Employee Benefits and Share-Based Payment
Measurement
Employee Benefits and Share-Based Payment
Syllabus tag: KASNEB CPA | Advanced Level | CA32 Advanced Financial Reporting and Analysis | Topic 7 Employee Benefits and Share-Based Payment
Lesson objectives
By the end of this topic, you will be able to:
- Distinguish defined contribution from defined benefit plans
- Set out the components of defined benefit cost and where each is recognised
- Explain remeasurements and why they go to OCI
- Compute the expense on an equity-settled share-based payment
- Distinguish market from non-market vesting conditions
Why this matters
Both standards recognise a cost for something no cash has yet been paid for — a pension that falls due in thirty years, or an option that may never be exercised. The measurement is uncertain by nature, and the standards manage that uncertainty rather than removing it.
Defined contribution and defined benefit
| Defined contribution | Defined benefit | |
|---|---|---|
| Employer promises | A contribution | A benefit |
| Who bears the investment risk | The employee | The employer |
| Balance sheet | Accrual for unpaid contributions only | Net defined benefit liability or asset |
| Measurement | Simple | Actuarial |
Defined contribution accounting is straightforward precisely because the obligation ends when the contribution is paid. Recognise the contribution as an expense in the period the service is rendered, and that is all.
Defined benefit is complex because the obligation persists. The employer has promised an amount that depends on final salary, length of service, and how long the employee lives — none of which is known. The plan assets may underperform, and the employer must make up the shortfall.
The net defined benefit position
Present value of the obligation − Fair value of plan assets = Net liability (or asset)
Where the result is an asset, it is limited to the asset ceiling — the present value of refunds or reductions in future contributions available. A surplus the employer cannot access is not an asset.
Components of defined benefit cost
| Component | Where recognised |
|---|---|
| Current service cost | Profit or loss |
| Past service cost — from plan amendments or curtailments | Profit or loss, immediately |
| Net interest on the net liability or asset | Profit or loss |
| Remeasurements — actuarial gains and losses, and the return on plan assets other than net interest | Other comprehensive income |
Net interest is computed on the net position at the discount rate used for the obligation — the same rate for both sides. This removes an old source of manipulation, where an optimistic expected return on plan assets could flatter profit.
Remeasurements go to OCI and are never reclassified to profit or loss.
The reasoning is worth stating: actuarial gains and losses arise from changes in assumptions — mortality, discount rates, salary growth — over an obligation running decades. They swing widely and reverse. Putting them through profit would make reported earnings depend on actuarial estimates rather than on operations.
:::checkpoint A company improves its pension benefits for past service. State where the cost is recognised and over what period, and explain why the treatment differs from that of an actuarial loss. :::
Share-based payment
Equity-settled — settled in shares or options. Measured at the fair value of the instruments granted at the grant date, and never remeasured for subsequent changes in the share price.
Cash-settled — settled in cash based on the share price. Measured at fair value and remeasured at every reporting date, with changes to profit or loss.
Worked example. 300 employees each receive 500 options with a grant date fair value of KES 24, vesting after three years. Initially 15% are expected to leave.
| Expected options (300 × 500 × 85%) | 127,500 |
| Total expense (127,500 × 24) | KES 3,060,000 |
| Year 1 expense (one third) | KES 1,020,000 |
At the end of year 2 the estimate is revised: only 12% will leave.
| KES | |
|---|---|
| Revised total (300 × 500 × 88% × 24) | 3,168,000 |
| Cumulative to date (two thirds) | 2,112,000 |
| Less recognised in year 1 | (1,020,000) |
| Year 2 expense | 1,092,000 |
The cumulative catch-up is the mechanism. Each year the total is recalculated on current estimates, the cumulative amount is determined, and the difference is the charge. Prior years are not restated.
Vesting conditions
| Condition | Example | Treatment |
|---|---|---|
| Service | Remain employed three years | Estimate and revise |
| Non-market performance | Profit growth of 10% | Estimate and revise |
| Market | Share price reaches KES 80 | Built into the grant date fair value; never revised |
The market condition rule catches candidates out. If a share price target is not met, the expense is not reversed — the possibility of failure was already priced into the fair value at grant. If a profit target is not met, the expense is reversed, because that possibility was handled through the estimate instead.
Both routes charge an expense to profit with a credit to equity, which is the point the standard exists to enforce. Before IFRS 2, options could be granted with no charge at all, making them appear to cost nothing.
:::checkpoint Options vest only if the share price reaches KES 80, which it does not. A director argues no expense should be recognised since nothing was received. Explain the correct treatment and its reasoning. :::