Strategic Business Reporting (International) · Share-based payment

IFRS 2 Choice of Settlement, Group Schemes and Deferred Tax

Updated 11 October 2026 · Fact-checked

Under IFRS 2, if the counterparty chooses cash or shares, you split the award into a debt component and an equity component. If the entity chooses, you treat it as cash-settled if it has a present obligation to pay cash, otherwise equity-settled. In groups, the entity receiving services recognises the expense. Deferred tax follows intrinsic value.

Understand Share-based Payments with Choice of Settlement and Group Schemes

Some awards let one party choose how the award is settled: in cash or in equity instruments. IFRS 2 treats the two cases differently, depending on who holds the choice.

If the counterparty (usually the employee) has the choice, the entity has granted a compound instrument. It has given a right to cash (a liability) and a right to shares (equity). The fair value of the compound instrument is the fair value of the debt component (the cash alternative) plus the fair value of the equity component (the equity alternative, taking into account that the counterparty must give up the right to cash to receive shares). In practice, you measure the debt component first, at the fair value of the cash alternative. The equity component is the fair value of the equity alternative (the shares) less the fair value of the cash alternative. The liability is then remeasured at fair value at each reporting date, with changes going to profit or loss.

If the entity has the choice, you look at substance. The award is a cash-settled transaction if the entity has a present obligation to settle in cash. That obligation exists if the choice of equity settlement has no commercial substance (for example, the entity is legally prohibited from issuing shares), or if there is a past practice or stated policy of settling in cash, or if the entity usually settles in cash when the counterparty asks. Otherwise it is equity-settled. Where it is equity-settled and the entity elects to pay cash, the payment is treated as a repurchase of an equity interest. Any cash paid over the fair value of the shares that would otherwise have been issued is an expense.

In group schemes, the parent often grants its own shares to employees of a subsidiary. The entity that receives the services recognises an expense in its own financial statements. The parent has no direct employee service, so it records an increase in its investment in the subsidiary. The subsidiary credits equity as a contribution from the parent if the parent settles. If the subsidiary must settle in cash, it recognises a liability. The classification depends on the nature of the award and on who has the obligation to settle, assessed from the point of view of each entity.

In consolidated accounts, the intragroup entries cancel out. The group looks at the arrangement as a whole and classifies it from its own perspective. For deferred tax, the tax deduction is often based on intrinsic value at the date of exercise. The deferred tax asset is based on the estimated future deduction, using the current share price, and spread over the vesting period. The credit to profit or loss is limited to the tax on the lower of the cumulative expense and the cumulative estimated deduction. Any excess of the total deferred tax over that amount is credited to equity, not profit or loss.

Key rules to remember

Equity component of compound award: Equity component = Fair value of equity alternative (the shares) − Fair value of cash alternative (the debt component); Debt component is the fair value of the cash alternative. Measure at grant date. Equity part is never remeasured.
Liability at reporting date: Liability = Fair value of cash alternative × Expected vesting proportion × (Years elapsed ÷ Total vesting period); Remeasure to fair value at each year end and at settlement. Changes go to profit or loss.
Annual expense for compound award: Expense = Change in cumulative liability + Equity component expensed for the year; Equity portion is spread over the vesting period. Liability movement is cumulative.
Settlement of compound award by cash: Remeasure the liability to its fair value at settlement date and extinguish it with the cash paid. Any cash paid in excess of the liability is treated as a repurchase of the equity component and charged to equity; The equity component already recognised stays in equity, though you may transfer it between components of equity. Treat any payment beyond the liability as a repurchase of the equity component, charged to equity. Do not call it an expense.
Deferred tax asset on share-based payment: Deferred tax asset = Estimated future deduction (intrinsic value at reporting date × number of awards expected to vest) × (Years elapsed ÷ Total vesting period) × Tax rate; Intrinsic value per award is the current share price less the exercise price, if any. Use the estimated future tax deduction based on the current share price. Spread over the vesting period.
Deferred tax split between P&L and equity: Tax credit to P&L = Tax rate × the lower of (cumulative IFRS 2 expense, cumulative estimated deduction). Excess of total deferred tax over this amount is credited to equity; If the estimated deduction is at or below the cumulative expense, all tax goes to profit or loss. The P&L credit is then the tax on the lower deduction, and nothing goes to equity.

How to solve Share-based Payments with Choice of Settlement and Group Schemes questions

Use this method for any question on choice of settlement, group schemes or deferred tax on awards.

1Identify who holds the choice: the counterparty or the entity.
2If the counterparty chooses, value the cash alternative as the debt component and the remainder of the award as the equity component at grant date.
3If the entity chooses, test for a present obligation to pay cash. If one exists, treat as cash-settled. Otherwise treat as equity-settled.
4Spread costs over the vesting period, adjusting for expected leavers. Remeasure the liability at each year end.
5For groups, decide which entity receives the services and who settles. Apply IFRS 2 in each entity's own accounts, then eliminate intragroup entries on consolidation.
6Calculate deferred tax on intrinsic value using the current share price, multiplied by the expected vesting proportion and elapsed time.
7Compare the deferred tax with tax rate × cumulative expense. Put the excess in equity.
8Write short explanations. Give the journal and the reasoning for the classification.

