Models of the reporting entity and accounting for equity-based consideration

Abstract

Conventional accounting practice for equity-based consideration (EBC) and, in particular for employee share schemes (ESS), recognises an expense for cash-based settlement but not for settlement by the issue of new shares. In principle, expense recognition based on a choice of method of settlement is inconsistent and, in the case of ESS, undermines managerial accountability by understating pay, overstating profit and weakening the link between reported profit and the change in the wealth of existing shareholders. The choice of a model of the reporting entity (MRE) provides the conceptual basis to address issues in accounting for EBC. In the light of the controversy over the FASB's recommendation for partial expense recognition based on the date of grant fair value of EBC, and the recent decisions of the ASB and G4+1 to consider how to account for EBC. this paper reviews the role of MRE in expense recognition for EBC. To provide a consistent, reliable and relevant measure of expense for resources acquired by EBC, the application of fair value and clean surplus accounting is recommended. A method of presentation is proposed to separate the expense based on the date of grant fair value from the cost of subsequent changes in the value of EBC. This allows income measured according to different MREs to be reported in a single set of financial statements, and allows users to choose the information best suited to their purposes.