Financial reporting on Ledgy
Financial reporting can be accomplished on Ledgy with our expensing feature for share based-payments, designed to adhere to IFRS 2 standards. This article serves as a comprehensive guide on understanding the calculations used in Ledgy and the disclosures required in an audit.
The report uses the underlying grant, vesting, and valuations data entered into Ledgy to calculate a fair value per grant. This is then multiplied by the number of shares allocated to each reporting period based on the vesting schedule and selected accounting methodology.
Expensing follows the approach:
Cumulative expense to date - prior period cumulative expense to date = current period expense
Terminations are automatically trued-up so that the appropriate vested amount is ultimately recognized. Users can further customize the reporting interval, vesting projection, valuation, and forfeiture methods. Reports generated in Ledgy can be exported to Excel at any time.
Please note that if a grant does not have sufficient data to perform the calculations above (e.g. the strike price or expiry date is missing) then it won’t return any expense values.
Adding valuation transactions
Valuation methods like Black Scholes require the fair market value share price, volatility, and risk-free rate as inputs. These inputs need to be added using a valuation transaction. You can add a valuation transaction on the Transactions page. Choose the
Fair value valuation type to enter these valuation parameters.
Fair value transactions will only impact the IFRS 2 report and not affect the cap table or stakeholder dashboards. The date you select for the transaction will be used to determine which grants it applies to in the IFRS 2 report (grants use the latest valuation as of the measurement date). You can add as many valuation transactions as you need, depending on what parameters you want to use on specific dates.
You can adjust your accounting settings from the report page. Any saved changes take effect immediately.
The report date acts as an “as of” date for the report. Any grants or other transactions (for example: terminations or fair market values) after this date are filtered out and ignored in the report calculations.
You can choose either a yearly, quarterly, or monthly reporting interval depending on how frequently you book expenses.
Ledgy offers two amortization methods: front-loaded and linear. These are applied per grant independent of the valuation method. You can see the results of the selected amortization method in the “vesting projections” view.
Front-loaded (also known as “accelerated”) allocates each tranche across all periods prior to the vest date, based on the number of vesting days in each period. This results in more expense being recognized earlier in the grant’s service period. This is the standard approach under IFRS 2.
Linear (also known as “straight-line”) vesting allocates each tranche from the vest date of the previous tranche to the vest date of the current tranche. This results in expenses that are evenly distributed across the periods according to the vesting schedule.
If vesting starts before the grant date, expenses are only recognized from the grant date.
For grants with performance conditions, IFRS 2 states that companies should estimate the vesting duration based on when the condition is likely to be satisfied. On Ledgy, the “target date” of a performance vesting milestone can be used for this purpose. Grants with performance vesting will use the “target date” as the tranche vest date when calculating expenses. However, if a “target date” is later adjusted this will affect expense calculations for all periods (including past periods) and therefore requires manual review by the user to ensure correctness.
If a vesting pause is added to a grant, this will affect the tranche vest dates and change the expenses in Ledgy (including past periods). This scenario also requires manual review by the user to ensure correctness.
See the forfeiture ratef section for more information on forfeiture rates.
See the fair value section for more information on valuations.
The report is separated into several “views” (or tabs in the exported spreadsheet) that show the building blocks for calculating the expenses.
Expected expenses: the estimated expense per grant, per period. This is the product of the number of shares and their fair value.
Vesting projections: the number of shares allocated to each period, according to the grant's vesting schedule and the selected amortization method.
Valuations: the fair value used to determine the expense for each period, calculated according to the selected valuation method (e.g. Black-Scholes).
Valuation parameters: the inputs used to calculate the valuation (added by the user against a specific date). These are: share price, volatility, and risk-free rate. Strike price, expiry date, and expected term are pulled from the existing grant data.
Expected term: the expected term input used to calculate the valuation each period. This is calculated by Ledgy based on the grant date, expiry date, and vesting schedule.
Price estimates: disclosure information.
Equity vs. cash settlement
IFRS 2 states that entities should account for all share-based payment transactions whether they are equity-settled, cash-settled, or there is a choice between the two. Equity-settled awards result in the recipient receiving equity instruments, whereas cash-settled awards are paid out in cash (e.g. the employee receives the cash equivalent of the share value).
