ESOP Accounting Treatment

Overview

ESOP provides systematic planning for companies to retain their talented employees. ESOP involves granting options to buy shares to employees at fixed discounted price in the future and giving them a shareholding interest in the company. Since the company is providing an option to the employee, ESOP accounting is important as it shows the cost to the company. 

Since in exchange of the discounted price the company issues shares to the employees, the issue of shares through ESOPs impacts the share capital of the company. Companies can choose between two options for maintaining records in the books of accounts which are either using ESOP accounting standard Ind AS accounting standards or guidance notes issued by Institute of Chartered Accountants of India(ICAI). The companies who follow ESOP accounting standard Ind AS, have to comply with Ind AS 102 (Share Based Payments) which pertains to the ESOP accounting treatment of share based payments. Else, companies can choose to follow the guidance notes regarding the share based payments issues by ICAI. In this blog we will look at the ESOP accounting treatment using Ind AS 102. 

In this blog we will delve into a detailed example of a startup company ABC Pvt. Ltd. who wanted to retain its key talented employees and hence choose to issue ESOPs to them. The example entails the key steps to be involved, the calculations to be performed, and accounting for ESOP entries to be recorded in the books of accounts. 

Step 1: Identify the number of employees leaving the organization

The first step involves the identification of the number of employees who are expected to leave the organization each year till the vesting date.The company estimates that 10 employees will leave the organization each year. This implies that although the company has decided to issue ESOPs to 100 employees but by the time these options vest ( 5 years from now), 50 employees would have left the company i.e. before vesting of the options and hence forfeit their ESOPs. 

The total expected expenses to be incurred by the company can be estimates as = Number of options to be vested*Fair value of each Option*Expected number of employees to whom the option will vest

For ABC the total expected expense = 2000*50*50 = 50,00,000

Now the expense to be recorded each year can be estimated by recalculating the total expense based on the actual number of employees who left the organisation during the year. 

Formula for the amount to be amortized= Number of options to be vested*Far value of each Option*Approximate number of employees to whom shares will vest*Time PeriodVesting Period

 At the end of 1st year: Number of employees who actually left the organization= 5

(31-03-2025)

Approximate number of employees to whom shares will vest= 100-5-10-10-10-10= 55

Journal entry for recording the expense at the end of 1st year:

At the end of 2nd year: Number of employees who actually left the organization= 9

(31-03-2026)

Approximate number of employees to whom shares will vest= 100-5-9-10-10-10= 56

Journal entry for recording the expense at the end of 2nd year:

At the end of 3rd year: Number of employees who actually left the organization= 2

(31-03-2027)

Approximate number of employees to whom shares will vest= 100-5-9-2-10-10= 64

Journal entry for recording the expense at the end of 3rd year:

At the end of the 4th year: Number of employees who actually left the organization= 4

(31-03-2028)

Approximate number of employees to whom shares will vest= 100-5-9-2-4-10= 70

Journal entry for recording the expense at the end of 4th year:

At the end of the 5th year: Number of employees who actually left the organization= 6

(31-03-2028)

Approximate number of employees to whom shares will vest= 100-5-9-2-4-6= 74

Journal entry for recording the expense at the end of 5th year:

Total expense incurred by the company in these 5 years= 11,00,000 + 11,40,000 + 16,60,000+ 17,00,000+ 18,00,000= 74,00,000

When shares are allotted after 5 years

(assuming that the option was exercised by 50 employees at the end of 5 years)

Journal entry for transfer of balance of Share Based Payment Reserve to General Reserve

Note: It is to be noted that if ESOPs are granted in between the financial year, then, the expense to be calculated for amortization will be from the month of grant of ESOPs to the year ending of the respective financial year. 

Conclusion

ESOP accounting is a complex process because it needs careful consideration of various attributes such as exercise price, vesting period, number of stock options etc. but it can be made easier by performing calculations in the right manner. ESOP accounting provides information about the cost incurred by the company in granting the stock options. It shows records of ESOPs granted and is also necessary to ensure that financial statements reflect a true and fair picture. ESOP accounting standard affects the tax liability also because compensation expense reduces the tax payable. In short, accounting for ESOP in corporate accounting is necessary not only for the complete picture of financial statements but also to make informed decisions about the company.