Equity Settled Share-based Payments | IFRS 2

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Equity Settled Share-based Payments as per IFRS 2 account for the payment for goods/services in the form of Equity Instruments (‘Shares’ or ‘Share Options’) of the Co./group company.

📘 IFRS 2 · Accounting Standard
📅 Standard: IFRS 2 🏛 Body: IASB 📂 Category: Financial Reporting
2004IFRS 2 Issued
3Transaction Types
FVGrant-date Measure
E&PEquity & P&L Impact

01 · OVERVIEWWhat Are Equity Settled Share-based Payments?

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Equity Settled Share-based Payment is a transaction in which an entity receives goods or services as consideration for its own equity instruments (including shares, share options, or other equity instruments). The entity settles its obligation by issuing equity rather than paying cash.

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Grant Date

The date on which the entity and counterparty agree to the arrangement and fair value is measured.

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Equity Instruments

Shares, share options, or instruments that give the holder a residual interest in the entity.

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Fair Value

Measured at grant date; not remeasured subsequently (key difference from cash-settled).

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Vesting Period

The period over which all specified vesting conditions are to be satisfied.

02 · SCOPEWhen Does IFRS 2 Apply?

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IFRS 2 applies to all share-based payment transactions, whether with employees or other parties supplying goods or services. It covers three broad categories:

✅ In Scope
  • Employee share option schemes
  • Restricted stock unit (RSU) plans
  • Long-term incentive plans (LTIPs)
  • Save-As-You-Earn (SAYE) schemes
  • Share purchase plans
  • Goods/services settled by issuing equity
  • Group share-based arrangements
❌ Out of Scope
  • Business combinations (IFRS 3)
  • Equity instruments issued for financial instruments (IAS 32 / IFRS 9)
  • Routine share issuances to raise capital
  • Contract modifications outside the standard
  • Transactions with owners acting as owners

03 · RECOGNITIONRecognition Principles

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Under IFRS 2, when an entity grants equity instruments to employees, it recognises:

The Core Accounting Entry

Debit: Employee Benefit Expense (P&L) or the relevant cost (e.g., inventory, fixed asset)
Credit: Equity Reserve (Share-based Payment Reserve in equity)

The expense is recognised over the vesting period as the services are received.

Transactions with Employees vs. Non-employees

For employee transactions, the fair value of services cannot be reliably estimated directly, so the fair value of the equity instruments granted is used as a proxy, measured at grant date.

For non-employee transactions, the fair value of goods or services received is measured directly (with the equity instruments’ fair value used only if the goods/services fair value cannot be reliably estimated).

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Key principle: The total expense recognised over the full vesting period equals the fair value of equity instruments that ultimately vest (adjusted for market conditions baked into the grant-date fair value).

04 · MEASUREMENTMeasuring Fair Value

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The Fair Value of Equity Settled Share-based Payments (particularly share options) is determined at grant date using an option-pricing model. IFRS 2 does not mandate a specific model but cites:

ModelBest Used ForKey Inputs
Black-Scholes-MertonEuropean-style options; simple plansSpot price, exercise price, volatility, risk-free rate, dividend yield, time to expiry
Binomial LatticeAmerican-style options; early exercise likelySame as BSM plus expected early exercise patterns
Monte Carlo SimulationMarket-based conditions (TSR, relative performance)Correlated share price paths, market conditions
Intrinsic ValuePermitted only if fair value cannot be estimated reliablySpot price minus exercise price (minimum)

Key Inputs & Considerations

Black-Scholes-Merton Option Value (simplified) C = S₀ · N(d₁) − X · e−rT · N(d₂) Where: S₀ = current share price | X = exercise price | r = risk-free rate | T = time to expiry | N(·) = cumulative normal distribution | d₁, d₂ = derived from volatility and time parameters
InputEstimation Guidance
Share PriceMarket price of shares at grant date
Exercise PriceSet in the option award terms
Expected VolatilityHistorical volatility of entity’s shares; implied volatility if available
Expected LifeWeighted average period options are expected to be outstanding (often shorter than contractual term)
Risk-Free RateYield on zero-coupon government bonds with term matching expected life
Expected DividendsDividends excluded from fair value if option holder doesn’t receive dividends during vesting

05 · VESTINGVesting Conditions Explained

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Vesting conditions determine whether and when the counterparty is entitled to the equity instruments. IFRS 2 classifies conditions into two types, each with distinct accounting treatment:

Market Conditions
  • Linked to market price of entity’s shares (e.g., Total Shareholder Return vs. index)
  • Included in grant-date fair value via Monte Carlo model
  • Expense recognised regardless of whether condition is met
  • No true-up for market condition outcomes
Non-Market Conditions
  • Service conditions (continuing employment)
  • Performance conditions (EPS growth, revenue targets)
  • NOT included in grant-date fair value
  • Expense based on best estimate of instruments expected to vest
  • True-up required at each period end

The Vesting Timeline

Grant Date

Entity and counterparty agree to the arrangement. Fair value of Equity Settled Share-based Payments is determined. Vesting period begins.

During Vesting Period

Expense recognised on a straight-line basis (or accelerated where appropriate). Estimate of instruments expected to vest updated each period.

Vesting Date

Cumulative expense equals number of instruments actually vested × grant-date fair value. No subsequent remeasurement of equity reserve.

Exercise Date (Options)

Share-based payment reserve transferred to share capital and Share Premium. Cash received for exercise price (if any).

Lapse / Forfeiture

If options lapse unexercised post-vesting, the reserve may be transferred to retained earnings — no reversal of P&L expense.

