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IND-AS: Share Based Arrangements

Published on Fri, May 29,2015 | 22:48, Updated at Fri, May 29 at 22:48Source : CNBC-TV18 

IND-AS: SHARE BASED ARRANGEMENTS & THEIR IMPACT ON FINANCIAL STATEMENTS

By: Sandip Khetan, Partner, member firm of EY Global

BACKGROUND
Ind-AS 102, Share-based Payment prescribes the accounting and disclosure related matters in relation to stock options as may be granted by the Company to its employees as well as non-employees.  Under existing Indian GAAP, only employee related share based payments are covered by the guidance note. Further the guidance note is not a notified accounting standard and hence the accounting practices around share based payment are not consistent.

Guidance note on share based payments used to provide an accounting alternative in which a Company was allowed to determine the fair value of the share on the date of the grant and if the fair value of the share and the exercise price of the share was same on the date of grant then no accounting charge was required to be recorded by the Company. This method is currently being called as intrinsic value method.

However, Ind-AS 102 now will require accounting for the same using the fair value method. This will essentially require the determination of the fair value of the options (as against the share in the intrinsic value method) and recording of such costs over the vesting period of such option with the employees.  This method inherently assumes that every option has a value and its fair value should be accounted through statement of income.

DETERMINATION OF FAIR VALUE OF STOCK OPTIONS
•    Ind-AS 102 will require the application of different method of valuation for determining the fair value which is depending on whether such arrangement is with employees or with non- employees. For transaction with employees, it recommends the option pricing model to determine the fair value of the options whereas for transaction with non-employees, it require us to determine the fair value of the goods or services so received as an evidence of the fair value of the options so granted to the non-employees.

Determination of fair value can be very tedious and long drawn exercise whereas it may require the use of a valuation expert to determine the same. Similarly if the stock option award scheme is linked to multiple variables ( for example continuity of service, achievement of targets, linked with future stock price etc) then determining fair value of such options may require use of complex valuation models and which will further necessitate the use of valuation experts.

WHAT WILL CHANGE?
As a result of the mandatory accounting of stock options at its fair value, Company financial statements can be impacted in many ways and some of them are discussed below;
 
Assessment Of Grant Date
•    Grant date of share based arrangement is extremely important in determining the total costs of such arrangement to be recognised by the Company over the period of vesting. This is achieved when the employer and employee have full understanding of all the terms and conditions of such grant. On the date of grant the Company is required to assess the total costs of the options using the option pricing model and depending on the classification of such award (Equity settled vs Cash settled), a Company may be required to reassess (for cash settled) the costs on an ongoing basis.

Historically we have seen that the date of grant is a matter of contention for an unlisted company and significant amount of documentation may be required to be maintained by the Company to demonstrate that such event has indeed taken place and it is appropriate to determine the costs on such date.

Change In Costs Base
•    For example if a Company operate on a costs plus model and currently grant stock options to its employees (or such option is granted by the holding company to its employees), such Company will now require to account for the stock option costs as employee benefit costs and as a consequence of that their costs based and related revenue may go up which may result in increased outflow of taxes as well.

If a Company has granted stock option to its employees and such employee is engaged in any construction of an asset or inventory, then stock option costs of such employees will be required to be capitalised with the respective fixed asset or the inventory as the case may be.
If the stock options are supposed to vest in a graded manner over the terms of the option, then the Company may end up recording higher costs in the initial years which will decline over the years in a progressive manner. For example a Company has granted 500 options to its employees and out of which 100 options vests each year. Further assume that the fair value of options is INR 10 and thus the total stock option cost is INR 5000 to be recognised over 5 years (no forfeiture is estimated). The Company will be required to treat each tranche of vesting (5 different tranche in this case) as a separate grant which will result in accelerated costs being recognised in first year, which will keep on reducing in subsequent period. Accordingly in year 1 the Company will end up recording an accounting charge of INR 2,284 ((1000 +500 +333+250+200) for each tranche) which is approximately 46% of total costs.

Volatility In The Statement Of Income
•    If the stock option award is likely to be cash settled as oppose to equity settled awards, then such arrangement can add significant volatility to the statement of income as total costs of options will only be known on settlement of the options.

Negative Impact On EBIDTA And Earnings Per Share
•    Most of the companies which operate in the IT/ITES sector or in the e-commerce sector uses stock option as a form of incentive to reward and retain its employees. Several companies use this as an arrangement to extract more business from its customers or as a mode of payment to its vendors.  All such arrangements are likely to negatively impact the EBIDTA as well as basic earnings per share of the Company.

Currently the operational parameters of some of the companies which use stock options as a form of reward vs the companies which do not use this instrument are not comparable which in future are likely to become more comparable.

Lot of companies uses stock options as a form of reward to employees immediately before the IPO; such schemes will now impact the pre and post IPO profitability of the Company.

Incentive To The Customers Or Vendors
•    If a Company is using share based arrangement as a form of incentive to its customers then the fair value of such services needs to be determined and to be recorded as a reduction of revenue. Similarly if the same has been used for settling its obligations with its vendors then the fair value of services so received needs to be recorded as costs with a corresponding credit to equity.

Change In The Terms Of The Stock Options
•    If a Company changes the terms of the stock option either by re-pricing the exercise price or by accelerating the vesting date or by cancellation of such stock option plan, all such changes are considered as the modification of the original terms of the award and the incremental costs of the modification along with the originally determined costs on the date of grant is required to be recognised by the Company.

Disclosure And Other Matters
Significant amount of disclosures are required to be provided by companies which are now engaged in using share based arrangements with its employees or its non-employees. Companies are now required to ensure that all such data points are captured well in advance to ensure the completeness of all disclosures as required to be made under Ind-AS 102.

Significant increase in the costs may impact the plan of several companies to use this as a form of reward for its employees and companies may need to evaluate the costs benefit analysis before using this in future.

Transition Provision Under Ind-AS 101
•    Ind-AS 101, First time Adoption of Indian Accounting Standards provides certain relief in relation to accounting for past vested share based arrangement. A Company is required to carefully evaluate the impact of the same and determine its policy choice on the date of transition.

CONCLUSION
All Companies using share based arrangement will be required to carefully analyse and evaluate the terms of its arrangement with its employees and its non-employees on its financial statements as well as related disclosures. Companies may need to gather additional data points to ensure that all disclosures are made as required under the standard. This may also necessitate the engagement with external stakeholders and update them the impact of this in relation to financial performance of the Company.

 
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