TUTORIAL QUESTIONS: SHARE BASED PAYMENTS

Question 1 Luploid

SBR September/December 2019 Background Luploid Co is the parent company of a group

Exhibit 1 - Acquisition of Colyson Co

Luploid Co acquired 80% of the five million equity shares ($1 each) of Colyson Co on 1 July 20X4 for
cash of $90 million. The fair value of the non-controlling interest (NCI) at acquisition was $22 million.
The fair value of the identifiable net assets at acquisition was $65 million, excluding the following
asset. Colyson Co purchased a factory site several years prior to the date of acquisition. Land and
property prices in the area had increased significantly in the years immediately prior to 1 July 20X4.
Nearby sites had been acquired and converted into residential use. It is felt that, should the Colyson
Co site also be converted into residential use, the factory site would have a market value of $24
million. $1 million of costs are estimated to be required to demolish the factory and to obtain
planning permission for the conversion. Colyson Co was not intending to convert the site at the
acquisition date and had not sought planning permission at that date. The depreciated replacement
cost of the factory at 1 July 20X4 has been correctly calculated as $17.4 million.

Exhibit 2 - Impairment of Colyson Co

Colyson Co incurred losses during the year ended 30 June 20X8 and an impairment review was
performed. The recoverable amount of Colyson Co's assets was estimated to be $100 million.
Included in this assessment was the only building owned by Colyson Co which had been damaged in
a storm and impaired to the extent of $4 million. The carrying amount of the net assets of Colyson
Co at 30 June 20X8 (including fair value adjustments on acquisition but excluding goodwill) are as
follows

$m

Land and buildings 60

Other plant and machinery 15

Intangibles other than goodwill 9

Current assets (recoverable amount) 22

Total 106

None of the assets of Colyson Co including goodwill have been impaired previously. Colyson Co does
not have a policy of revaluing its assets.

Exhibit 3 - Acquisition of Hammond Co

Luploid Co acquired 60% of the 10 million equity shares of Hammond Co on 1 July 20X7. Two Luploid
Co shares are to be issued for every five shares acquired in Hammond Co. These shares will be issued
on 1 July 20X8. The fair value of a Luploid Co share was $30 at 1 July 20X7. Hammond Co had
previously granted a share-based payment to its employees with a three-year vesting period. At 1
July 20X7, the employees had completed their service period but had not yet exercised their options.
The fair value of the options granted at 1 July 20X7 was $15 million. As part of the acquisition,
Luploid Co is obliged to replace the share-based payment scheme of Hammond Co with a scheme of
its own which has the following details:

Luploid Co issued 100 options to each of Hammond Co's 10,000 employees on 1 July 20X7. The
shares are conditional on the employees completing a further two years of service. Additionally, the
scheme required that the market price of Luploid Co's shares had to increase by 10% from its value
of $30 per share at the acquisition date over the vesting period. It was anticipated at 1 July 20X7 that
10% of staff would leave over the vesting period but this was revised to 4% by 30 June 20X8. The fair
value of each option at the grant date was $20. The share price of Luploid Co at 30 June 20X8 was
$32 and is anticipated to grow at a similar rate in the year ended 30 June 20X9.

Required

Draft an explanatory note to the directors of Luploid Co, addressing the following:

(a) (i) How the fair value of the factory site should be determined at 1 July 20X4 and why the
depreciated replacement cost of $17.4 million is unlikely to be a reasonable estimate of fair
value. (7 marks)
(ii) A calculation of goodwill arising on the acquisition of Colyson Co measuring the non-
controlling interest at:  fair value;  proportionate share of the net assets. (3 marks)
(b) Discuss the calculation and allocation of Colyson Co's impairment loss at 30 June 20X8 and
why the impairment loss of Colyson Co would differ depending on how non-controlling
interests are measured. Your answer should include a calculation and an explanation of how
the impairments would impact upon the consolidated financial statements of Luploid Co. (11
marks)
(c) (i) How the consideration for the acquisition of Hammond Co should be measured on 1 July
20X7. Your answer should include a calculation of the consideration and a discussion of why
only some of the cost of the replacement share-based payment scheme should be included
within the consideration. (4 marks)
 (ii) How much of an expense for the share-based payment scheme should be recognised in
the consolidated profit or loss of Luploid Co for the year ended 30 June 20X8. Your answer
should include a brief discussion of how the vesting conditions impact upon the calculations.
(5 marks) Note: Any workings can either be shown in the main body of the explanatory note
or in an appendix to the explanatory note. (Total = 30 marks)

Question 2

(b) Moyes has an equity investment in an entity called Yanong. The directors of Yanong are
inexperienced and would like to confirm how some share appreciation rights (SARs) should have
been accounted for. The details of the SARs are as follows:

On 1 October 20X5, Yanong granted 500 share appreciation rights to its 300 managers. All of the
rights vested on 30 September 20X7 but they can be exercised from 1 October 20X7 up to 30
September 20X9. At the grant date, the value of each SAR was $10 and it was estimated that 5% of
the managers would leave during the vesting period. At 30 September 20X6, the estimate of how
many managers would leave during the vesting period remained at 5%. The fair value of the SARs
was as follows:

