How share-based payment replacement awards in business combinations are accounted for under IFRS 2, IFRS 3, and ASC 718

When an acquirer buys a target that has outstanding stock options or other share-based payment awards, the acquirer often replaces those awards with its own equity instruments. Accounting for these “replacement awards” is a technical area where IFRS 2, IFRS 3, and ASC 718 intersect—because part of the fair value of the award is treated as consideration transferred for the business combination, while the remainder is treated as post-combination compensation expense.

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Why replacement awards exist and what they represent

In many acquisitions, the target’s employees hold options or RSUs over the target’s shares. Once the target is acquired, those instruments no longer make sense:

• The target’s shares may cease to exist or no longer be traded.

• The acquirer wants employees aligned with the acquirer’s equity.

• Deal terms may require the acquirer to honour or improve existing employee incentives.

To preserve incentives, the acquirer issues replacement awards:

• Old target awards are cancelled or modified.

• New awards over the acquirer’s shares (or cash-settled plans) are granted.

Economically, part of the fair value of these replacement awards compensates employees for pre-combination service (so it is part of the purchase price), while the remainder compensates future service (so it is post-combination compensation).

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How IFRS 3 and IFRS 2 split the fair value of replacement awards

IFRS requires a split of the fair value of replacement awards between:

• The portion attributable to pre-combination service (treated as consideration transferred in the business combination under IFRS 3).

• The portion attributable to post-combination service (accounted for as share-based payment expense under IFRS 2).

The split is based on vesting period proportions, using grant-date fair value of the replacement awards:

• Let FVnew be the fair value of the replacement award at the acquisition date.

• Let Ttotal be the total vesting period (from original grant date to final vesting date).

• Let Tpast be the period from original grant date to the acquisition date.

Pre-combination portion (consideration):

FV_{\text{pre}} = FV_{\text{new}} \times \frac{T_{\text{past}}}{T_{\text{total}}}

Post-combination portion (future compensation):

FV_{\text{post}} = FV_{\text{new}} - FV_{\text{pre}}

The pre-combination portion is added to consideration transferred in the goodwill calculation; the post-combination portion is recognized as expense over the remaining vesting period after the acquisition date.

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How ASC 718 and ASC 805 treat replacement awards under US GAAP

US GAAP applies a similar split between pre-combination and post-combination components, but using the language of ASC 805 (Business Combinations) and ASC 718 (Compensation—Stock Compensation).

Key points:

• Replacement awards are measured at their fair value at the acquisition date.

• The portion attributable to pre-combination service is included in consideration transferred (ASC 805).

• The portion attributable to post-combination service is recognized as stock-based compensation expense over the remaining requisite service period (ASC 718).

If the vesting terms are changed (for example, accelerated vesting, modified performance conditions, or new vesting schedules), this can change how much of the award is treated as acquisition consideration versus post-combination compensation.

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IFRS vs US GAAP — replacement award mechanics compared

Topic	IFRS 2 / IFRS 3	US GAAP (ASC 718 / ASC 805)
Measurement of replacement awards	Fair value at acquisition date, using IFRS 2 valuation methods	Fair value at acquisition date, using ASC 718 valuation methods
Split of fair value	Allocate between pre-combination and post-combination based on vesting proportion	Same principle: split between business combination consideration and compensation
Pre-combination portion	Included in consideration transferred in goodwill calculation	Included in consideration transferred under ASC 805
Post-combination portion	Recognized as share-based payment expense over remaining vesting period	Recognized as stock-based compensation expense over remaining requisite service period
Forfeitures and vesting conditions	Future service and performance conditions handled under IFRS 2	Future service and performance conditions handled under ASC 718
Goodwill impact	Pre-combination portion increases consideration, therefore may increase goodwill	Same; part of purchase price, affecting goodwill

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Worked example under IFRS — equity-settled replacement options

Facts:

• Target employees hold options granted three years ago, with a five-year vesting period.

• At the acquisition date, the acquirer replaces each target option with an option over its own shares.

• Fair value of each replacement option at acquisition: 10 (using IFRS 2 option pricing).

• Ttotal = 5 years (original vesting period).

• Tpast = 3 years (service already rendered before acquisition).

• Remaining service period = 2 years.

