Explain how share-based compensation is accounted for
The idea
Share-based compensation is an expense because employees provide services in exchange for it, even though no cash leaves the company. For equity-settled awards both IFRS and US GAAP measure the cost at fair value on the grant date: the share price for restricted stock, and an option pricing model such as Black–Scholes or a binomial model for options, with inputs like volatility and expected life. That cost is spread over the vesting period and is not remeasured when the share price later moves. Cash-settled awards such as share appreciation rights are liabilities, remeasured to fair value at each reporting date. With graded vesting, IFRS treats each tranche as a separate award, front-loading the expense, while US GAAP allows straight-line recognition for service-only awards. Disclosures cover the valuation model and its inputs, awards outstanding and the expense recognised, which analysts need to judge dilution and how much of reported pay bypasses cash flow.
A practice question
Under both IFRS and US GAAP, an equity-settled employee share option award is measured at:
- fair value at the grant date — correct
- intrinsic value at exerciseWhy not: Measuring at exercise would push the cost into a later period and ignore the time value that options carry.
- fair value at each year-endWhy not: Remeasurement applies to cash-settled awards. Equity-settled awards are fixed at the grant date.
The grant-date fair value sets the total cost, which is then recognised over the vesting period as employees provide service.
A harder one
A company grants 100,000 options with a grant-date fair value of 6 each. All vest at the end of three years of service. The compensation expense in year 1 is:
- 600,000Why not: Recognises the full cost at grant. The cost is spread over the three-year service period.
- 0Why not: Assumes no cost because the options are not yet exercisable. Service is being received now, so expense accrues now.
- 200,000 — correct
Total cost = 100,000 x 6 = 600,000, recognised evenly over 3 years: 600,000 / 3 = 200,000 per year.
The hardest tier
After grant, a company's share price rises sharply. Which awards will show an increase in recognised compensation cost because of this rise?
- Equity-settled share optionsWhy not: Their cost is fixed at grant-date fair value and is not remeasured for later price moves.
- Cash-settled share appreciation rights — correct
- Restricted shares settled in stockWhy not: Also equity-settled, so they stay at the share price on the grant date.
Cash-settled awards are liabilities remeasured to fair value at each reporting date, so a rising share price raises the liability and the expense. Equity-settled awards are locked at grant-date fair value.
In the app: 6 practice questions on this outcome, a narrated walkthrough with diagrams, spaced review that brings it back before you forget it.
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