September, December 2019 SBR Past Exam – Employee Shared based Payment

Dear Sir,

Could you please explain the answer from ACCA past exam of September, December 2019 for the following questions:

Question 1: Acquisition of Hammond Co

Luploid Co acquired 60% of the 10 million equity shares of Hammond Co on 1 July 20X7. Two Luploid Co shares are to be issued for every five shares acquired in Hammond Co. These shares will be issued on 1 July 20X8.

The fair value of a Luploid Co share was $30 at 1 July 20X7. Hammond Co had previously granted a share-based payment to its employees with a three-year vesting period.

At 1 July 20X7, the employees had completed their service period but
had not yet exercised their options. The fair value of the options granted at 1 July 20X7 was $15 million. As part of the acquisition, Luploid Co is obliged to replace the share-based payment scheme of Hammond Co with a scheme of its own which has the following details:

Luploid Co issued 100 options to each of Hammond Co’s 10,000 employees on 1 July 20X7. The shares are conditional on the employees completing a further two years of service. Additionally, the scheme required that the
market price of Luploid Co’s shares had to increase by 10% from its value of $30 per share at the acquisition date over the vesting period. It was anticipated at 1 July 20X7 that 10% of staff would leave over the vesting period but this was revised to 4% by 30 June 20X8. The fair value of each option at the grant date was $20. The share price
of Luploid Co at 30 June 20X8 was $32 and is anticipated to grow at a similar rate in the year ended 30 June 20X9.

(i) How the consideration for the acquisition of Hammond Co should be measured on 1 July 20X7. Your answer should include a calculation of the consideration and a discussion of why only some of the cost of the replacement share-based payment scheme should be included within the consideration.

(ii) How much of an expense for the share-based payment scheme should be recognised in the consolidated profit or loss of Luploid Co for the year ended 30 June 20X8. Your answer should include a brief discussion of how the vesting conditions impact upon the calculations.

Answer from ACCA:

IFRS 3 Business Combinations requires all consideration to be measured at fair value on acquisition of a subsidiary.
This will include the deferred shares. Since Luploid Co is obliged to replace the share-based scheme of Hammond Co on
acquisition, the replacement scheme should also be included as consideration. There is, however, a post combination
service period which means that the portion of the replacement scheme attributable to pre-combination service is the
market value of the acquiree award multiplied by the ratio of the portion of the vesting period completed to the greater of the total vesting period or the original vesting period of the acquiree award.

The vesting period of the acquiree award had vested and was three years. As there is a two-year post combination vesting period, the total vesting period is five years. Therefore the amount attributable to the pre-combination period (and therefore added to the cost of the investment) should be $15 million x 3/5 = $9 million.

Deferred shares should be measured at the fair value at the acquisition date with subsequent changes in fair value ignored. Luploid Co will issue 2·4 million (60% x 10m x 2/5) shares as consideration. The market price at the date of acquisition was $30, so the fair value is $72 million. The total consideration should be valued as $81 million (72 + 9).

I do not understand why $9mil added to cost of investment. Could you please give an explanation.