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Hi,
Another question.. from what I understand, where a transaction can be settled in either equity issue or cash, this is treated as a liability and valued in the same way as a convertible bond, ie the debt element is calculated and the equity element is the balancing figure. But doesn’t this mean, if the trader chooses the equity option, that the shares issued are going to be valued at completely the wrong figure, far too low? Or is there a further entry when the choice is made to correct the values? Or do I have the wrong idea completely (have a feeling I do!)
thanksI’ve copied some detail from EY’s guidance on IFRS 2 but the key is on who has the choice of settlement. So from what you’ve said above if the investor has the choice it will be split accounting. On conversion it entirely depends on what the investor decides, if they take shares or cash. Our estimates of the liability and equity won’t be perfect but any differences we can adjust through profit or loss.
IFRS 2 gives specific guidance for the situation in which cash settlement is a choice. The accounting differs depending on whether the choice rests with the counterparty or the entity.
If a counterparty chooses settlement of the award in either shares or cash, IFRS 2 treats it as a compound award. A compound award is split into two components: a liability component (the counterparty’s right to demand settlement in cash) and an equity component (the counterparty’s right to demand settlement in shares). Once split, the entity accounts for the two components separately.
For awards that can be settled in cash as an alternative, it is important to determine
whether the choice rests with the counterparty or the entity.If an entity chooses the settlement method, it treats the whole award as either cash-settled or equity-settled, depending on whether or not the entity has a present obligation to settle in cash. An entity has a present obligation to settle in cash, if any of the following apply:
• The choice of settlement has no commercial substance (e.g., because an entity is prohibited by law from issuing shares)
• An entity has a past practice or stated policy of settling in cash
• An entity generally settles in cash whenever the counterparty asks for cash settlement
If an entity has a present obligation to settle in cash, it is a cash-settled award (i.e., a liability). If an entity does not have a present obligation to settle in cash, it is an equity-settled award.Thanks very much for your response, I hadn’t properly thought through the differences in treatment depending on which party had the choice. so if its the investor with the choice the method of initial valuation is the same you would use for a convertible bond. I also found the guidance below from Deloitte which seems to clarify that there is an adjustment once the choice is made (I wasn’t sure there was):
‘Until now, IFRS 2 did not specifically address situations where a cash-settled share-based payment changes to an equity-settled share-based payment because of modifications of the terms and conditions. The IASB has intoduced the following clarifications:
On such modifications, the original liability recognised in respect of the cash-settled share-based payment is derecognised and the equity-settled share-based payment is recognised at the modification date fair value to the extent services have been rendered up to the modification date.
Any difference between the carrying amount of the liability as at the modification date and the amount recognised in equity at the same date would be recognised in profit and loss immediately.’Thanks for your help again!
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