06 · MODIFICATIONSModifications, Cancellations & Settlements

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Entities sometimes modify the terms of share-based payment (whether Equity Settled Share-based Payments Or Cash Settled SBP) awards during the vesting period. IFRS 2 provides specific guidance:

EventAccounting Treatment
Beneficial Modification (e.g., reduced exercise price)Recognise incremental fair value (modified FV minus original FV) over remaining vesting period, in addition to original grant-date FV
Non-beneficial ModificationIgnore the modification; continue accruing based on original grant-date FV
Cancellation or Settlement (during vesting period)Accelerate recognition of remaining unvested expense immediately as if vesting had occurred; any payment up to grant-date FV charged to equity; excess charged to P&L
Replacement Awards (e.g., in restructurings)Treated as a modification; incremental FV recognised over remaining vesting period
Post-vesting CancellationNo P&L effect; equity reserve may be transferred to retained earnings
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Cancellation rule: When an entity cancels an award during the vesting period, the unvested expense must be accelerated immediately. IFRS 2 treats cancellation as if vesting occurred on the date of cancellation.

07 · JOURNAL ENTRIESAccounting Entries — Worked Examples

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Example Setup

On 1 January 20X1, an entity grants 1,000 share options to an employee, with an exercise price of £5 per option. Grant-date fair value = £3 per option. Vesting condition: 3 years’ service. All options vest and are exercised on 31 December 20X3.

Annual expense = (1,000 × £3) ÷ 3 years = £1,000 per year

Year 1 — 31 December 20X1: Recognise Annual Expense
Dr Employee Benefit Expense (P&L)£1,000
Cr Share-based Payment Reserve (Equity)£1,000
Years 2 & 3 — Repeat annually (same entry each year)
Dr Employee Benefit Expense (P&L)£1,000
Cr Share-based Payment Reserve (Equity)£1,000
31 December 20X3 — Exercise of Options (£5 exercise price × 1,000)
Dr Cash£5,000
Dr Share-based Payment Reserve (Equity)£3,000
Cr Share Capital + Share Premium£8,000
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Note: If options lapse unexercised after vesting, the £3,000 reserve is simply reclassified within equity to retained earnings, no P&L reversal is permitted.

Forfeiture Adjustment Example

If at Year 2 the entity revises its estimate downward (expecting only 800 options to vest due to leavers), the cumulative expense is recalculated:

Cumulative Expense — Year 2 (Revised) Cumulative = (800 options × £3) × (2 yrs ÷ 3 yrs) = £1,600 Year 1 recognised: £1,000 → Year 2 charge = £1,600 − £1,000 = £600 (reduced expense due to forfeiture estimate)

08 · DISCLOSUREDisclosure Requirements

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IFRS 2 requires extensive disclosures to enable users to understand the nature and extent of share-based payment arrangements and their effect on financial statements.

Nature & Extent Disclosures

  1. Description of each type of share-based payment arrangement in existence during the period
  2. Number and weighted average exercise price of options outstanding at start and end of period, granted, forfeited, exercised, and expired
  3. Weighted average share price at date of exercise for options exercised during the period
  4. Range of exercise prices and weighted average remaining contractual life of outstanding options

Fair Value Determination Disclosures

  1. Weighted average fair value of options granted and information on how fair value was measured
  2. Option pricing model used and its inputs (exercise price, share price, expected volatility, option life, dividends, risk-free rate)
  3. How expected volatility was determined and whether it is based on historical volatility
  4. Any other features of the option grant incorporated into fair value measurement

Effect on P&L and Balance Sheet

  1. Total expense recognised in P&L from share-based payment transactions
  2. Total carrying amount in equity at period end
  3. Liabilities arising from cash-settled arrangements (if any)

09 · FAQFrequently Asked Questions

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What is the key difference between Equity Settled Share-based Payments and cash-settled share-based payments?
In Equity settled Share-based Payments, the entity issues equity instruments and the fair value is fixed at grant date; no subsequent remeasurement. In cash-settled arrangements (e.g., phantom shares, SARs), the entity pays cash equal to the value of shares, and the liability is remeasured to fair value at each reporting date until settlement, with changes going through P&L.
Is the expense reversed if options are forfeited due to non-market performance conditions?
Yes. For non-market conditions (e.g., EPS growth target not met), the cumulative expense is reversed because the vesting condition was not satisfied. However, for market conditions (e.g., TSR-linked awards), the expense is not reversed as the probability of achieving the market condition is already factored into the grant-date fair value via the Monte Carlo simulation.
Can a company use intrinsic value instead of fair value?
Only in rare cases where fair value cannot be reliably measured. IFRS 2 allows intrinsic value as a fallback, but requires remeasurement at each reporting date and at settlement date (unlike grant-date fair value). This is an exception, not the norm, and must be justified.
How does a graded vesting plan differ from cliff vesting for expense recognition?
With cliff vesting (all vest at once at end of period), expense is spread evenly over the vesting period. With graded vesting (e.g., one-third per year over 3 years), each tranche is treated as a separate award with its own vesting period. This results in front-loaded expense recognition, as earlier tranches have shorter vesting periods and are recognised more quickly.
What happens to the share-based payment reserve when options lapse after vesting?
When vested options lapse unexercised (e.g., the share price is below the exercise price), the entity has already recognised the full expense in P&L. The reserve in equity may be reclassified to retained earnings within equity, but no P&L entry is made. IFRS 2 does not require or prohibit this reclassification, it is an accounting policy choice.
How are group share-based payment arrangements accounted for?
In group schemes (e.g., parent grants awards over its own shares to subsidiary employees), the subsidiary receiving the services recognises an expense and a corresponding equity contribution from the parent. The parent recognises the equity instruments granted. IFRS 2 amendments (2009) clarified that the receiving entity accounts for the transaction as equity-settled if the instruments granted are its own or the parent’s equity.