By the MIA Financial Statements Review Committee
Application of MFRS 2 on Special Share Plan Issued to Employees in IPO Listing Exercise.
An Initial Public Offering (IPO) allows a company to raise funds from public investors. A company going public may be subject to certain new and complex financial reporting requirements as a consequence of the transactions entered into upon listing. These range from the recognition and disclosures in financial statements to complying with the listing and other statutory requirements.
It is common for entities to issue share options to employees in conjunction with an IPO exercise. Due to the complexity of share-based payment transactions, and that the facts and circumstances may differ in each scheme, it is considered one of the financial reporting areas that warrants careful attention in an IPO exercise.
Share-based payments are common features of employee remuneration for directors, senior executives and other employees. Typically, an employee share option scheme executed under an IPO involves allocation of shares to the eligible employees. Some entities also make settlement arrangement with vendors by issuing shares or share options. The Malaysian Financial Reporting Standard (MFRS) 2 Share-based Payment outlines the accounting requirement for these transactions.
In recent years, there are instances where the Promoters of listing schemes grant shares directly to eligible employees of the entity. This raises the concern of whether these share grants fall within the ambit of share-based payment for which an expense is required to be recognised in the statements of profit or loss of the entity.
Scenario – Special Share Plan
The listing scheme of Company X includes a Special Share Plan (SSP) in which shares of Company X will be granted by the Promoters (who are also the Offerors) to selected employees at zero consideration concurrent with the listing of the entity. The SSP is a one-off share plan for the eligible employees as a gesture of the Promoter’s goodwill due to the long-term and close working relationship with these employees. The question arises as to whether the shares granted by the Promoters to the employees should be accounted for as a share-based payment given the following considerations:
- Neither Company X nor the Promoters have an agreement with the eligible employees which entitled the employees to receive equity instruments as payment for services rendered by them.
- Shares were issued to the Promoters pursuant to the listing scheme. There was no constructive obligation on the Promoters to grant shares to the eligible employees. The grant of shares is at the sole discretion of the Promoters without any involvement of Company X.
- The SSP was not meant as an arrangement to pay for services rendered by the eligible employees but rather as a gesture of goodwill by the Promoters.
MFRS 2 Applies
The application of MFRS 2 together with the Basis for Conclusion (BC) on MFRS 2 issued by the International Accounting Standards Board (IASB) addresses the scenario of the aforesaid SSP.
MFRS 2 addresses group share-based payment transactions involving group entities, including shareholders of any group entity.
Paragraph 3A, MFRS 2
“A share-based payment transaction may be settled by another group entity (or a shareholder of any group entity) on behalf of the entity receiving or acquiring the goods or services. Paragraph 2 also applies to an entity that:
- receives goods or services when another entity in the same group (or a shareholder of any group entity) has the obligation to settle the share-based payment transaction, or
- has an obligation to settle a share-based payment transaction when another entity in the same group receives the goods or services
unless the transaction is clearly for a purpose other than payment for goods or services supplied to the entity receiving them.”
Application Guide Paragraph B49, MFRS 2
“An entity shall account for share-based payment transactions in which it receives services as consideration for its own equity instruments as equity-settled. This applies regardless of whether the entity chooses or is required to buy those equity instruments from another party to satisfy its obligations to its employees under the share-based payment arrangement. It also applies regardless of whether:
- The employee’s rights to the entity’s equity instruments were granted by the entity itself or by its shareholder(s); or
- The share-based payment arrangement was settled by the entity itself or by its shareholder(s).”
A transaction in which the company receives employees’ services and the employees receive shares of the company is a share-based payment transaction. The share-based payment transaction may be settled by a shareholder. In the listing scheme, the Promoters are shareholders of the company. The shares were granted to the selected employees at zero consideration and settled by the Promoters. Applying the above principles, regardless of whether the share-based payment arrangement was granted / settled by Company X or the Promoters, the transaction should be accounted for as share-based payment.
BC for MFRS 2
In the BC for MFRS 2, the IASB has addressed some of the issues encountered in the application of MFRS 2.
