Introduction – IFRS 3 Remuneration prior to acquisition
In any business combination, the treatment of employee compensation arrangements can be deceptively complex. When key executives, founders, or employees of the target company receive share-based payments, cash bonuses, or retention awards around the time of an acquisition, the fundamental question arises: are these payments part of the purchase price, or are they compensation for future services? IFRS 3 requires acquirers to make this distinction carefully, as it directly affects both the amount of goodwill recognized and the timing of expense recognition after the acquisition.
The fair value principles of IFRS 13 further guide how these payments are measured, ensuring that any portion linked to pre-acquisition service is included in the consideration transferred, while post-acquisition elements are expensed through profit or loss. The following overview summarises how entities should attribute the fair value of such arrangements between precombination (or prior to acquisition) and post-combination (or after acquisition) services.
Employee compensation arrangements should be analysed to determine whether they represent compensation for
- prior to acquisition services,
- after acquisition services, or
- a combination of prior to acquisition and post-combination services.
Amounts attributable to prior to acquisition services are accounted for as part of the consideration transferred for the acquiree. Amounts attributable to post-combination services are accounted for separately from the business combination and are usually recognized as compensation cost in the post-acquisition period.
Under IFRS 3 51, amounts attributable to a combination of prior to acquisition and post-combination services are allocated between the consideration transferred for the acquiree and the after acquisition services.
Illustrative summary of attributing fair value to IFRS 3 Remuneration prior to acquisition and IFRS 3 after acquisition
The examples presented in the next table are based on the following assumptions:
- the original terms of the acquiree’s awards cliff vest following four years of service
- the acquirer is obligated to issue replacement awards under the terms of the acquisition agreement (except as specified in Example 6 in the table below), and
- the fair value of the replacement awards is equal to the fair value of the acquiree awards on the acquisition date (except as specified in Example 3 in the table below).
See Awards with graded-vesting features in IFRS 3 Executive compensation in acquisitions for information on awards with graded-vesting features.
Table – Attribution of fair value to precombination and postcombination services
| Acquiree’s awards | Acquirer’s replacement awards | Greater of total vesting period or original vesting period | Fair value attributable to precombination services | Fair value attributable to post-combination services |
| Example 1:
4 years of service required under original terms. All required services rendered prior to acquisition. |
No service required after the acquisition date. | 4 years. The original vesting period and the total vesting period are the same | 100% (4 years precombination service/4 years total service). | 0.00% |
| Example 2:
4 years of service required under original terms. 3 years of service rendered prior to acquisition |
1 year of service required after the acquisition date | 4 years (3 years prior to acquisition plus 1 year after acquisition). The original vesting period and the total vesting period are the same. | 75% (3 years precombination service/4 years total service). | 25% (total fair value of the replacement award less the 75% for precombination services). This amount is recognized in the post-combination financial statements over the remaining vesting period of 1 year. |
| Example 3:
4 years of service required under original terms. 4 years of service rendered prior to acquisition. |
1 year of service required after the acquisition date. The employee has agreed to the additional year of service because the fair value of the replacement awards is greater than the fair value of the acquiree awards. | 5 years (4 years completed prior to acquisition plus 1 year required after acquisition). The total vesting period of 5 years is greater than the original vesting period of 4 years. | 80% of the acquiree award (4 years precombination service/5 years total service). | 20% of the acquiree award and the excess fair value of the replacement award (total fair value of the replacement award less the 80% for precombination services). This amount is recognized in the post-combination financial statements over the remaining vesting period of 1 year. |
| Example 4:
4 years of service required under original terms. 1 year of service rendered prior to acquisition. |
2 years of service required after the acquisition date. Therefore, the replacement awards require one less year of service | 4 years (since only 2 years of service are required postcombination, the total vesting period for the replacement awards is 3 years, which is less than the original vesting period of 4 years). Therefore, the original vesting period is greater than the total vesting period. | 25% (1 year precombination service/4 years original vesting period). | 75% (total fair value of the replacement award less the 25% for precombination services). This amount is recognized in the post-combination financial statements over the remaining vesting period of 2 years. |
| Example 5:
4 years of service required under original terms. 3 years of service rendered prior to acquisition. There was no change in control clause in the terms of the acquiree awards. |
No service required after the acquisition date. | 4 years (since no additional service is required, the total vesting period for the replacement awards is 3 years, which is less than the original vesting period of 4 years). Therefore, the original vesting period is greater than the total vesting period. | 75% (3 years precombination service / 4 years original vesting period). | 25% (total fair value of the replacement award less the 75% for precombination services). This amount is recognized in the post-combination financial statements immediately because no future service is required. |
| Example 6:
4 years of service required under original terms. 3 years of service rendered prior to acquisition. There was a change in control clause in the original terms of the acquiree awards when granted that accelerated vesting upon a change in control. |
No service required after the acquisition date.
