Full explanation
Overview
A company gives an employee options over its own shares instead of a cash bonus. No cash leaves the business that day. But under IFRS two, an expense still has to be booked — because the company gave up something real: a slice of itself.
IFRS two governs share-based payment — any time a company pays someone in shares, share options, or a cash amount linked to its own share price, instead of straight cash. The rule that surprises almost everyone: even though no cash moves, you still recognise an expense, because equity is a real cost, not a free lunch.
How the expense works
Three things to cover: how a grant is measured, how the expense is spread over time, and what happens when people leave, or the company changes the deal.
What counts
Scope: share-based payment covers shares, share options, and share appreciation rights — sometimes shortened to SARs, share appreciation rights — where the payout is tied to the share price but settled in cash. It does not cover an ordinary cash bonus that just happens to be calculated with reference to profit.
Equity-settled vs cash-settled
Every arrangement splits into one of two paths, and this single fork explains almost everything else in the standard. Equity-settled: the company hands over actual shares or options. It's measured once, at grant date, and never remeasured — even if the share price moves wildly afterwards. Cash-settled: the company pays cash linked to the share price, like SARs, share appreciation rights. That's remeasured at fair value every single reporting date, right up until it's paid.
Why does equity-settled freeze at grant date but cash-settled keep moving? Because with equity-settled, the company's own obligation is fixed the day the options are granted — it's already given away that slice of itself. With cash-settled, the company still owes real cash in the future, and that liability has to reflect today's value, not the value from years ago.
Grant-date fair value
Grant date fair value isn't pulled from thin air — it comes from an option-pricing model, commonly Black-Scholes, using inputs like the share price, volatility, and expected life of the option. The model itself isn't an IFRS two question; IFRS two only cares that the fair value gets measured properly at grant date and then used consistently.
Vesting conditions
Vesting conditions decide how long the expense gets spread, and they come in two flavours. Service conditions — stay employed for three years. Performance conditions — split again into market conditions, like hitting a share price target, and non-market conditions, like hitting a revenue target.
Trued up, or not?
Here's the trap almost everyone falls into. A market condition — the share price target — is baked directly into the grant-date fair value by the option model, and it is never trued up, even if the target is missed and the options end up worthless. A non-market condition — the revenue target, or simply staying employed — is NOT baked into the fair value. Instead, you re-estimate how many people are expected to actually vest, every single period, and true up the expense accordingly.
Let's make that concrete with Meridian Limited. Meridian grants three hundred options each to fifty employees — fifteen thousand options in total — with a three-year service condition. Grant-date fair value, from the option model: four euros per option.
Expecting 90% to stay
Year one: Meridian expects ninety percent of employees will still be there at vesting. Expected cost: fifteen thousand options, times ninety percent, times four euros — fifty-four thousand euros total, spread over three years. Year one's expense: fifty-four thousand divided by three, which comes to eighteen thousand euros.
Revised to 85%
Year two: turnover has been higher than expected. Meridian now expects only eighty-five percent to stay. Revised total cost: fifty-one thousand euros. Two years' worth of that revised total is thirty-four thousand — and eighteen thousand was already booked in year one — so year two's expense is a catch-up: sixteen thousand euros.
Actual: 82% stayed
Year three, vesting date: eighty-two percent actually stayed. Final total cost: forty-nine thousand two hundred euros. Thirty-four thousand was already booked — so year three's expense is the final true-up: fifteen thousand two hundred euros. After vesting date, there are no more adjustments, no matter what happens to the share price next.
The double entry
Every year, the double entry for equity-settled awards is the same shape: debit an expense, credit equity — a separate share-based payment reserve, not a liability. That's the other half of the fork from earlier: equity-settled never creates a liability, only cash-settled does.
Three situations change the standard path. Forfeiture — someone leaves before vesting, service condition not met — you reverse the cumulative expense already booked for them. Cancellation — the company itself cancels the award — that's treated as accelerated vesting: recognise whatever expense was left, immediately, in full.
Repricing underwater options
And modification — say the company reprices underwater options to make them attractive again. If the modification increases fair value, you recognise that incremental value over whatever vesting period remains, ON TOP of the original expense. You never reduce the expense already locked in, even if a modification makes the award less valuable.
What must be shown
Disclosure: IFRS two requires a reconciliation of the number and weighted-average exercise price of options — outstanding at the start, granted, forfeited, exercised, expired, and outstanding at the end. It also requires the option-pricing model's own inputs — volatility, risk-free rate, expected life — disclosed, so a reader can sanity-check the fair value instead of just trusting it.
There's a tax twist worth knowing. The tax deduction for share-based payment often only arrives on exercise — not on grant — and it's frequently based on the option's INTRINSIC value at exercise, not the grant-date fair value that was actually expensed. That mismatch creates a genuine book-tax difference, which is exactly IAS twelve's territory.
Group transactions
Group transactions are common in practice: a parent grants options over its OWN shares to a subsidiary's employees. The subsidiary still recognises the expense for services received — measured at grant-date fair value — with the credit going to equity, treated as a capital contribution from the parent, not a liability in the subsidiary's own accounts.
Two things that changed
Two amendments worth knowing, issued in 2016 and effective from 2018. First: many plans net-settle to cover the employee's tax withholding — the company withholds shares equal to the tax owed and pays that to the tax authority. That withholding feature no longer breaks equity-settled classification for the whole award, as long as it's limited to the tax obligation itself. Second: modifying an award from cash-settled to equity-settled is treated as a full re-measurement at the modification date, then accounted for as equity-settled from that point forward.
Real-world applicability
Where this shows up in practice: tech and startup equity compensation, where options can be the single largest non-cash cost on the income statement. Listed-company long-term incentive plans. And private companies granting options ahead of an eventual sale or listing — all fall under the same standard.
Is it a real cost?
Question: is share-based payment expense really a cost, if no cash is paid? Yes — existing shareholders get diluted, which is a real economic transfer of value, even though the mechanism isn't a cash outflow.
Share price crashes ?
Question: what happens if the share price crashes and the options go underwater? For equity-settled awards, nothing changes to the expense already recognised — grant-date fair value is frozen. Only a deliberate modification, like repricing, triggers any new accounting.
The adjusted EBITDA question
For investors, share-based payment expense is one of the most common — and most criticised — add-backs to adjusted EBITDA, because dilution is a real cost to existing shareholders even when it never touches cash. A company that consistently strips it out is asking you to ignore a genuine, recurring expense of running the business.
Next up: IAS nineteen, employee benefits — pensions, and why the promise a company makes to its retirees can be one of the biggest, least understood numbers on its balance sheet.