What is IFRS 2 share-based payment accounting?

When an award is tied to the company’s equity, there is no such thing as a free lunch: the economic cost of the award must be recognised in the financial statements. 

Cue IFRS 2.

What's IFRS 2?

International Financial Reporting Standard 2 (IFRS 2) sets out how companies must account for share‑based payment transactions with employees, suppliers and others. 

It ensures that these transactions are recorded at their fair value, that the cost is spread over any vesting period and that investors can compare schemes across businesses.

This guide explains what IFRS 2 covers, which UK businesses have to use it, how it differs from UK GAAP (FRS 102) and what your finance team should watch out for.

Who uses IFRS 2?

IFRS 2 is part of the International Financial Reporting Standards (IFRS), developed by the International Accounting Standards Board (IASB). In the UK, listed companies must prepare their consolidated financial statements under UK‑adopted IFRS.

Private companies generally follow UK GAAP (FRS 102) but may voluntarily adopt IFRS to align with international investors, to prepare for a potential listing or to simplify group reporting. So:

• Listed/public companies – mandatory use of IFRS 2 within their consolidated financial statements.
  
  
• Private companies – normally follow FRS 102 but may choose IFRS; if they do, IFRS 2 applies.
  
  
• Micro-entities – use FRS 105, which doesn’t cover share-based payments, so they’re the one exception. But if you have a material option scheme, you should still disclose it.

Why does IFRS 2 matter? 

Share-based payments often form a central part of an organisation’s approach to talent retention and performance incentives. But while they can be commercially valuable, they also introduce complexities in financial reporting.

Without clear rules, companies could under‑recognise the cost of options or shares and overstate profit. IFRS 2 addresses this by requiring entities to recognise all share‑based payment transactions – whether equity‑settled, cash‑settled or a combination – and to measure them at fair value. 

Companies must therefore:

1. Determine the fair value of each award at the grant date.
   
   
2. Recognise an expense over the vesting period (the period during which the employee or supplier must provide service to become entitled to the award).
   
   
3. Disclose the nature and terms of the schemes.

Understanding IFRS 2 is particularly important when preparing for an audit, raising external finance or considering an exit. Auditors will expect to see a robust valuation model, documentation of assumptions (share price, volatility, expected life, risk‑free rate) and a reconciliation of movements in outstanding awards.

How does IFRS 2 work in practice?

Types of share‑based payment

The standard covers three broad types of arrangement:

1. Equity‑settled transactions: This is where the company issues shares or options. IFRS 2 requires the fair value of the equity instruments* granted to be measured at the grant date and recognised as an expense over the vesting period.
   
   
2. Cash‑settled transactions: This applies where, instead of receiving shares, participants receive cash based on the share price, such as share appreciation rights (SARs). 
   
   The obligation is recognised as a liability measured at fair value at the grant date and re‑measured at each reporting date, with changes taken to profit or loss. This means the expense can fluctuate up or down as the share price changes.
   
   
3. Awards with a choice of settlement: Sometimes, the terms of an award allow either the company or the participant to choose between cash and shares. 
   
   IFRS 2 treats these awards as containing both an equity and a liability component – the fair value of each component is measured at grant and recognised separately. 
   
   If the company has the choice, IFRS generally classifies the award as equity‑settled unless the employer routinely settles in cash or the equity alternative lacks commercial substance.

*Equity instruments are things like shares, share options, or rights to acquire shares – in other words, anything that gives someone a slice of the pie. Examples include EMI, unapproved options, growth shares, and ordinary shares.

Recognition and measurement

Fair value at grant date

IFRS 2 requires the fair value of share options and other equity‑settled awards to be determined at the grant date.

For employee services, the fair value of the equity instruments must be used because the value of the services cannot be reliably measured. The expense is then recognised over the vesting period; if options vest immediately, the entire expense is recognised up front.

Expense over the vesting period

For awards that require future service, the total fair value is spread on a straight‑line basis over the vesting period (unless a different pattern better reflects how services are received).

The number of awards expected to vest is revised at each reporting date. If the vesting conditions are not met (for example, an employee leaves), the cumulative expense is reversed.

Cash‑settled liabilities

For SARs and similar schemes, IFRS 2 requires recognition of a liability measured at fair value. The liability is re‑measured at each reporting date until settlement, with changes recognised in profit or loss.

Performance and vesting conditions

Vesting conditions can be service conditions (e.g. tenure) or performance conditions. Performance conditions may be market‑based (e.g. reaching a share price or total shareholder return) or non‑market (e.g. achieving targets). IFRS 2 treats them differently:

• Market conditions: These are factored into the grant‑date fair value and are not revisited later. Thus, if a share price target is not achieved and the award fails to vest, the previously recognised expense is not reversed.
  
  
• Non‑market conditions: These affect the number of options expected to vest; the estimate is updated at each reporting date. If options are forfeited because an employee leaves or a non‑market target is not met, the expense is adjusted.

Any other conditions that do not meet the definition of a vesting condition (aka non‑vesting conditions) must be built into the grant‑date fair value. Examples include the employee continuing to contribute to a Save‑As‑You‑Earn scheme.

Modifications, cancellations and settlements

It is common to modify option terms – for example, to reduce an exercise price when the share price falls. IFRS 2 requires companies to continue recognising at least the original grant‑date fair value of services received, even if the award is modified or cancelled.

Suppose a modification increases the total fair value or is otherwise beneficial to the employee. In that case, the incremental fair value is measured at the date of modification and recognised over the remaining vesting period.