|
Not applicable.
Because the awards contain a preexisting change in control clause, the total fair value of the acquiree awards is attributable to precombination services. |
100%. For acquiree awards with a change in control clause that accelerates vesting, the total fair value of the acquiree awards is attributable to precombination services. | 0%. For acquiree awards with a preexisting change in control clause, no amount is attributable to post-combination services because there is no future service required. |
Read the PDF of IFRS 13 Business Combinations at ifrs.org.
An acquirer may elect to pay cash to settle outstanding awards held by employees of the acquiree instead of granting replacement awards. The accounting for the cash settlement of share-based payment awards outside of a business combination is addressed by IFRS 2 28. The accounting for the cash settlement of share-based payment awards within a business combination is not explicitly addressed by IFRS 3. However, many of the same principles that apply to the exchange of share-based payment awards should be applied to these transactions.
That is, determine the portion of the cash settlement to be attributed to precombination services or postcombination services using the guidance for the exchange of share-based payment awards and the allocation formula described in Calculation of the amount of fair value attributed to precombination services or postcombination services above.
The following sections discuss cash settlements initiated by the acquirer as well as cash settlements initiated by the acquiree. Determining who initiated the cash settlement may require analysis of the factors listed above in Assessing what is part of the consideration transferred for the acquiree and Contingent payments—determining whether the arrangement is compensation.
Initiated by the acquirer
Cash payments made by the acquirer to settle vested awards should be included in the consideration transferred for the acquiree up to an amount equal to the fair value of the acquiree’s awards measured at the acquisition date. To the extent the cash payment is greater than the fair value of the acquiree’s awards, the excess fair value amount is considered an expense incurred by the acquirer outside of the business combination rather than as consideration transferred for the acquiree.
Accordingly, the excess amount of cash paid over the fair value of the acquiree’s awards should be immediately recognized as compensation cost in the postcombination financial statements in accordance with IFRS 3 B59.
If cash payments are made by the acquirer to settle unvested awards (assuming no future service is required to receive the cash payment), the acquirer has effectively accelerated the vesting of the awards by eliminating the postcombination service requirement and settled the awards for cash. The portion attributable to precombination service provided to the acquiree should be included in the consideration transferred for the acquiree.
The remaining portion of the cash payment to the acquiree’s employees, attributable to the postcombination service, should be immediately recognized as compensation cost in the postcombination financial statements. This analysis is similar to the illustration in Attribution of fair value when service required after the acquisition date is less than the original service requirement above, in which vested replacement share-based payment awards are transferred for unvested acquiree awards in accordance with IFRS 3 IE70–IE71.
An acquirer may pay cash in exchange for unvested awards of the acquiree and additional postcombination service, with the cash payment made at the completion of the additional vesting period. In this case, the acquirer will need to determine the portion of the payment attributable to precombination services and postcombination services.
The amount attributable to precombination services is determined by multiplying the fair value of the acquiree award by the ratio of the precombination vesting period completed prior to the payment, to the greater of the total vesting period or the original vesting period of the acquiree award. The amount attributable to postcombination services would be recognized in the postcombination financial statements over the remaining vesting period.
The acquiree (as opposed to the acquirer) may cash-settle outstanding awards prior to the acquisition. However, these transactions, including their timing, should be carefully assessed to determine whether the cash settlement, or a portion thereof, was arranged primarily for the economic benefit of the acquirer (or the combined entity).
