Findings from the Institute’s practice review programme
The Practice Review Committee is a statutory committee responsible for exercising the powers and duties given to the Hong Kong Institute of CPAs as the regulator of auditors in Hong Kong under the Professional Accountants Ordinance. From time to time, the committee becomes aware of matters arising from the practice review programme carried out by the Institute’s Quality Assurance department that warrant further communication with members. This article sets out some matters concerning the accounting for share options granted by holding companies to purchase their own shares to employees of subsidiaries for their services provided to the subsidiaries (referred to as “defined share options” below).
The Institute’s practice reviewers have encountered a number of cases recently where subsidiaries recognized in their separate financial statements share-based payments arising from defined share options by reference to the values of those options advised by holding companies without giving due consideration to the requirements under Hong Kong Financial Reporting Standard (HKFRS) 2 Share-Based Payment. In this regard, we wish to highlight two particular aspects that have commonly been overlooked when determining the appropriate accounting for the relevant share-based payments and related matters.
Obligations to settle the share-based payments
According to paragraph 43B of HKFRS 2, the way that the subsidiaries should classify the share-based payments resulting from defined share options granted should depend on whether the subsidiaries have obligations to settle the related share-based transactions. If they do not, they should classify the related share-based transactions as equity-settled transactions. Otherwise, they should classify the related share-based transactions as cash-settled transactions.
The key difference between the two classification is that, unlike cash-settled transactions of which the liabilities are required to be remeasured at each year end until settlement, equity-settled transactions are recognized based on the grant date fair value of the equity instruments. For equity-settled share-based payment, the value of the grant is not subsequently remeasured, although adjustments may be made to reflect the number of equity instruments that is estimated to ultimately vest due to changes to non-market vesting conditions.
Intragroup repayment arrangements do not necessarily indicate obligations to settle the share-based payments by the subsidiaries. Such arrangements are therefore separate issues and should not affect how the subsidiaries should classify the related share-based payments under HKFRS 2.
Given the obligation to settle the related share-based transactions would be the key decision factor to determine the classification and therefore the amount of cost recognized in a particular case, a careful review of the relevant agreements and obtaining sufficient appropriate evidence to ascertain which party has the obligation to settle the share-based transaction is important to adequately support the appropriateness of the classification of the transaction in the separate financial statements of the subsidiaries.
Intragroup repayment arrangements
Although group share-based payments are within its scope, HKFRS 2 does not give specific guidance on how to deal with intragroup repayment arrangements. Public literature, including a previous International Accounting Standards Board staff paper, Timing of the Recognition of Intercompany Recharges, identified a number of possible approaches to the accounting for such arrangements and those approaches could result in significant differences in the timing of recognition and, probably, measurement of such arrangements.
One approach identified is the “linked transaction” approach whereby the recognition of the recharge is linked with the share-based arrangement as the recharged amount recognized is based on the share-based payment arrangement. Under this approach and taking a group share-based payment arrangement that is classified as equity-settled as an example, (a) the recharge transaction from the holding company is accounted for as a separate transaction from the share-based payment transaction and (b) the recharge is recognized as a liability to the holding company with a corresponding debit to equity as contribution from the holding company. Another approach identified is the “liabilities” approach whereby the recharge is recognized when the subsidiaries have a present obligation to recognize the recharge under Hong Kong Accounting Standard 37 Provisions, Contingent Liabilities and Contingent Assets, which might not be until all the vesting conditions have been satisfied and it is probable that the employees would exercise the options. There are also other approaches that are considered less common.
Given the diversity of accounting treatments, disclosure of the particular accounting policies adopted and, if applicable, the judgment involved, in arriving at one particular accounting treatment of the repayment transaction is important to enable financial statements users to appreciate the financial impact arising from the share-based payments and the recharge and their interaction, including the net financial effect.
The Quality Assurance department will continue to monitor the application of professional standards through its practice review programme and regularly bring to members' attention on issues identified to help improve audit practices in Hong Kong.
This article was contributed by the Institute’s Quality Assurance department.