If an award is cancelled or settled during the vesting period (other than forfeiture for not meeting a vesting condition), IFRS 2 treats this as an acceleration of vesting: the outstanding expense for the original award is recognised immediately.

Any payment on cancellation is generally treated as a deduction from equity, except to the extent it exceeds the fair value of the instrument; any excess is expensed.

If replacement options are granted, they are accounted for as a modification: the incremental fair value is the difference between the fair value of the replacement award and the fair value of the cancelled award immediately before cancellation.

Valuation methods under IFRS 2 

There is no single prescribed model, but the standard expects fair value to be determined using market prices where available or valuation models where no market price exists.

Two valuation methods are supported on Vestd:

Black-Scholes Model 

The Black-Scholes Model is a widely used option pricing model that calculates the fair value of a share option based on factors such as:

• Exercise price
• Current share price
• Expected volatility
• Risk-free interest rate
• Expected life of the options 

This model is suitable for standard share options without complex performance conditions and provides a market-based valuation. 

Try it yourself using our black-scholes valuation calculator.

Intrinsic Value Model 

For unlisted companies, it can be difficult to determine a fair market value, as there’s often no observable share price. That's where the intrinsic value model comes into play.

The intrinsic value model measures only the difference between the share price and the option's exercise price. This is only used when fair value (which includes additional factors like volatility and time to vest) can’t be reliably measured.

As the share price moves, so does the intrinsic value. For example:

If a share option is granted when the share price is £20 and the option can be exercised at £15 – the difference between what it’s worth and what it costs to buy.

Because intrinsic value ignores time value and the likelihood of vesting, it can understate the true cost of the award.

IFRS 2 vs FRS 102 (UK GAAP)

FRS 102’s Section 26 on share-based payments is based on IFRS 2, so the two are closely aligned. Here are a few points to be aware of:

• Measurement hierarchy: Both standards require fair value measurement at grant date, but FRS 102 explicitly allows a valuation based on entity‑specific market data when available and requires an option‑pricing model only if a direct market value cannot be obtained.
  
  IFRS 2 requires an option‑pricing model whenever a market price is unavailable
  
  
• Choice of settlement: If an employee can choose between cash and shares, FRS 102 treats the entire award as a cash‑settled liability.
  
  IFRS 2 splits such awards into equity and liability components and treats employee‑choice as a compound instrument
  
  
• Disclosure: The core disclosure requirements in IFRS 2 and FRS 102 are broadly similar – both require information on award types, vesting conditions, valuation assumptions, and movement in share options. 
  
  Listed companies may have additional obligations under IFRS due to market expectations and other listing rules.

When choosing between IFRS and FRS 102, private companies should consider their investor base, future capital‑raising plans and the administrative effort of applying each framework. 

Adopting IFRS may ease comparability with international peers but will involve more extensive disclosures and may require splitting awards into equity and liability components.

What do auditors look for?

An auditor will typically review: 

• Valuation methodology and assumptions used (e.g. volatility, expected term).
• Reconciliation of movement in share-based payments during the year.
• Expense recognition schedule across the vesting period.
• Disclosures in the financial statements (including award types, assumptions, and sensitivities).

Lack of documentation, errors in valuation, or failure to update for scheme changes are common causes of audit challenges. Companies should ensure that:

• Valuations are independently reviewed or externally supported.
• Share scheme records are complete and up to date.
• Accounting treatment is consistent with IFRS 2 requirements.

IFRS 2 for private companies?

Some private companies in the UK choose to report under IFRS voluntarily. Reasons include:

• Preparing for a potential IPO.
• Aligning with investors or international parent companies.
• Meeting group reporting requirements in IFRS-based consolidated accounts.

In these cases, IFRS 2 becomes directly relevant, even though the company is not listed.

Private companies using IFRS must apply the same valuation, expense recognition, and disclosure rules as listed firms. This often requires additional resource, expertise, or tooling to manage share-based payments appropriately.

Summary: What finance teams need to know

• IFRS 2 covers all share‑based payments, whether equity‑settled, cash‑settled or with a choice of settlement, and applies to both employees and other suppliers.
  
  
• Listed UK companies must follow IFRS 2. Private companies generally apply FRS 102 but may choose IFRS for group or investor reasons.
  
  
• Awards are measured at fair value at the grant date. For equity‑settled awards, the fair value of the instrument is used; for cash‑settled awards, a liability is recognised and re‑measured at fair value at each reporting date.
  
  
• Performance conditions matter. Market‑based targets are incorporated into the grant‑date fair value and not revisited; non‑market targets affect the number of awards expected to vest.
  
  
• Modifications and cancellations can create incremental expenses. Increasing the fair value of an award results in additional cost; cancelling an award accelerates expense recognition.
  
  
• Full audit trail, documentation, and disclosures are essential for compliance.

If you’re planning to implement a share scheme or review your equity compensation, ensure you have a clear record of your share movements, engage a qualified valuer and understand the accounting requirements early on. 

A little preparation will help you avoid unexpected audit challenges and give your team (and your investors) confidence in the numbers.

What next?

If your company uses (or plans to use) share-based compensation, is subject to IFRS, and reviewing current processes or valuation models, then record-keeping is a good place to start.

Vestd’s digital platform includes a comprehensive IFRS 2 report that generates a detailed vesting expense spreadsheet, using valuation-based share prices and configurable settings.

We support both Black-Scholes and Intrinsic value methods to help you stay compliant, audit-ready and fully in control.

Book a call to explore how we can take the hassle out of valuations, reporting, and share scheme accounting. 

Our team, content and app can help you make informed decisions. However, any guidance and support should not be considered as 'legal, tax or financial advice.'