In October 2025, the Financial Reporting Council (FRC) published its first thematic review of share-based payments. International Financial Reporting Standard 2 (IFRS 2) which covers these payments is an accounting standard that companies find very challenging to apply. What were the common pitfalls identified by the FRC and how can your company address them?
Why IFRS 2 is a problem
Used to account for transactions in which goods or services are provided in exchange for equity instruments in the company, as well as arrangements settled in cash by reference to the value of those equity instruments, IFRS 2 can be complex to apply. It requires the use of valuation models incorporating significant judgements and assumptions, alongside the correct application of vesting conditions. Different accounting treatments apply depending on whether awards are equity‑settled or cash‑settled, and the accounting for related tax effects can also be problematic.
To identify the main pitfalls, the FRC conducted a thematic review of 20 listed-entity annual reports and focussed on:
- Classification of share-based payments;
- Measurement and recognition principles of share-based payments; and
- Completeness and appropriateness of disclosures.
Classification
The correct classification of share-based transactions is fundamental to appropriately accounting for IFRS 2 transactions, as it determines both the measurement and the recognition.
Misclassification of share-based payment transactions can result in material misstatements within the financial statements and erroneous disclosures being made.
Common pitfalls
The main pitfalls identified within the FRC’s thematic review concerning the classification of share-based payments included:
- Entities disclosing that awards were equity-settled, while simultaneously presenting unexplained cash outflows in the statement of cash flows;
- Limited disclosures of control within arrangements with settlement alternatives;
- Inconsistencies between entities with settlement alternatives, with some companies classifying the awards as equity-settled while others presented them as cash-settled.
In particular, the review honed in on arrangements with a choice of settlement. It is crucial for companies to be able to identify the correct classification in these circumstances and who holds the choice of settlement within the arrangement:
- If the entity has the choice, it must assess whether it has a present or constructive obligation to settle in cash; or
- When the counterparty has the choice of settlement, the arrangement is treated as a compound instrument, with the entity being required to separately measure the fair value of the liability and equity components of the compound instrumentX.
Key takeaways
The FRC expects disclosures to explain how companies classified share-based payment transactions, by covering off the core tenets of the classification criteria under IFRS 2:
- Whether the award is equity settled or cash settled;
- Where a settlement choice/alternative is present, clearly outlining who holds the choice and what the intended settlement will be; and
- Ensure consistency of disclosures across the financial statements, with particular due care as to the cash flows and classification thereon.
Measurement and recognition
Transactions must be measured at the fair value of the goods or services received. Where this fair value cannot be reliably determined, the transaction is measured by reference to the fair value of the equity instruments granted.
For employee share‑based payment arrangements, IFRS 2 presumes that the fair value of the services received cannot be measured reliably and therefore requires measurement based on the fair value of the equity instruments at the grant date.
While not explicitly defined within IFRS 2, share‑based payment arrangements typically include conditions that determine whether an award ultimately vests, classified as either vesting or non‑vesting conditions. Vesting conditions determine whether the entity receives the services that entitle the counterparty to the award and comprise service conditions (e.g., completion of a specified service period) and performance conditions (requiring both service and achievement of specified targets), which may be market‑based (tied to the price of an entity’s equity instruments) or non‑market‑based (linked to operational or financial metrics). Non‑vesting conditions are unrelated to service or performance but still affect entitlement, such as employee contributions under share plans (e.g. SAYE schemes) or post‑vesting holding restrictions. This distinction is critical, as vesting conditions affect the recognition of expense over the vesting period, whereas non‑vesting conditions are incorporated into the measurement of the award at grant date.
Common pitfalls
- Insufficient detail in disclosures on valuation and the explanation of inputs;
- Limited explanation as to how different vesting conditions impact the expense recognition;
- Inadequate transparency around group share-based payment arrangements.
Key takeaways
The mechanism by which an entity determines the grant-date fair value of the equity instruments or cash liability is not explicitly proscribed within IFRS 2. The FRC observed that companies reviewed tended to use the Black-Scholes Merton model where awards had no market conditions and Monte Carlo simulation models where market-based performance conditions applied.
The FRC placed significant emphasis on the principles of the fair value determination, and the impact that non-market and market conditions can have on the fair value of the awards. It is the FRC’s expectation that valuation techniques and key assumptions are clearly explained for all new grants in a financial period, and for any entity-specific vesting conditions to be sufficiently and appropriately explained in the disclosure as to their accounting impact.
Completeness of disclosures
The quality of disclosures showed the widest variation across the 20 listed-entity reports sampled. The disclosure requirements within IFRS 2 often mean that notes in the financial statements are lengthy and unconcise, reducing the effectiveness of the disclosure to users of the financial statements.
While minimum information is considered within the standard, IFRS 2 does permit information to be aggregated where schemes are ‘substantially similar’.
Common pitfalls
- Inclusion of non-specific accounting policies or accounting policies that were erroneous i.e. cash-settled accounting policies where all schemes were equity-settled, or the repetition of similar information;
- Internal inconsistencies in the financial statements between different disclosures pertaining to share-based payments;
- Insufficient explanation of judgements made in the classification of share-based payment arrangements and the valuation of the grant-date fair values thereon,
Key takeaways
The FRC expects entities to ensure that disclosures relating to share‑based payment arrangements are both complete and proportionate. Disclosures should focus on material information that clearly explains the nature, terms, and financial impact of share‑based payment arrangements on the financial statements.
To enhance clarity and avoid unnecessary complexity, entities should consider appropriate aggregation of similar arrangements and make effective use of signposting and cross‑referencing.
In addition, disclosures should be internally consistent across the annual report and accounts and should clearly articulate any significant judgements applied in determining classification, measurement, and presentation.
How we can help
PKF can help companies assess the accounting treatment of share-based payment arrangements, support valuations, review disclosures and ensure compliance with IFRS 2 and FRC expectations, helping to reduce reporting risk and enhance transparency. For more information, please contact Capital Markets Partner, Imogen Massey or Senior Manager, Calum McChrystal.
