IFRS 2 Vesting Conditions — Core Rule

Vesting conditions determine both how long the expense is spread and how many awards are expected to vest. IFRS 2 distinguishes sharply between non-market conditions (which affect the number of awards expected to vest and require periodic revision) and market conditions (which are priced into the grant-date fair value and never revised afterwards) — IFRS 2.19 and IFRS 2.21.

Three Types of Vesting Condition

1. Service Conditions (IFRS 2 Appendix A)

A service condition requires the counterparty to complete a specified period of service. It is the most common condition in employee share plans.

• Expense is spread over the expected service period (the vesting period).
• If the employee leaves before vesting, reverse the expense accrued for that employee — no expense is recognised for awards that do not vest due to a service condition failure.
• Estimate at each reporting date the number of employees expected to complete the service period; revise the estimate until the vesting date.

2. Non-Market Performance Conditions (IFRS 2 Appendix A)

Examples: EPS growth target, revenue threshold, return on equity, cost-saving milestones.

• Estimate at each reporting date whether the performance condition is likely to be met, and adjust the number of awards expected to vest accordingly.
• Revise upward or downward each period; the cumulative expense at the final vesting date is based on the actual number of awards that vest.
• If the target is ultimately not met: reverse all recognised expense. If partially met: recognise expense only for the awards that actually vest.
• The vesting period may itself depend on when the condition is met — in that case, estimate the most likely vesting date and revise the estimate if that changes.

3. Market Conditions (IFRS 2 Appendix A)

Examples: total shareholder return (TSR) relative to a peer group, a share price hurdle (e.g., share must reach €50 before options can vest).

• Incorporate the market condition into the grant-date fair value using an appropriate valuation model (Monte Carlo simulation for TSR conditions; standard Black-Scholes for simple share-price hurdles).
• Once the grant-date fair value is set, do not adjust expense if the market condition is subsequently not met. Expense continues to be recognised as long as other (non-market) conditions are satisfied.
• The probability of achieving the market condition is already reflected in the lower grant-date fair value — reducing the expense again for a missed hurdle would double-count the probability discount.

The Cumulative True-Up Mechanism

For non-market conditions, IFRS 2 uses a catch-up approach rather than prospective adjustment:

Cumulative expense at period-end = Grant-date FV per award × Estimated awards to vest × (Elapsed periods ÷ Total vesting period)

Period charge = Cumulative expense to date − Cumulative expense in prior periods

This formula automatically corrects for revisions without restating prior-period financials.

Worked Example — EPS Performance Condition

Setup: 3,000 options granted on 1 January 20X1, grant-date fair value €5 each, three-year vesting. Options vest only if cumulative EPS growth exceeds 15% over the three years. Service condition also applies.

Final cumulative expense: 2,400 × €5 = €12,000.

Note the year 20X2 charge drops to €2,000 because the estimate of vesting dropped — a mechanical result of the catch-up formula, not a manual adjustment.

Worked Example — TSR Market Condition

Setup: 1,000 PSP awards, grant-date fair value €12 (incorporating 30% probability of TSR target), three-year vest, service condition only.

At year-end 20X2 it becomes clear the TSR hurdle will not be met. Does the expense change?

No. As long as the employee remains in employment (the service condition is satisfied), the full expense continues to accrue:

• Year 20X1: €4,000 (1,000 × €12 ÷ 3)
• Year 20X2: €4,000
• Year 20X3: €4,000
• Total: €12,000 — regardless of whether the TSR condition is met.

If instead the employee leaves in year 20X3 (service condition fails), reverse all accrued expense in year 20X3 (credit P&L for €8,000 recognised in years 1–2).

Non-Vesting Conditions

A non-vesting condition is a condition that is not a service or performance condition (e.g., requiring the employee not to transfer the award to a third party, or to hold a minimum shareholding post-vesting). Non-vesting conditions:

• Are incorporated into the grant-date fair value measurement.
• Do not affect the number of awards assumed to vest.
• Failure to meet a non-vesting condition does not permit reversal of expense.

IFRS 2 Vesting Conditions — Common Pitfalls

• Adjusting expense for a missed market condition: the most common error. Once grant-date fair value is set, market condition outcomes are irrelevant to subsequent expense recognition.
• Treating the EPS condition as a market condition: EPS is a non-market performance condition — it is not linked to share price. Expense must be revised each period based on probability of meeting the target.
• Using a fixed forfeiture rate instead of period-by-period estimates: IFRS 2.21 requires a best estimate at each reporting date, not a one-time assumption. If turnover patterns change, the estimate must change.
• Confusing vesting conditions with non-vesting conditions: only vesting conditions affect whether expense is recognised — non-vesting conditions affect only the grant-date fair value.

Key Paragraphs

• IFRS 2.19 — equity-settled: grant-date measurement and the role of vesting conditions
• IFRS 2.21 — non-market vesting conditions: revise estimated number of awards each period
• IFRS 2.24 — if vesting condition is not met: no expense (or reverse any recognised)
• IFRS 2.26 — non-vesting conditions: incorporated into fair value, not into expected vesting
• IFRS 2 Appendix A — definitions of service condition, performance condition, market condition, non-vesting condition