Ledgy considers whether a grant is equity or cash-settled when calculating expenses. Equity-settled grants are valued once on the grant date, based on the latest valuation parameters as of the grant date. Cash-settled grants are “marked to market” meaning they are re-valued every period, using the latest valuation parameters on the last day of the period.
Because mark-to-market awards are re-valued every period, this means the expense can keep changing even after vesting has completed if there is a change in value. Only once the award is settled (e.g. paid out) is compensation finalized and further expensing ceases. Ledgy automatically handles this based on the valuation parameters you add to the platform.
Below are the default settlement approaches per grant type in Ledgy:
Stock options: equity-settled
Phantom shares: cash-settled
For both equity and cash-settled transactions, IFRS 2 states that entities should measure awards at their fair value. Ledgy offers three valuation methods for calculating the fair value of a grant:
Intrinsic value (for RSUs only)
These valuation methods are run at the grant level, not the vesting tranche level.
Black Scholes is an option pricing formula that takes several assumptions and estimates a terminal value for an option. It is a commonly used pricing model in the financial industry due to its simplicity, and is generally accepted when it comes to stock expensing. The valuation parameters are:
Strike price (or exercise price)
Fair market value (per share)
Volatility of the stock
Risk-free interest rate
The formula is:
The following sections go into more depth on the assumptions used in this model.
The expected term is the length of time the grant is expected to be outstanding before it is exercised or forfeited. Typically measured in years, it is derived from the grant date, expiry date, and vesting schedule. Since most employees tend to exercise their options before they expire, the expected term is shorter than the contractual term of the grant.
Calculating expected termcan hypothetically take many variables into account, but due to the lack of historical data at private companies it is acceptable to use the midpoint between the service period and the contractural term.
Ledgy automatically calculates the expected term at the grant level according to the formula below. If a grant does not have an expiry date, expected term cannot be calculated and Black Scholes won’t return a fair value.
For example, the expected term of a grant with 4 tranches of 250 options vesting over 4 years and expiring 10 years after the grant date would be:
expected term =
((1 * 250 / 1000 + 2 * 250 / 1000 + 3 * 250 / 1000 + 4 * 250 / 1000)
+ 10 ) / 2
= (2.5 + 10) / 2
For mark-to-market grants, expected term is calculated from the measurement date.
The strike price (or exercise price) is the price an option holder must pay to exercise the option, or convert it into an actual share. This is specified on the grant. If a value hasn’t been added, calculating fair value using Black Scholes is not possible and the expense will be blank.
Fair market value (share price)
The fair market value is the most recent share price associated with the awards. For listed companies, this would be the public market price. For private companies that do not have a live market price, the share price is usually agreed with local tax authorities (e.g. an HMRC or 409A valuation). In Ledgy, you can enter fair market value share prices using “Fair value” valuation transactions. Grants use the latest share price as of the date the valuation is being run (e.g. as of the grant date for equity settled awards). If no value exists the expense will be blank.
Volatility is a statistical measure of how much a stock price fluctuates over a period of time. Generally, the higher the volatility the riskier the stock. In the Black Scholes formula, an expected volatility is used. Ideally this is estimated based on historical volatility, however, private companies often do not have sufficient historical data to make a reasonable estimate. In this case, deriving volatility from a publicly traded peer group is a common approach.
In Ledgy, users can directly enter volatility rates against specific dates. Fair value calculations will use the latest volatility entered as of the valuation date. Users must determine this rate on their own outside the platform, and should retain supporting documentation that explains how the rate was chosen (to provide in an audit).
The risk-free rate is the hypothetical return on an investment with no risk. Risk-free rates are based on an investor’s home market, and market participants often use the yield to maturity of a risk-free government bond where the risk of default is negligible. For example, the interest rate on U.S. Treasury bills (T-bills) is often used as the risk-free rate for the U.S.
In Ledgy, users can directly enter risk-free rates against specific dates. Fair value calculations will use the latest risk-free rate entered as of the valuation date. Ideally, the risk-free rate should have a time period that matches the expected term of the grant. Users must determine this rate on their own outside the platform, and should retain supporting documentation that explains how the rate was chosen (to provide in an audit).
Ledgy assumes the dividend yield is 0.
