Financial Management Assignment Essay
The share-based transaction, such as share options for employees, was not attributed a cost in the past although the use of such equity instruments was widespread. As a result, the SAAB 2 Share- based Payment was introduced to force entities to incur a cost the transaction.
Moreover, the treatment of share-based payment transactions was very introverts before 2005 which made inter-firm comparison difficult. So the introduction of an accounting standard has become necessary to cover this Issue. 2. Referring to the standard answer the following question: a) Does a share based payment arrangements always relate to employees? No.
It is very common that entities usually use share options for the purpose of employee remuneration. However the scope of the standard is much broader than this.
Under SAAB 2, the definition of share-based payment transaction indicates that a share-based payment arrangement only requires the exchange f goods or services or incurs an obligation to settle the transaction with the supplier when another group entity receives those goods or services.
Consequently, the common share-based payment arrangements are not only related to employees but also related to external consultants or suppliers or shareholders. B) When are transactions with employees outside the scope of SAAB 2?
It is not related to the receipt of goods or services; or the amount paid to the employee is not based on the market price of that entity’s equity instruments. An entity makes a rights issue of shares to all shareholders, including employees ho are shareholders. The transaction is an arrangement with employees in their capacity as owners of equity instruments, not in their capacity as employees. Therefore the transaction is not within the scope of SAAB 2. Furthermore, if entity acquires goods as part of the net assets acquired, this should be considered as Business Combination under SAAB 3.
Apply the Standard in accounting for all share-based payment transactions including: equity-settled share-based payment transactions; cash-settled share- based payment transactions; and transactions in which the entity receives or acquires goods or services and the terms of the arrangement provide either the entity or the supplier of those goods or services with a choice of whether the entity settles the transaction in cash or other assets) or by issuing equity instruments (SCABS, Scopes). C) Are employee bonuses share based payment?
It depends. Shares, share options or other equity instruments are granted to employees as part of their remuneration package, in addition to a cash salary and other employment benefits. Usually, it is not possible to measure directly the services received for particular components of the employee’s remuneration cage. It might also not be possible to measure the fair value of the total remuneration package independently, without measuring directly the fair value of the equity instruments granted.
Furthermore, shares or share options are sometimes granted as part of a bonus arrangement, rather than as a part of basic remuneration, for example, as an incentive to the employees to remain in the entity’s employ or to reward them for their efforts in improving the entities performance. By granting shares or share options, in addition to other remuneration, the entity is paying additional remuneration to obtain additional unifies. Estimating the fair value of those additional benefits is likely to be difficult.
Because of the difficulty of measuring directly the fair value of the services received, the entity shall measure the fair value of the employee services received by reference to the fair value of the equity instruments granted (SAAB 2, Overview) In general, if the bonus is calculated by reference to an entity’s share price, also known as share appreciation rights, it is accounted for as a cash-settled share- based payment. This applies even if the payment is made under a bonus or profit-sharing plan.
However, If the bonus is not calculated by reference to an entity’s share price such as those based on the revenue or profits of the employer entity, or not settled using equity instruments of the group, then it is accounted for as an employee benefit under the scope of SAAB 119. D) Can a share based payment involve the purchase of goods? Yes. Share-based payments are used to procure goods in addition to being used with employees and other parties to purchase services. An entity shall recognize the goods or services received or acquired in a share- based payment transaction when it obtains the goods or as the services are achieved.
The entity shall recognize a corresponding increase in equity if the goods or services were received in an equity-settled share-based payment transaction or a liability if the goods or services were acquired in a cash-settled share-based payment transaction. For example, Entity A is developing a new product and purchases a patent from entity B. The parties agree a purchase price of 1 of entity Bi’s shares. These shares will be issued to entity B within 60 days of finalizing the legal documentation that transfers the patent from entity B to entity A.
This is an equity-settled share-based payment. The goods to which applies include inventories, consumables, property, plant and equipment, intangible assets and other non-financial assets (SCABS, Recognition). 3. In relation to share options outline the arguments for and against recognizing an expense when options are granted. Accounting for employee share options has been very controversy arise from the issue that should share options attribution be expensed? According to SAAB 2 (par. 9), an expense arises from the consumption of goods or services.
Furthermore, sometimes it is necessary to recognize an expense before the goods or services are consumed or sold, cause they do not qualify for recognition as an asset. Based on the definition, two opinions of the share options’ economic implications are formed. On one hand, it is believed that share options should not be recognized as an expense when granted. On the other hand, some may argue that share options as a form of remuneration for services rendered by employees should be recognized as an expense.
Elves (2010) indicates both sides of views as following: The arguments for recognizing an expense are: 1) Share options meet the definition of an expense as there an transaction teen the company and its employee, in which the employees agree to provide services to the company during the specific period usually 3 to 5 years in return; 2) Share options grant is not a capital transaction since the employees provide services to the company not the shareholders; 3) The compensation cost of the share options is not recognized in the diluted earnings per share; 4) Disclosure is not a substitute for recognition; 5) The cost of share options is more likely to be estimated by option pricing model.
The arguments for the expensing of share options are: ) Share options do not meet the definition of an expense as it does not meet the requirement that there is sacrifice of future economic benefits; 2) Share options are considered as a capital transaction including issuing shares; 3) The potential dilution of the stock options is already reflected adequately in the diluted earnings per share; 4) The devaluation of stock options cost is considered enough 5) Stock options cannot be estimated reliably because there is no accurate and reliable valuation method. The famous Black – Schools model is used for the treatable options. 4. What approach does SAAB 2 take to the valuation of share options? Under SAAB 2 Par. 10, the general rule requires that the entity should measure the good or services received at its fair value. If the reliable value cannot be estimated, the entity shall measure their value and the corresponding increase in equity, indirectly, by reference to the fair value of the equity instruments granted. Share options as part of remuneration for employee is not possible to measure the fair value directly.
As a result, the entity shall measure the fair value of the employee service received by reference to the fair value of the equity instruments granted (par. 12). Furthermore, to measure the fair value of equity instruments as share options which is not traded, fair value might be determined by valuation techniques such as option pricing models as follows: (BE, Appendix B) (a) the exercise price of the option; (b) the life of the option; (c) the current price of the underlying shares; (d) the expected volatility of the share price; (e) the dividends expected on the shares (if appropriate); and (f) the risk-free interest rate for the life of the option.