Quickest way: Three-question shortcut

When to use it: Use when time is short and the scenario is dense. Decide the classification first, then the numbers.

Who chooses? Counterparty means compound. Entity means test for obligation.
Which entity gets the services and who pays? That sets each entity's entry.
Is tax on intrinsic value? Then DTA = intrinsic value × proportion × rate, with any excess over rate × expense credited to equity.
Write the journal for each year. Check the credits equal the debits.
Add one sentence per judgement on why you chose the classification.

Common mistakes in Share-based Payments with Choice of Settlement and Group Schemes

Treating a counterparty-choice award as fully equity-settled.
Students focus on the shares and ignore the cash right.
Fix: Whenever the employee can demand cash, split into a liability and an equity component.
Remeasuring the equity component each year.
Students copy the liability treatment.
Fix: Only the liability is remeasured. The equity component is fixed at grant date.
Ignoring who holds the choice when the entity decides.
Students assume entity choice means equity.
Fix: Check for past practice of paying cash or a present obligation. If either applies, treat as cash-settled.
Recording the full cost in the subsidiary's books as a liability when the parent settles in shares.
Confusing who receives services with who pays.
Fix: If the parent settles in its own shares, the subsidiary credits equity as a capital contribution. Only credit a liability if the subsidiary must pay cash.
Calculating deferred tax on the accounting expense instead of intrinsic value.
The expense is the number already on the page.
Fix: Use the estimated future deduction based on the current share price, then compare with the cumulative expense to find any equity portion.
Taking the whole deferred tax credit to profit or loss.
Students forget the excess rule.
Fix: Limit the P&L credit to tax rate × cumulative expense. Credit the excess to equity.

Worked examples

Example 1

On 1 January 20X1, Rajan Co grants one director a choice, at the end of 3 years' service, of 10,000 phantom units paid in cash or 15,000 shares. At grant date the share price is $5. Fair value of the cash alternative is 10,000 × $5 = $50,000. Fair value of the share alternative is 15,000 × $5 = $75,000 (ignore vesting conditions, expect the director to stay). At 31 December 20X1 the share price is $6. Show the 20X1 entries.

Show the solution

The director chooses, so this is a compound instrument.
Debt component at grant date = $50,000.
Equity component = $75,000 − $50,000 = $25,000.
Equity expense for 20X1 = $25,000 × 1/3 = $8,333 (rounded).
Liability at year end = fair value of the cash alternative at the reporting date × proportion of the service period elapsed = 10,000 × $6 × 1/3 = $20,000. One of the three years has passed.
Total expense for 20X1 = $20,000 + $8,333 = $28,333.

Answer: Dr Profit or loss $28,333; Cr Liability $20,000; Cr Equity $8,333.

Example 2

Parent P grants 100 of its own shares to each of 50 employees of subsidiary S, vesting after 2 years. Fair value at grant date is $10 per share. All employees are expected to stay. P will deliver its own shares. Show S's and P's entries for year 1, and state the effect on consolidation.

Show the solution

Total fair value = 50 × 100 × $10 = $50,000.
Year 1 expense = $50,000 × 1/2 = $25,000.
S receives the services, so S recognises the expense: Dr Staff cost $25,000.
P settles in its own shares, so S credits equity as a contribution from the parent: Cr Equity $25,000.
P has no employees receiving services, so it records Dr Investment in S $25,000, Cr Equity $25,000.
On consolidation, the investment in S and the contribution in S's equity cancel. The group shows the $25,000 expense and an equity credit.

Answer: S: Dr Expense $25,000, Cr Equity $25,000. P: Dr Investment in S $25,000, Cr Equity $25,000. Group: expense $25,000 with equity credit $25,000.

Exam tips

Always state who holds the choice before any numbers. Markers award marks for classification.
Show the debt and equity components separately in a compound award. Label each clearly.
In group questions, write the entries for each entity in turn and then the consolidated effect.
For deferred tax, show the comparison of tax rate × cumulative expense with the total deferred tax. State where the excess goes.
Link your answer to the scenario and add a short professional skills comment, such as advising on the effect on reported profit.

Practice questions from Share-based payment

Share-based Payments with Choice of Settlement and Group Schemes: frequently asked questions

How do you account for a share-based payment where the employee can choose cash or shares?

Treat it as a compound instrument. Measure the cash alternative as a liability and the remainder of the award as equity at grant date. Remeasure the liability at each year end, and take changes to profit or loss.

When is an award with entity choice cash-settled?

It is cash-settled if the entity has a present obligation to pay cash. This arises where the choice has no commercial substance, where the entity has a past practice of paying cash, or where it usually settles in cash when asked. Otherwise it is equity-settled.

Who recognises the expense in a group share-based payment?

The entity that receives the services recognises the expense in its own accounts. If the parent settles in shares, the subsidiary credits equity and the parent increases its investment in the subsidiary.

How does deferred tax work for share-based payments under IAS 12?

The deferred tax asset is based on the estimated future tax deduction, usually the intrinsic value at the reporting date. Tax up to the rate multiplied by the cumulative expense goes to profit or loss. Any excess goes to equity.