Fair value of SAR $

30 September 20X6 9

30 September 20X7 11

30 September 20X8 12

All of the managers who were expected to leave employment did leave the company as expected
before 30 September 20X7. On 30 September 20X8, 60 managers exercised their options, when the
intrinsic value of the right was $10.50, and were paid in cash. The directors of Yanong would like to
confirm how the SARs should have been accounted for from the grant date to 30 September 20X8
and whether IFRS 13 Fair Value Measurement or IFRS 2 Share-based Payment applies. Required
Prepare a briefing note for the directors of Yanong which answers their queries relating to the SARs.
(6 marks)
Question 3

Part (a) adapted from ACR December 2005

(a) The directors of Lupin, a public limited company, want advice on how the provision for deferred
taxation should be calculated for the year ended 31 October 20X5 in the following situations under
IAS 12 Income Taxes:

(i) On 1 November 20X3, the company had granted ten million share options worth $40 million
subject to a two-year vesting period. Local tax law allows a tax deduction at the exercise date of the
intrinsic value of the options. The intrinsic value of the ten million share options at 31 October 20X4
was $16 million and at 31 October 20X5 was $46 million. The increase in the share price in the year
to 31 October 20X5 could not be foreseen at 31 October 20X4. The options were exercised at 31
October 20X5. The directors are unsure how to account for deferred taxation on this transaction for
the years ended 31 October 20X4 and 31 October 20X5.

(ii) Lupin is leasing plant over a five-year period. A right-of-use asset was recorded at the present
value of future lease payments of $12 million at the commencement of the lease which was 1
November 20X4. The right-of-use asset is depreciated on a straight-line basis over the five years. The
annual lease payments are $3 million payable in arrears on 31 October and the effective interest rate
is 8% per annum. The directors have not leased an asset before and are unsure as to the treatment
of leases for deferred taxation. The company can claim a tax deduction for the annual lease
payments. (You should assume that the IAS 12 recognition exemption for assets and liabilities does
not apply in this situation.)

(iii) A wholly owned overseas subsidiary, Dahlia, a limited liability company, sold goods costing $7
million to Lupin on 1 September 20X5, and these goods had not been sold by Lupin before the year
end. Lupin had paid $9 million for these goods. The directors do not understand how this transaction
should be dealt with in the financial statements of the subsidiary and the group for taxation
purposes. Dahlia pays tax locally at 30%. Assume a tax rate of 30%.

Required Discuss, with suitable computations, how the situations (i) to (iii) above will impact on the
accounting for deferred tax under IAS 12 in the consolidated financial statements of Lupin.

Note. The situations in (i) to (iii) above carry equal marks. (12 marks)

(b) At the last annual meeting, one of Lupin's shareholders raised a question regarding deferred tax
to the company's executives. The shareholder stated that he did not understand the concept of
deferred tax and did not understand why the accounting standards make adjustments for tax that do
not reflect the actual amount of tax paid. He questioned the benefit of the tax reconciliation that is
included within the disclosure note as it is too complicated to understand. The finance director has
since suggested that the tax reconciliation could be removed on the grounds that it is difficult to
prepare and does not serve its purpose if the users cannot understand it anyway.

Required
 (i) In response to the shareholder's statement regarding the concept of deferred tax,
discuss the conceptual basis for the recognition of deferred taxation using the
temporary difference approach to deferred taxation. (5 marks)
(ii) Discuss the view of the finance director and the shareholder that the tax reconciliation is
difficult to understand and comment on the finance director's suggestion that it should
not be disclosed. You should refer to the requirements of IFRS Standards, the
Conceptual Framework and IFRS Practice Statement 2, Making Materiality Judgements
where relevant. (4 marks)

(c) Lupin has recently incurred a large item of expenditure which is not expected to recur next year.
The finance director plans to present this as a separate line item after profit after tax from ordinary
activities in the statement of profit of loss, with the heading 'unusual expenditure'. The finance
director believes this will provide useful information for Lupin's investors and that it is acceptable
given the IASB's recent proposals to replace IAS 1 Presentation of Financial Statements. Required
Discuss whether the finance director's planned presentation of this expenditure is permitted under
IFRS Standards, and briefly explain the proposals relating to unusual expenditure in ED 2019/7
General Presentation and Disclosures. (4 marks) (Total = 25 marks)

Question 4

P2 December 2017 (amended)

When an entity issues a financial instrument, it has to determine its classification either as debt or as
equity. The result of the classification can have a significant effect on the entity's reported results
and financial position. An understanding of what an entity views as capital and its strategy for capital
management is important to all companies and not just banks and insurance companies. There is
diversity in practice as to what different companies see as capital and how it is managed.

