How to Audit Share-Based Payment Under IFRS 2

Why IFRS 2 creates audit risk in mid-market engagements

IFRS 2 is not a Big 4 problem exclusively. Dutch mid-market entities, particularly in technology, life sciences, and professional services, increasingly use share-based payment to attract talent. A B.V. with €40M revenue offering stock appreciation rights to its management board triggers the same IFRS 2 requirements as a listed multinational. The difference is that the mid-market entity rarely has internal expertise in option valuation, and the plans are often designed by lawyers without input from anyone who understands the accounting implications.

The audit risk concentrates in two places. First, the fair value measurement. IFRS 2.B1–B41 requires the use of an option pricing model (Black-Scholes-Merton or a binomial/lattice model) with inputs for expected volatility, expected term, risk-free rate, expected dividends, and exercise price. Each input requires judgment. For unlisted entities, expected volatility has no observable market data and must be estimated from comparable listed companies or historical transaction data. Small changes in volatility produce large swings in the calculated fair value.

Second, the expense allocation over the vesting period. IFRS 2.20 requires the entity to recognise services received during the vesting period based on the best available estimate of the number of equity instruments expected to vest. That estimate changes at every reporting date. When employees leave and forfeit unvested options, the cumulative expense adjusts. Many mid-market entities set the IFRS 2 charge at grant date and never revisit it.

Classification: the first question you answer

Before testing any numbers, classify the arrangement. IFRS 2 has separate measurement and recognition rules for each category, and misclassification changes the entire accounting treatment.

Equity-settled transactions (IFRS 2.10–29): the entity grants equity instruments (shares or options) to employees. The entity measures the transaction at fair value of the equity instruments at grant date. That fair value is fixed at grant date and never remeasured. The expense accrues over the vesting period. This is the most common classification for employee stock option plans.

Cash-settled transactions (IFRS 2.30–33D): the entity grants a right that will be settled in cash (or other assets) based on the value of equity instruments. Stock appreciation rights (SARs) are the typical example. The entity recognises a liability, measured at fair value at each reporting date until settlement. The remeasurement at each reporting date distinguishes cash-settled from equity-settled: the P&L charge fluctuates.

Transactions with choice of settlement (IFRS 2.34–43): some arrangements give either the entity or the employee a choice between equity and cash settlement. IFRS 2.37 requires you to look through the legal form. If the entity has a present obligation to settle in cash (because past practice, stated policy, or a constructive obligation makes cash settlement the substance), it accounts for the arrangement as cash-settled regardless of the contractual label.

Read the plan document and identify the settlement mechanism before opening any spreadsheet. A plan labelled “stock option plan” that includes a cash-out clause at the employee’s election contains a cash-settled component under IFRS 2.34. If the HR director calls it an option plan, but the plan terms allow employees to demand cash, the classification shifts.

Group share-based payment arrangements

Dutch mid-market entities that are part of a group face an additional classification question under IFRS 2.43A–43D. When a parent grants equity instruments to employees of a subsidiary, the subsidiary must recognise the share-based payment expense in its own financial statements. The question is whether the subsidiary recognises an equity-settled or cash-settled transaction. IFRS 2.43C provides the rule: the subsidiary classifies the arrangement based on its own obligation. If the subsidiary has no obligation to settle (the parent settles directly with the employee), the subsidiary recognises an equity-settled transaction with a corresponding increase in equity (as a capital contribution from the parent). If the subsidiary has an obligation to settle in cash, it recognises a cash-settled liability.

This matters in practice because many Dutch group structures grant stock appreciation rights at the holding company level to employees across multiple subsidiaries. At the consolidated level, the parent has a cash-settled liability. At the subsidiary level, the treatment depends on whether the subsidiary will reimburse the parent. If an intercompany recharge agreement exists, the subsidiary may have a cash-settled liability. Without a recharge, the subsidiary treats it as an equity-settled capital contribution. Obtain the intercompany agreements and verify the substance.

Arrangements with performance conditions that straddle categories

Performance conditions add a classification layer. IFRS 2.19 distinguishes between vesting conditions and non-vesting conditions. Only conditions that require a specified period of service or meeting performance targets during that service period are vesting conditions. Conditions that apply after the employee has already vested (post-vesting restrictions on sale, holding periods) are not vesting conditions and do not affect the expense allocation during the vesting period.

Within vesting conditions, the distinction between market conditions (share price targets) and non-market conditions (revenue thresholds, EBITDA targets) drives different accounting treatments. Get the plan document’s performance criteria in front of you and classify each condition before testing any numbers.

Fair value measurement: testing the option pricing model

IFRS 2.16–17 requires fair value of equity instruments granted to be based on market prices if available. For unlisted entities (where no market price exists), IFRS 2.B4 directs you to a valuation technique. In practice, almost every mid-market IFRS 2 engagement involves either Black-Scholes-Merton or a binomial model.

Your job is not to build the model. Your job is to test each input. IFRS 2.B25–B41 specifies what each input should reflect.