The fair market value share price, strike price, volatility, and risk-free rate can be directly specified by the user in Ledgy. Expected term is calculated automatically and cannot be overridden. The overall fair value of a grant also cannot be overridden — one of the available valuation methods must be used.
Monte Carlo is another valuation method that has many applications within the world of finance. It is a stochastic (random sampling of inputs) method that simulates many possible scenarios and estimates a result. Ledgy’s implementation of Monte Carlo takes the average of 1 million approximations to calculate an expected value. Please note this is more computationally intensive than Black-Scholes.
This valuation method simply uses the fair market value share price to calculate the expense (Ledgy assumes awards are issued at zero cost to the stakeholder). It only applies to restricted shares and will automatically be used for RSUs in Ledgy. These awards cannot be valued using methods like Black Scholes because the expected term is undefined.
Ultimately, the total expense should reflect the actual number of vested shares. When an employee leaves a company or is otherwise terminated, expenses need to be adjusted to reflect any terminated unvested shares. Expenses are not adjusted for terminations of vested shares since vested shares are considered compensated under IFRS 2. These may be accounted for elsewhere in your financial statements.
When portions of grants are terminated in Ledgy, the expense is reduced by the terminated amount. The reduction is applied to the period in which the termination takes place and any future periods, so past expenses are unaffected. This can result in a negative expense when expenses are front-loaded (see example below), which is perfectly fine. If a forfeiture rate is being used, any estimated forfeitures will be “trued up” in the period of the termination so that the total expense reflects the actual number of vested shares.
The forfeiture rate is an estimate of what percentage of awards will fail to vest, usually because an employee leaves the company. Unvested awards should not be expensed, or reversed in the event they were previously expensed. Therefore, if a company does not want to overreport their expenses they can choose to reduce them up front by using an estimated forfeiture rate. Forfeiture rates do not apply to grants without vesting.
Since 2016, IFRS 2 no longer requires companies to use forfeiture rates. If you choose to use one, the rate should be carefully selected by analyzing historical forfeiture data as well as expectations for the future. If expectations change, the rate should be updated. Ledgy does not suggest a rate based on historical data — users must do this on their own. We recommend that you save all supporting calculations to justify your chosen rate in an audit.
Ledgy supports either entering a forfeiture rate or ignoring it by setting the rate to 0%. Two forfeiture methods are offered: static and dynamic.
Static simply reduces each expense by the percentage specified. Any discrepancies with the actual vested amount (once a grant fully vests or is terminated) are automatically trued up.
Dynamic is a more sophisticated approach that is considered best practice. The rate is applied at the tranche level and is automatically adjusted based on the amount of time left to vest, relative to the reporting period date. The result is a smoother and more accurate estimation of forfeitures that naturally trues up as vesting progresses. You can see an illustrative example below.
You can customise the expected term, valuation or settlement type of a grant in a way that will be reflected only in the IFRS 2 report. This can be done via the Custom accounting feature.
By using the “Bulk edit” function on IFRS 2 accounting settings, you will be able to add, remove or edit customised accounting settings per grant for your IFRS 2 expensing report.
This functionality supports the following overrides:
adjusting the expected term and valuation for an equity-settled grant
adjusting a cash-settled grant to be treated as an equity-settled grant
adjusting an equity-settled grant to be treated as a cash-settled grant
At the moment, we only support overriding the expected term and valuation for equity-settled grants.
When navigating back to the IFRS 2 expensing report, you can check if the overridden values have been reflected in the report. In the “Valuations” view, grants that have overridden valuation used in the IFRS 2 report will have a “Valuation method” - “User input”. Cash-settled grants that have an overridden settlement type to “equity” will display valuation values per period in the “Valuations” view. Grants that have overridden the expected term will reflect that number in the “Expected term” view.
For more information on the difference between equity-settled and cash-settled grants, see the Equity vs. cash settlement section.
IFRS 2 asks companies to disclose information that will aid in understanding the report, including information on the nature of its share-based payments, how the fair value was calculated, as well as the effect of share-based payments on the company’s profit.
The various report views in Ledgy should provide sufficient information for understanding the report and how fair value was calculated. Ledgy provides additional disclosures information, such as weighted average strike prices, in the “Price estimates” view. Please note that this information, while extensive, may not be comprehensive and users should ensure they are providing sufficient data points to satisfy the disclosure requirements under IFRS 2.