Even though the form of the transaction may indicate that the acquiree initiated the cash settlement, it may be determined that, in substance, the acquirer reimbursed the acquiree for the cash settlement (either directly or as part of the consideration transferred for the acquiree). This assessment should include an analysis of the factors listed in Assessing what is part of the consideration transferred for the acquiree above.
If the acquiree cash-settles its awards and it is determined that the transaction was for the economic benefit of the acquiree, the settlement should be recorded in the acquiree’s financial statements prior to the business combination in accordance with IFRS 2 28.
If it is determined that the acquirer reimbursed the acquiree for the cash settlement (either directly or as part of the transaction price paid for the acquiree), the accounting by the acquirer should generally be the same as if the acquirer had settled the awards directly. The following example illustrates this guidance.
EXAMPLE – Example of cash settlement of awards by the acquiree
Company D (the acquiree) cash-settles the outstanding unvested awards held by its employees immediately prior to being acquired by Company C (the acquirer). The amount of cash paid by Company D is CU100 million, which is equal to the current fair value of the awards. At the time of settlement, the employees had completed 75% of the service required to vest in the awards (and 25% of the service period remained)
How should Companies C and Company D account for the cash settlement of the outstanding unvested awards by Company D?
Analysis
Company C should determine whether a portion of the consideration transferred for Company D is attributable to the settlement of unvested awards held by Company D’s employees. The settlement of the portion of the unvested awards not attributable to precombination services may be a transaction arranged primarily for the economic benefit of Company C. Factors to consider in this analysis (as discussed in IFRS 3 B50) include:
- The reasons for the transaction: Why did Company D elect to cash-settle the outstanding awards?
- Who initiated the transaction: Did Company C direct Company D to settle the awards? Was the settlement a condition of the acquisition?
- The timing of the transaction: Was the settlement in contemplation of the business combination?
If Company D was requested by Company C to cash-settle the awards, the settlement of the unvested awards would be deemed a transaction arranged primarily for the economic benefit of Company C. Therefore, a portion of the total consideration transferred should be attributed to the cash settlement of the awards and excluded from the consideration transferred to acquire Company D.
In this example, the fair value of the unvested awards that is not attributable to precombination services, or CU25 million (the fair value of the awards of CU100 million remaining vesting period of 25%), is the amount that would be excluded from consideration transferred and recognized as expense in Company C’s postcombination financial statements. The CU25 million should be recognized immediately because no postcombination service is required.
Other arrangements
Other forms of compensation arrangements may be provided to the employees of the acquiree in conjunction with a business combination. Two common arrangements are “last-man-standing” arrangements and “dual trigger” arrangements. IFRS 3 Executive Compensation in Acquisitions
“Last-man-standing” arrangements
Awards granted to a group of employees and reallocated equally among the remaining employees if any of the employees terminate employment prior to completion of the vesting period are often described as ‘last-man-standing’ arrangements. The estimated number of awards that are expected to vest does not change; therefore, a reallocation of awards would generally not have an accounting impact. IFRS 3 Executive Compensation in Acquisitions
The first example below illustrates “last-man-standing” arrangements that are provided as share-based payment awards; the second example illustrates those that are payable in cash.
On 1 January 2X10, Company M (the acquirer) acquires Company G (the acquiree) and, as part of the acquisition agreement, grants 100 awards to each of five former executives of Company G. Each set of awards has a fair value of CU300 on the acquisition date. The awards cliff vest upon two years of continued employment with the combined company. However, if the employment of any one of the executives is terminated prior to 1 January 2X12, any awards forfeited by that executive are reallocated equally among the remaining executives who continue employment. The reallocated awards will continue to cliff vest on 1 January 2X12. IFRS 3 Executive Compensation in Acquisitions
On 1 January 2X11, one of the five executives terminates employment with the combined company. The 100 unvested awards (100 awards × 1 executive) are forfeited and redistributed equally to the other four executives. At the time of the forfeiture, the fair value of each set of awards is CU360. IFRS 3 Executive Compensation in Acquisitions
How should Company M account for the “last-man-standing” arrangement?
