreciation rights which are payable in cash to the employees at the end of the vesting period. (3 marks)

 

Note 2 – Granting of share appreciation rights to senior executives

On 1 October 20X5, Delta granted 500 share appreciation rights to 20 senior executives. The rights are redeemable in cash on 30 September 20X9 provided the executives remain employed by Delta until at least 30 September 20X9.

On 1 October 20X5, Delta estimated that two of the 20 executives would leave in the period from 1 October 20X5 to 30 September 20X9 and this estimate remained unchanged at 31 March 20X6.

During the year ended 31 March 20X7, one executive left Delta and on that date Delta estimated that the other 19 executives would remain in employment until 30 September 20X9 and so be entitled to the share appreciation rights.

On 1 October 20X5, the fair value of a share appreciation right was estimated to be $6. The fair value of a right had increased to $6·20 by 31 March 20X6 and to $6·40 by 31 March 20X7.

You can assume that this transaction was correctly accounted for by Delta in its financial statements for the year ended 31 March 20X6. (5 marks)

Required:

Briefly explain and show how the transactions described in notes 1 and 2 would be reported in the financial statements of Delta for the year ended 31 March 20X7.

Note: The mark allocation is shown against each of the two notes above.

(20 marks)

Answer

(a) IFRS 2 – Share-based Payment – requires that the total estimated cost of granting share options to employees be recognised over the vesting period. 

The total estimated cost should be charged as a remuneration expense and credited to equity (IFRS 2 does not specify where in equity the credit should be made).

The cumulative charge at the end of each period should be a proportion of the total estimated cost. The proportion should be based on the proportion of the total vesting period which has accrued at the reporting date.

The incremental charge is a remuneration expense for any period and should be the difference between the cumulative charge at the end of the period and the cumulative charge at the start of the period.

The charge should be based on the fair value of the option at the grant date. This continues to be the case throughout the vesting period – subsequent changes in the fair value of the option are not adjusted for. 

Where the vesting conditions are non-market conditions (i.e. not directly related to any change in the entity’s share price), then the cumulative cost at each year end should be estimated based on the expected number of options which will vest at the vesting date.

(b) If an entity grants cash-based share appreciation rights to employees rather than share options, then the basic principle of recognising the total estimated cost over the vesting period taking account of relevant vesting conditions is the same. 

However, since any ultimate payment will be made in cash, the credit entry to account for the remuneration expense is to liabilities rather than equity. 

Also, since any ultimate payment to the holders of share appreciation rights will normally be based on their fair value either at the vesting date or the payment date, subsequent changes in the fair value of the rights cannot be ignored. Measurement of the remuneration expense will be based on the fair value of the share appreciation rights at each reporting date.

Note 2 – Granting of share appreciation rights to senior executives

The expected fair value of the total liability at 31 March 20X7 will be $60,800 (500 x 19 x $6·40).

The amount which will be shown as a liability in the statement of financial position at 31 March 20X7 will be the proportion based on the period elapsed since the rights were granted compared with the total vesting period. In this case that proportion is 18/48. Therefore the closing liability will be $22,800 ($60,800 x 18/48). This will be shown as a non-current liability.

The liability which would have been recognised in the statement of financial position at 31 March 20X6 would have been $6,975 (500 x 18 x $6·20 x 6/48).

Delta would show a remuneration expense in profit or loss of $15,825 ($22,800 – $6,975) in respect of the share appreciation rights for the year ended 31 March 20X7.


Feedback

Answers to part (a) were somewhat disappointing. Many candidates did not appear to have read the requirements of the question carefully enough. Instead of describing the recognition and measurement principles relating to share options many wasted time describing the mechanics of a share-based payment scheme. Often these descriptions were accurate but did not attract any marks because they were not asked for. Most performed rather better when describing the differences between the treatment of share options and share appreciation rights. Most correctly identified the different dates at which ‘fair values’ were measured and the fact that the credit entry to record the transaction was to liabilities, rather than to equity.

Answers to part (b) were much better – many candidates gaining very good marks. This shows sound basic application knowledge on the part of such candidates. However one area in which some candidates struggled was computing the cost to date of the share appreciation rights. These rights were granted part-way through an accounting period so the apportionment calculation involved the use of periods that were not exact years (18 months at the end of the year, 6 months at the start of the year). Candidates cannot always assume that every question contains transactions that start off on the first day of an accounting period. That said, a clear overall conclusion from this question is that candidates are generally better at applying knowledge than explaining principles. Both are important in this examination.