The Monthly: August 2019

01 Aug 2019 / Corporate research

Accounting update

Treatment of ‘share-based payments’

The introduction of IFRS 2 in 2004 generated considerable debate about the best approach for handling ‘share-based payments’ (SBP). While it is clearly a cost to shareholders, which should be included in the statutory reporting lines through the P&L account, the question arose as to whether it should be part of our underlying EBIT calculation. Following discussion, it was decided to exclude SBP from the calculation of underlying EBIT in Hardman & Co research for the following reasons:

  • Relative importance: When IFRS 2 was introduced, the size of SBP, usually related to long-term remuneration for directors, was small and insignificant compared with all other costs.
  • Ability to calculate/forecast: There is a large amount of information needed, including expected vesting, together with a number of assumptions, in order to calculate SBP. Given that neither the information nor the assumptions are disclosed, forecasting this ‘cost’ is almost impossible for an analyst.
  • Non-cash item: In order to keep underlying EPS as a close proxy to the preferred valuation metric – operating cashflow per share (OCFPS) – SBP should not be included. SBP are added back into the cashflow statement because they are a non-cash item.

Fifteen years on, we now have to reconsider the decision to exclude SBP from our underlying EBIT calculations for the following reasons:

  • Relative importance: Since the introduction of IFRS 2, SBP have become an increasingly larger proportion of operating costs, and shares are used as remuneration incentives for many more employees than just the directors.
  • Geographical comparisons: In a global sector such as pharmaceuticals, SBP are widely used as employee incentives, particularly in the US. Therefore, to make direct comparisons between global peers, the accounting treatment needs to be the same. US companies routinely add back SBP for the calculation of their non-GAAP EPS because the payments are so large – thereby inflating EPS.
  • Broader use: In addition to being used to reward more employees, many companies are also using SBP, instead of cash, to remunerate professionals and advisors for services provided – notably fees and commissions related to capital increases – ؘthereby protecting their cash position.

After lengthy discussion surrounding all the above-mentioned points, we have decided that SBP should now be included as part of underlying EBIT. This decision has not been taken lightly, because they are still very difficult to forecast – therefore we will keep them constant on the last reported year – and are a non-cash item.

However, this change does reflect better the true operating costs of the business, and it will mean that international comparisons can be made more easily. It will involve a significant amount of work to alter all the historical and forecast P&L calculations and to add back SBP into cashflow statements, so it will be introduced when the next research report is written on each company.

At the time of writing, we are unsure whether to continue to state SBP as a separate line in the P&L account, or to include them as part of administration costs (SG&A). The dilemma here is that, in the US, SEC filings have SBP split by COGS, SG&A and R&D, whereas, in Europe, SBP tend to be a single cost included only in SG&A. Whatever the decision, we will, as always, be as transparent and informative as possible.

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