Required

(a) (i) Discuss why the information about the capital of a company is important to investors,
setting out the nature of the published information available to investors about a company's
capital. Note. Your answer should briefly set out the nature of financial capital in integrated
reports. (8 marks)
(ii) Discuss the importance of the classification of equity and liabilities under IFRS Standards,
with reference to the Conceptual Framework, and how this classification has an impact on
the information disclosed to users in the statement of profit or loss and other
comprehensive income and the statement of financial position. (6 marks)
(b) Amster has issued two classes of preference shares. The first class was issued at a fair value
of $50 million on 30 November 20X7. These shares give the holder the right to a fixed
cumulative cash dividend of 8% per annum of the issue price of each preferred share. The
company may pay all, part or none of the dividend in respect of each preference share. If the
company does not pay the dividend after six months from the due date, then the unpaid
amount carries interest at twice the prescribed rate subject to approval of the management
committee. The preference shares can be redeemed but only on the approval of the
management committee. The second class of preference shares was issued at a fair value of
$25 million and is a non-redeemable preference share. The share has a discretionary annual
dividend which is capped at a maximum amount. If the dividend is not paid, then no
 dividend is payable to the ordinary shareholders. Amster is currently showing both classes of
preference shares as liabilities.

On 1 December 20X6, Amster granted 250 cash-settled share awards to each of its 1,500
employees on the condition that the employees remain in its employment for the next three
years. Cash is payable at the end of three years based on the share price of the entity's
shares on that date. During the year to 30 November 20X7, 65 employees left and, at that
date, Amster estimates that an additional 115 employees will leave during the following two
years. The share price at 30 November 20X7 is $35 per share and it is anticipated that it will
rise to $46 per share by 30 November 20X9. Amster has charged the expense to profit or
loss and credited equity with the same amount. The capitalisation table of Amster is set out
below:

Amster Group – capitalisation table

30 November 20X7

$m

Long-term liabilities 81

Pension plan deficit 30

Cumulative preference shares 75

Total long-term liabilities 186

Non-controlling interest 10

Shareholders' equity 150

Total group equity 160

Total capitalisation 346

Required

Discuss whether the accounting treatment of the above transactions is acceptable under
International Financial Reporting Standards including any adjustment which is required to the
capitalisation table and the effect on the gearing and the return on capital employed ratios. (9
marks) Professional marks will be awarded in this question for clarity and quality of presentation. (2
marks) (Total = 25 marks)

Question 5 Leigh 49 mins ACR June 2007 (amended)

(a) Leigh, a public limited company, purchased the whole of the share capital of Hash, a limited
company, on 1 June 20X6. The whole of the share capital of Hash was formerly owned by the
five directors of Hash and under the terms of the purchase agreement, the five directors
were to receive a total of three million ordinary shares of $1 of Leigh on 1 June 20X6 (market
value $6 million) and a further 5,000 shares per director on 31 May 20X7, if they were still
employed by Leigh on that date. All of the directors were still employed by Leigh at 31 May
20X7.
 Leigh granted and issued fully paid shares to its own employees on 31 May 20X7. Normally
share options issued to employees would vest over a three-year period, but these shares
were given as a bonus because of the company's exceptional performance over the period.
The shares in Leigh had a market value of $3 million (one million ordinary shares of $1 at $3
per share) on 31 May 20X7 and an average fair value of $2.5 million (one million ordinary
shares of $1 at $2.50 per share) for the year ended 31 May 20X7. It is expected that Leigh's
share price will rise to $6 per share over the next three years. (10 marks)

(b) On 31 May 20X7, Leigh purchased property, plant and equipment for $4 million. The supplier
has agreed to accept payment for the property, plant and equipment either in cash or in
shares. The supplier can either choose 1.5 million shares of Leigh to be issued in six months'
time or to receive a cash payment in three months' time equivalent to the market value of
1.3 million shares. It is estimated that the share price will be $3.50 in three months' time and
$4 in six months' time. Additionally, at 31 May 20X7, one of the directors recently appointed
to the board has been granted the right to choose either 50,000 shares of Leigh or receive a
cash payment equal to the current value of 40,000 shares at the settlement date. This right
has been granted because of the performance of the director during the year and is
unconditional at 31 May 20X7. The settlement date is 1 July 20X8 and the company
estimates the fair value of the share alternative is $2.50 per share at 31 May 20X7. The share
price of Leigh at 31 May 20X7 is $3 per share, and if the director chooses the share
alternative, they must be kept for a period of four years. (9 marks)

(c) Leigh acquired 30% of the ordinary share capital of Handy, a public limited company, on 1
April 20X6. The purchase consideration was one million ordinary shares of Leigh which had a
market value of $2.50 per share at that date and the fair value of the net assets of Handy
was $9 million. The retained earnings of Handy were $4 million and other reserves of Handy
were $3 million at that date. Leigh appointed two directors to the Board of Handy, and it
intends to hold the investment for a significant period of time. Leigh exerts significant
influence over Handy. The summarised statement of financial position of Handy at 31 May
20X7 is as follows.

$m

Share capital of $1 2

Other reserves 3

Retained earnings 5

10

Net assets 10

There had been no new issues of shares by Handy since the acquisition by Leigh and the
estimated recoverable amount of the net assets of Handy at 31 May 20X7 was $11 million.
(6 marks) Required Discuss with suitable computations how the above share-based
transactions should be accounted for in the financial statements of Leigh for the year ended
31 May 20X7. (Total = 25 marks)