AASB 2 Share-Based Payment and its predecessors have now been in force for over 15 years, so the requirement to record any issue of shares, options and performance rights to employees and consultants as part of their remuneration is not new.
For equity settled share based payment transactions, the key is that the entity shall measure the goods or services received at the fair value of the goods and services received, unless that fair value cannot be estimated reliably. If the entity cannot estimate the fair value of the goods or services received, the entity shall measure their value by reference to the fair value of the equity instruments granted (para 10).
Typically, the services received will be employment services. As the valuation of employment services is variable and can be difficult to estimate due to that variability from company to company and person to person, the better source of valuation is the equity instrument issued in return for the services.
Option and performance right valuation
The value of the equity instrument is measured at the measurement date, or grant date of the option. This value is based on market prices if available, and if not available, the entity shall use a valuation technique to estimate what the price of those equity instruments would have been on the measurement date in an arm’s length transaction between knowledgeable parties. The valuation technique has to be consistent with generally accepted valuation methodologies for pricing financial instruments and must incorporate all factors and assumptions that participants would consider in setting the price (para 16-17).
What does this typically mean for a company that needs to value these equity instruments?
If the company issues shares, and that company is publicly listed, then the value is typically taken from the share price on the grant date – this is the day that the equity instruments are issued, or approved by shareholders if shareholder approval is required for their issue.
If the company has issued options or performance rights, then it is usually the case that similar options or rights are not listed on the stock exchange, and as such there is no reference to a market price for those instruments. This is where a valuation technique is required to determine a value for the equity instruments issued – typically options or performance rights.
Treatment of vesting conditions
Equity instruments issued in return for services will usually have a vesting or performance condition attached to them, although this is not always the case as they may vest immediately.
If there is a vesting condition, then the type of condition will determine whether that vesting condition is required to be taken into account when the option or right is valued.
Vesting conditions that aren’t market conditions, are not taken into account when estimating the fair value of the options or rights at the measurement date. Instead, the performance conditions are taken into account by adjusting the number of instruments included in the measurement of the instruments.
For example, the performance condition might be that the employee has to remain an employee for three years for the options to vest. The value of the options does not get adjusted for this requirement, but the total number of options expected to vest may be adjusted. Historically the company might have an employee turnover rate of 30% over three years. Applying that data, the company may include in their measurement of the share based payment 70% of the options issued, on the basis that 30% are not expected to vest within the three years.
When do vesting conditions affect the valuation?
Where the performance conditions are market conditions, then those performance conditions are taken into account when calculating the value of the equity instrument issued.
Market conditions are performance conditions that are related to the market price of the entity’s equity instruments, such as:
- attaining a specified share price or a specified amount of intrinsic value of a share option; or
- achieving a specified target that is based on the market price of the entity’s equity instruments relative to an index of market prices of equity instruments of other entities
Examples are that the share must exceed a certain price by a certain date, or the total shareholder return for the company’s shares has to exceed the total shareholder return of an index to which the company belongs, or a general index such as the ASX200.
These conditions will then be taken into account when valuing the options or performance rights issued, and will require a valuation technique that is able to take into account these performance or market conditions when calculating a value.
Which valuation technique should I use to meet the requirements of AASB 2?
The valuation technique that is used is dependent on the terms and conditions of the options or performance rights issued.
The valuation technique should fit the options, and you should not be trying to make the options fit a particular valuation technique.
The simplest way to work out which valuation technique should be used, is to first work through the terms and conditions of the options or performance rights, and the features of the company’s shares.
Once you have determined the terms and conditions, then you will know which valuation technique will be the most appropriate for your situation.
And if you need to value options or performance rights and you aren’t sure how you should go about valuing those instruments, then contact us at Value Logic to help you out meeting the requirements of AASB 2 and ensuring that your period end audit will be smooth sailing.