BC19 and BC20 In some situations, an entity might not issue shares or share options to employees directly. Instead, a shareholder(s) might transfer equity instruments to the employees. Under this arrangement, the entity has received services (or goods) that were paid for by its shareholders. The arrangement could be viewed as being, in substance, two transactions, one transaction in which the entity has reacquired equity instruments for zero consideration, and a second transaction in which the entity has received services (or goods) as consideration for equity instruments issued to the employees (or other parties).
BC21 The second transaction is a share-based payment transaction. Therefore, the IASB concluded that the entity should account for transfers of equity instruments by shareholders to employees or other parties in the same way as other share-based payment transactions. The IASB reached the same conclusion with respect to transfers of equity instruments of the entity’s parent, or of another entity within the same group as the entity, to the entity’s employees or other suppliers.
Applying the above, Company X did not issue the shares directly to its employees. Instead, the Promoters had transferred the shares to the employees of entity through the SSP. As such, Company X received the employee’s services that were paid for by the Promoters.
The BC on MFRS 2 addressed the arguments commonly made against the recognition of expenses arising from share-based payment.
i. The entity is not a party to the transaction
It is argued that the grant of shares is at the sole discretion of the Promoters without the involvement of Company X.
The effect of the above is that the existing shareholders transfer some of their ownership interests to the employees. The transaction is between the shareholders and the employees without the involvement of Company X.
BC34 Some argue that the effect of employee share plans is that the existing shareholders transfer some of their ownership interests to the employees and that the entity is not a party to this transaction.
BC35, IASB’s opinion is that it is the entities and not the shareholders that set up the employee share plans and issue shares to the employees. Even if that were not the case, e.g. if the shareholders transferred shares or share options direct to the employees, this would not mean that the entity is not a party to the transaction. The equity instruments are issued in return for services rendered by the employees and it is the entity, not the shareholders, receives those services. Therefore, IASB concluded that the entity should account for the services received in return for the equity instruments issued.
To this effect, it is Company X and not the Promoters that set up the share scheme. The SSP is part of the listing scheme, in which the employees of the entity were identified and entitled for the SSP. Hence, the argument that Company X is not involved in the SSP is not justifiable.
ii. The employees do not provide services in exchange for the shares
It was argued that the SSP was not an arrangement to pay for services rendered by the selected employees.
BC36 Some who argue that the entity is not a party to the transaction counter the points made above with the argument that employees do not provide services for the options, because the employees are paid in cash (or other assets) for their services.
BC37 IASB is of the opinion that if it were true that employees do not provide services for their share options, this would mean that entities are issuing valuable share options and getting nothing in return. This concludes that by issuing such options the entity’s directors would be in breach of their fiduciary duties to their shareholders.
BC38 Typically, shares or share options granted to employees form one part of their remuneration package. It is usually not possible to identify the services received in respect of individual components of the remuneration package. But that does not mean that the employee does not provide services for the benefits received. Rather, the employee provides services for the entire remuneration package.
BC30 In summary, the shares, share options or other equity instruments are granted to employees because they are employees. The equity instruments granted form part of their remuneration package, regardless of whether that represents a large part or a small part.
Applying the above principles, the intention of the SSP was an act out of goodwill to only selected employees due to the long-term and close working relationships with those employees. In this instance, it may be construed that this intention is indicative that it is akin to a reward for the selected employees’ past services from which Company X benefited. Hence, this will further support the conclusion that the transaction is within the ambit of the MFRS 2, although there is no contractual arrangement between the Promoters and the selected employees.
Based on the application of the above, the SSP should be accounted for as a share-based payment in accordance with MFRS 2 and disclosed in the financial statements accordingly.
An IPO exercise may entail complex financial reporting requirements due to the transactions entered into upon going for listing, such as share-based payment. This warrants a greater level of diligence and care by the entity in ensuring compliance with the applicable financial reporting requirements. In a regulated IPO scenario, entities are under strict scrutiny by various authorities. It is therefore crucial that those involved in the IPO are familiar with accounting issues related to an IPO, such as share-based payment, to avoid any unexpected accounting implications on the financial reporting of the entity.