Step 1 — split the fair value:

• Pre-combination portion per option:10 × (3 ÷ 5) = 6

• Post-combination portion per option:10 − 6 = 4

Step 2 — pre-combination portion in business combination:

The 6 per option is treated as part of consideration transferred:

• Dr Goodwill (or reduction of bargain gain) 6 per option

• Cr Equity — Share Capital / Share Premium 6 per option

This embeds pre-acquisition employee service in the purchase price.

Step 3 — post-combination portion as IFRS 2 expense:

The 4 per option is recognized as share-based payment expense over the remaining 2 years:

• Annual expense per option: 4 ÷ 2 = 2.

Journal entry each year:

• Dr Share-based Payment Expense 2 per option

• Cr Equity — Share-based Payment Reserve 2 per option

If employees leave before vesting, the entity adjusts the expense for forfeitures according to IFRS 2’s rules.

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Worked example under US GAAP — accelerated vesting on acquisition

Facts:

• Target employees hold RSUs vesting in four years.

• Two years of service have been completed at acquisition.

• As part of the deal, the acquirer accelerates vesting of half of the remaining tranche.

• Acquisition-date fair value of replacement RSUs: $8 million.

• Original vesting period: 4 years; service completed: 2 years.

Allocation:

• Pre-combination portion: 8 × (2 ÷ 4) = $4 million.

• Post-combination portion: 8 − 4 = $4 million.

Because vesting is partially accelerated, some or all of that $4 million post-combination portion might be recognized immediately as compensation if the acceleration relates to post-combination service terms; the remainder is recognized over the remaining service period.

Journal entries:

At acquisition (consideration portion):

• Dr Identifiable Net Assets / Goodwill 4,000,000

• Cr Equity (Common Stock / APIC) 4,000,000

Post-acquisition compensation (if fully accelerated at closing):

• Dr Compensation Expense 4,000,000

• Cr Equity (APIC — Stock-based Compensation) 4,000,000

If not fully accelerated, the $4 million is recognized over the remaining requisite service period, similar to a normal ASC 718 award.

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How cancellations, modifications, and cash settlements affect accounting

Replacement awards can be more complex than a simple one-for-one swap:

• Cancellations at closing: If original awards are cancelled and no replacement is granted, any incremental benefit might be treated as compensation or as part of consideration, depending on contractual terms.

• Improved terms (e.g., lower exercise price, more shares, shorter vesting): are treated as a modification. Incremental fair value may be treated partly as additional consideration and partly as post-combination compensation, depending on whether it relates to past or future service.

• Cash-settled replacement awards: Under IFRS 2 and ASC 718, cash-settled awards (e.g., SARs) create a liability measured at fair value at each reporting date, with gains and losses recognized in P&L. The pre-combination portion of the fair value is still treated as part of the purchase price.

• Performance conditions: If performance conditions are changed on acquisition, the acquirer reassesses vesting expectations. The pre-/post-combination split still uses elapsed service time; actual expense recognition will follow updated expectations for vesting.

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Journal entries summary for replacement awards

At acquisition date (IFRS and US GAAP — simplified):

1. Recognize pre-combination portion as consideration:

2. Dr Identifiable Net Assets / Goodwill xx

3. Cr Equity (Share Capital / APIC — replacement awards) xx

4. Set up post-combination portion for future expense:

No immediate entry beyond classification; the fair value allocated to post-combination service will be expensed over time.

Post-acquisition (over remaining service period):

• Dr Share-based Payment Expense / Compensation Expense xx

• Cr Equity — Share-based Payment Reserve / APIC xx

For cash-settled awards (liability):

• Dr Compensation Expense xx

• Cr Liability for Cash-settled Share-based Payment xx

with remeasurement of the liability to fair value at each reporting date.

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Disclosure and analytical implications

Replacement awards affect several key areas:

• Goodwill: The pre-combination component of fair value increases consideration transferred, which can increase goodwill in the purchase price allocation.

• Post-combination profit: The post-combination portion increases personnel costs over the remaining vesting period, sometimes with large one-off charges if vesting is accelerated.

• EPS and share dilution: Equity-settled replacement awards increase diluted EPS denominator through additional potential shares.

• Quality of earnings: Analysts often separate acquisition-related share-based expenses from ongoing compensation to assess underlying performance.

Entities should disclose:

• The nature and terms of replacement awards.

• The fair value at acquisition date.

• The portion treated as consideration versus post-combination compensation.

• The expense recognized for share-based payments in the years following the acquisition.

Clear documentation of the pre- and post-combination split keeps the goodwill calculation robust and allows users to understand how acquisition-related incentives flow through future earnings.

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