Expected volatility (IFRS 2.B25–B33): for listed entities, use historical share price volatility over a period consistent with the expected term of the option. For unlisted entities, IFRS 2.B25 permits (and in practice requires) the use of comparable listed entity volatility. When the entity selected its peer group for the volatility estimate, verify the peers are in the same sector, of similar size, and at a comparable stage of development. A Dutch biotech B.V. using the volatility of Unilever is not a reasonable peer selection. Test the calculation: obtain the peer share prices, recalculate the standard deviation, and compare to management’s figure.

Expected term (IFRS 2.B16–B21): this is the period from grant date to expected exercise date. It is not the contractual term. IFRS 2.B17 notes that employees typically exercise options earlier than the contractual expiry, particularly when the option is in the money. For a first-time grant with no exercise history, the entity uses assumptions. Verify those assumptions are documented and reasonable. The SEC’s “simplified method” (midpoint between vesting date and contractual expiry) is not IFRS guidance, but many entities adopt it by analogy. If the entity uses it, note the basis in your file.

Risk-free rate (IFRS 2.B37–B38): the government bond yield matching the expected term of the option. Verify the tenor matches. If the expected term is six years, the risk-free rate should reference a six-year Dutch government bond (or eurozone equivalent), not a ten-year rate.

Expected dividends (IFRS 2.B31–B33): if the model reduces fair value for expected dividends, verify the dividend assumption against the entity’s dividend policy and recent history. For entities that have never paid dividends, a zero assumption is typically appropriate. For entities with a track record, the assumption should reflect expectations at grant date.

Exercise price: agree this directly to the plan document and the board resolution approving the grant. This is usually the simplest input to verify and the one most likely to be correct, but confirm it.

For unlisted entities where management engaged an external valuer, assess the valuer under ISA 500.8. Obtain the valuation report, verify the model type, test the inputs against the criteria above, and document your conclusions on each input separately. Do not accept a single-page summary that states a fair value without showing the inputs.

One additional check that catches errors: run a sensitivity analysis on volatility. If a 5-percentage-point change in expected volatility moves the total IFRS 2 expense by more than your performance materiality, the volatility input is a significant estimate under ISA 540.13. That triggers additional audit procedures: you need to evaluate the range of reasonable estimates and assess whether management’s point estimate falls within it. For most mid-market option grants, volatility is the input with the largest effect on fair value. Document the sensitivity.

The Financial Ratio Calculator can help you benchmark the entity’s financial profile against the comparable companies used for volatility estimation.

Vesting, forfeitures, and modifications

IFRS 2.19 sets the core principle: the entity recognises services received during the vesting period. The vesting period starts at the grant date and ends when all vesting conditions are met. For a four-year cliff-vesting plan, the entity recognises one quarter of the total expected expense each year.

IFRS 2.20 is where most mid-market files go wrong. The entity must base the expense on the best available estimate of the number of equity instruments expected to vest. That means estimating, at each reporting date, how many employees will remain employed through the vesting period and meet any performance conditions. If the entity granted 100 options to 50 employees and expects 10% attrition over the vesting period, the expected number vesting is 4,500 (50 × 100 × 90%). When actual attrition runs higher than expected, the cumulative expense adjusts downward. Lower attrition pushes it upward.

The distinction between market and non-market vesting conditions matters for how adjustments work. Non-market conditions (continued employment, revenue targets, profit thresholds) affect the estimated number of instruments expected to vest. You update the estimate each period. Market conditions (share price targets, total shareholder return hurdles) are already reflected in the grant-date fair value measurement (IFRS 2.B1, IFRS 2.21). You do not adjust the number of instruments expected to vest for market conditions, even if the target is clearly not going to be met.

Modifications require careful treatment under IFRS 2.26–29. If the entity modifies the terms of a grant (extends the vesting period, reduces the exercise price, adds a cash settlement feature), IFRS 2.27 requires the entity to recognise, at minimum, the expense as if the modification had not occurred. If the modification increases the fair value of the equity instruments, the entity recognises the incremental fair value over the remaining vesting period. Verify that any modification was approved by the board, that the entity obtained an updated fair value measurement, and that the incremental cost is being recognised correctly.

Cancellations are treated as an acceleration of vesting under IFRS 2.28. The entity recognises immediately the amount that would otherwise have been recognised over the remaining vesting period. If the entity cancels a plan and replaces it with a new one, the replacement is a modification under IFRS 2.28(c), not a fresh grant.

Worked example: auditing a Dutch employee stock option plan

Client: Strijbos Digital Solutions B.V., a Rotterdam-based SaaS company. €31M revenue, December 2025 year-end. The entity granted 200,000 stock options to 40 employees on 1 March 2024 under a new equity-settled plan. Options vest after four years of continuous employment. Exercise price: €12.00 per share. Contractual expiry: 1 March 2034.

1. Classify the arrangement

Review the plan document. Settlement is in shares only. No cash-out clause. No entity choice to settle in cash. Classification: equity-settled under IFRS 2.10.

2. Test the fair value inputs

Management used Black-Scholes-Merton with these inputs: expected volatility 38%, expected term 6.5 years, risk-free rate 2.85%, expected dividends nil, exercise price €12.00. Fair value per option: €5.42.