Analysis
Under IFRS, the estimated number of total awards that will ultimately vest is not expected to change; therefore, there is no accounting consequence arising from the reallocation
EXAMPLE “Last-man-standing” arrangement involving cash consideration
Company B (the acquirer) acquires Company A (the acquiree) for cash consideration of CU250. The selling shareholders of Company A were all key employees of Company A prior to the acquisition date and will continue as employees of the combined business following the acquisition by Company B. Company B will pay the selling shareholders additional consideration in the event Company A achieves pre-determined sales targets for the 3 years following the acquisition. This additional consideration will be paid to the previous shareholders in proportion to their relative previous ownership interests. IFRS 3 Executive Compensation in Acquisitions
Any shareholders who resign their employment with Company A during the 3-year period forfeit their portion of the additional payments. Amounts forfeited are redistributed among the previous shareholders who remain as employees for the 3-year period. If none of the previous shareholders remain employed at the end of the 3-year period, but the relevant sales targets are still achieved, all of the previous shareholders will receive the additional payment in proportion to their previous ownership interests. The selling shareholders will have the ability to influence sales volumes if they continue as employees.
How should the company account for this arrangement?
Analysis
The contingent payments are not automatically forfeited if all the selling shareholders cease employment. However, each of the selling shareholders controls their ability to earn their portion of the additional payment by continuing employment. The selling shareholders have the ability to influence sales volumes if they continue as employees. The commercial substance of the agreement incentivises the selling shareholders to continue as employees. IFRS 3 Executive Compensation in Acquisitions
Further, the scenario where all selling shareholders cease employment is unlikely because the last selling shareholder remaining in employment would not likely voluntarily leave employment and forfeit the entire amount of additional payment. The entire additional payment, given this combination of factors, would be accounted for as compensation expense in the postcombination period.
“Dual trigger” arrangements
Preexisting employment agreements often include clauses that accelerate vesting upon a change of control and termination of employment within a defined period of time from the acquisition date, often referred to as dual trigger arrangements. Employment agreements of the acquiree should be carefully assessed to determine whether acceleration of vesting is primarily for the economic benefit of the acquirer by considering the following factors: IFRS 3 Executive Compensation in Acquisitions
- The reasons for the transaction
- Who initiated the transaction
- The timing of the transaction [IFRS 3 B50]
If it is determined the clause or transaction that accelerates vesting is primarily for the economic benefit of the acquirer, the acceleration of vesting of unvested awards should be accounted for separately from the business combination and will be recognized as compensation cost to the acquirer in accordance with IFRS 3 51–52, IFRS 3 B50.
The dual trigger clause effectively places the decision to retain the acquiree’s employees in the control of the acquirer, and thus the decision would be made primarily for the acquirer’s economic benefit (e.g., reduce cost). Therefore, since the acquirer makes the decision to terminate the employees, the acquirer should recognize cost in the postcombination period for the acceleration of the unvested portion of the awards (measured as of the acquisition date using the methodology described in IFRS 3 B58–B59).
An acquiree may put in place a new, or alter an existing, compensation arrangement at the direction of the acquirer. In these instances, it may be necessary to record compensation cost in both the acquirer’s post-acquisition financial statements and the acquiree’s pre-acquisition financial statements. These scenarios typically arise when the acquiree legally incurred the related obligation, and other accounting standards require the acquiree to recognize the related cost even though the cost was incurred for the benefit of the acquirer.
The following example illustrates the accounting for a dual trigger arrangement.
EXAMPLE – Accelerated vesting conditioned upon a dual trigger consisting of change in control and termination
Company A acquires Company B in a business combination, and Company A is obligated to grant replacement awards as part of the business combination [IFRS 3R B56].
Company B has an existing employment agreement in place with one of its key employees that states that all of the key employee’s unvested awards will fully vest upon a change in control and termination of employment within 12 months following the acquisition date. The employment agreement was in place before Company A and Company B began negotiations for the acquisition of Company B.
The awards vest only if the employee is subsequently terminated without cause or leaves for good reason as defined in the employment contract. Prior to the acquisition date, Company A had determined it would not offer employment to the key employee of Company B, effectively terminating employment on the acquisition date. This resulted in the acceleration of all the key employee’s unvested awards upon closing of the acquisition.
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How should Company A account for the accelerated vesting of the awards?