Test each input:

• Volatility: management used a peer group of four listed Dutch/European SaaS companies (Exact Group, Unit4, Visma, Fortnox). Obtain the historical daily share prices for each peer over the six-year period preceding the grant date. Recalculate annualised volatility. Our recalculated peer group average: 36.8%. Management’s 38% is within a reasonable range. No exception.
• Expected term: management used the midpoint between the vesting date (1 March 2028) and contractual expiry (1 March 2034), producing 6.5 years. First-time grant with no exercise history. The simplified method is a reasonable starting point. No exception.
• Risk-free rate: the Dutch government 7-year bond yield at 1 March 2024 was approximately 2.82%. Management’s 2.85% is consistent. No exception.
• Dividends: Strijbos has never paid a dividend and has no stated dividend policy. Nil assumption is appropriate.
• Exercise price: agreed to the board resolution and plan document. €12.00 confirmed.

Recalculate the Black-Scholes value using verified inputs. Our recalculated fair value: €5.28 (using 36.8% volatility). Management’s €5.42 produces a total grant-date fair value of €1,084,000 (200,000 × €5.42) versus our €1,056,000 (200,000 × €5.28). The difference of €28,000 is below materiality (€350K). No adjustment required, but document the variance.

3. Test the vesting period expense and forfeiture estimate

For the ten months from 1 March 2024 to 31 December 2024, Strijbos should recognise 10/48 of the total expected expense. Management estimated 8% cumulative attrition over the four-year vesting period. At 31 December 2024, two of the 40 employees had left. Management’s updated attrition estimate: 12%.

Expected options vesting: 200,000 × (1 – 0.12) = 176,000. Total expected expense: 176,000 × €5.42 = €953,920. Expense for the ten-month period: €953,920 × 10/48 = €198,733. Management recorded €199,100. Difference: €367. Immaterial.

4. Test disclosure completeness

IFRS 2.44 requires disclosure covering the nature of share-based payment arrangements and their extent. The next paragraph (IFRS 2.45(a)) requires a description of each type of arrangement, including general terms and conditions. Paragraph 2.46 requires disclosure of the number and weighted average exercise prices of options outstanding, exercisable, granted, exercised, forfeited, and expired during the period. The model inputs (weighted average share price, exercise price, expected volatility, option life, expected dividends, and risk-free rate) must also be disclosed under IFRS 2.47(a).

Verify each disclosure element against the underlying data. Confirm the option roll-forward (opening nil, granted 200,000, forfeited 10,000, closing 190,000) agrees to the detailed records.

The completed file demonstrates that every fair value input was independently tested, the expense allocation was recalculated, the forfeiture estimate was assessed against actual data, and the disclosures were verified item by item.

Practical checklist for your engagement file

1. Obtain and file the share-based payment plan document, board resolution, and any amendments. Classify the arrangement as equity-settled, cash-settled, or with choice of settlement under IFRS 2.10–43
2. For equity-settled plans, verify grant-date fair value by testing each option pricing model input (volatility, expected term, risk-free rate, dividends, exercise price) against IFRS 2.B1–B41 criteria and document your assessment of each input separately
3. For cash-settled plans, verify that the liability is remeasured at fair value at each reporting date per IFRS 2.30–33D, not frozen at the original measurement
4. At each reporting date, recalculate the expected number of instruments vesting based on management’s updated forfeiture estimate under IFRS 2.20, verify the estimate against actual departures and HR data
5. If the entity modified or cancelled any arrangements during the period (including replacements), verify the accounting treatment against IFRS 2.26–29 (minimum expense recognition, incremental fair value for beneficial modifications, acceleration for cancellations)
6. Check IFRS 2.44–52 disclosures: option roll-forward by exercise price band, model inputs with weighted averages, total expense recognised in the period, and carrying amount of liabilities for cash-settled plans

Common mistakes

• Freezing the forfeiture estimate at grant date: IFRS 2.20 requires the entity to update its estimate of the number of instruments expected to vest at each reporting date. Setting the attrition assumption once and never revisiting it is the most common IFRS 2 deficiency in mid-market files. The FRC’s thematic review of share-based payment (2019) specifically flagged this as a recurring finding across Tier 2 firms.
• Using inappropriate comparable companies for volatility: for unlisted entities, the volatility estimate under IFRS 2.B25 must come from comparable companies of similar size and in the same sector. A construction holding company using technology sector volatility (or vice versa) produces a materially misstated fair value.

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Further reading and source references

• IFRS 2, Share-based Payment: the source standard covering recognition, measurement, and disclosure of all share-based payment transactions.
• IFRS 2.B1–B41: application guidance on fair value measurement of equity instruments, including option pricing model inputs.
• ISA 540, Auditing Accounting Estimates and Related Disclosures: the audit standard governing the auditor’s approach to significant estimates, including option fair values.
• FRC Thematic Review (2019): review of share-based payment accounting across Tier 2 firms, flagging forfeiture estimate deficiencies.