Analysis
Company A should immediately recognize compensation cost related to the accelerated vesting of the awards (measured as of the closing of the acquisition using the methodology described in IFRS 3 B58–B59) in its postcombination period. The accelerated vesting is conditioned upon both a change in control of the acquiree and the termination of employment of the key employee. At the acquisition date, both conditions were triggered.
The decision not to employ the key employee was in the control of Company A and effectively made for its primary economic benefit (e.g., reduce cost) and, therefore, should be recorded separately from the business combination [IFRS 3 51–52].
Compensation cost associated with share-based payment awards that is recorded in the acquirer’s postcombination financial statements should be accounted for in accordance with IFRS 2 26-29. For example, the determination of whether the acquirer’s replacement awards should be classified as equity or as a liability and the period over which compensation cost is recognized should be based on the guidance in IFRS 2.
Modifications of awards after the acquisition date should be accounted for based on the modification guidance in IFRS 2. No adjustments are made to the accounting for the business combination as a result of changes in forfeiture estimates (refer to Fair value of the acquirer’s unvested replacement… and Adjustment of compensation cost recognized….) or modifications of replacement awards after the acquisition date in accordance with IFRS 3 B60. This includes fair value adjustments for the remeasurement of liability-classified awards at each balance sheet date until the settlement date under IFRS 3 B61.
New share-based payment awards (as opposed to replacement awards) granted by the acquirer to the former employees of the acquiree will be subject to the guidance in IFRS 2, and will not affect the accounting for the business combination.
Acquirer accounting for the acceleration of unvested share-based payment awards that is triggered when the acquirer does not issue equivalent replacement awards as part of a business combination
If the provision that accelerates vesting is primarily for the benefit of the acquirer, the acceleration of vesting of unvested awards should be accounted for separate from the business combination and be recognized as compensation cost in the acquirer’s postcombination financial statements in accordance IFRS 3 51–52.
The aquirer’s decision not to issue replacement awards is in the control of the acquirer. Therefore, the acquirer should immediately recognize compensation cost in the postcombination period for the acceleration of the unvested portion of the awards. The accounting would be the same if the acquirer issued fully vested replacement awards.
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Acquirer accounting for a modification to an arrangement with contingent payments in a business combination when the modification occurs during the measurement period
A subsequent change to a compensation arrangement does not lead the acquirer to reassess its original conclusion under IFRS 3 B55 regarding whether the arrangement is treated as consideration transferred or is accounted for outside of the business combination. Assuming the original conclusion reached as of the acquisition date was not an error, the original treatment should be respected even if the subsequent change was made during the measurement period.
The following example illustrates an arrangement that includes contingent payments that is modified during the measurement period.
EXAMPLE – Accounting for modifications during the measurement period to compensation arrangements
Company A acquired Company B in a business combination. Company A wanted to retain the services of the former Company B shareholders to help transition the business.
Therefore, Company A agreed to pay a portion of the consideration to the former shareholders of Company B over the length of their new employment contracts (3 years) with the combined entity. The former shareholders would forfeit any unearned portion of the contingent payment if employment were voluntarily terminated.
After considering the guidance in IFRS 3 B55, Company A appropriately determined that it should account for the contingent payment as compensation cost and not as an element of consideration transferred. The contingent payment to the former shareholders was linked to their continued employment. IFRS 3 Executive Compensation in Acquisitions
Six months after the business combination, Company A decided it no longer needed the former shareholders for transition purposes and terminated their employment. As part of the termination, Company A agreed to settle the contingent payment arrangement with an additional payment to the former shareholders.
How should Company A account for the modification?
Analysis
Company A appropriately concluded at the acquisition date that the arrangement should be treated as compensation cost. A subsequent change to that arrangement does not cause Company A to reassess its original conclusion under IFRS 3 B55. IFRS 3 Executive Compensation in Acquisitions
This would also apply even if the subsequent change was made while Company A was in the process of finalizing any measurement period adjustments. Company A should consider the payment to the former shareholders of Company B as being made to settle their employment contracts with Company A (i.e., Company A accelerated the service period) and not as consideration transferred to acquire Company B.
Read the IFRS Accounting Standards Navigator at ifrs.org on IFRS 3 Business Combinations.
IFRS 3 Remuneration prior to acquisition
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