Accounting for ESOP IPCC Paper 5: Advanced Accounting Chapter 4 CA. Shruthi BN, Bangalore
Learning Objectives 1 After studying this unit, you will be able to learn the provisions of the Companies Act, 1956 in respect of ESOP 2 3 4 Understand the accounting treatment for ESOP Understand the provisions of Guidance Note of the ICAI on ESOP Understand issue of equity shares with differential voting rights
ESOP An introduction Employee stock ownership plans can be used to keep plan participants focused on company performance and share price appreciation. By giving plan participants an interest in seeing that the company's stock performs well, these plans are believed to encourage participants to do what's best for shareholders, since the participants themselves are shareholders. As per Section 2(15A) of the Companies Act, employee stock option means the option given to the whole time directors, officers or employees of a company, which gives such directors, officers or employees the benefits or right to purchase or subscribe at a future date, the securities offered by the company at a predetermined price.
Important Terminologies It means giving an option to the employees to subscribe to the shares of the Company It is the process by which the employee is given the right to apply for shares of the Company against the option granted to him in pursuance of ESOP It is the period during which vesting of the option takes place Option means a right but not an obligation granted to an employee to subscribe for the shares of the Company at a pre determined price Date on which the employee actually exercises the option by applying for shares and the period during which an employee has to exercise the option is exercise period.
Accounting Policy SEBI The Securities and Exchange Board of India (Employee stock option Plan and Employee Share Purchase Plan) guidelines, 1999 have been issued to guide the listed entities for the purpose of accounting for employee stock options. The unlisted entities, have an option to follow the SEBI guidelines or the guidance note on Employee Share Based payments issued by the ICAI Employee stock options are a part of the compensation paid to the employee, though, usually, they are granted over and above the fixed and variable component.
Accounting Policy SEBI (contd) The accounting value of the options granted should be taken in the books of accounts as compensation cost. Such compensation cost should be measured as on the date of grant based on the available market prices of the instruments or estimate the value using an appropriate valuation technique. The cost so arrived at should be amortized over the vesting period or the estimated vesting period as the case may be. The guidelines give an option to the entity to account for as per fair value or intrinsic value method.
Accounting Policy SEBI When we account for employee stock options, following new accounts come into existence (as per SEBI guidelines): Employee compensation expense account This account forms part of the compensation expense account and is taken in the Profit and loss account Deferred employee compensation expense This account is created at the time of grant of options for the total amount of compensation expense to be booked. This account is a part of the Balance sheet and forms a negative balance in the Shareholders equity or Net worth. Employee Stock Options Outstanding account It is a part of the Shareholders equity and is transitional in nature since it is ultimately transferred to Share Capital, Share Premium or General Reserves.
Disclosure requirement - SEBI Accounting policy given by the SEBI (applicable only for listed companies) In the director s report to be given u/s 217 of the Companies Act, 1956, following disclosures with respect to options shall also be included, amongst others, Options granted Pricing formula Options vested Options exercised Options lapsed Total number of shares arising as a result of exercise of option Money realized by exercise of options Employees wise details of options granted Diluted EPS pursuant to options as per AS 20
ICAI Guidance Note on ESOP The GN issued by the ICAI establishes financial accounting and reporting principles for employee share based payment plans, such as ESOP, ESPP and Stock appreciation rights For the purpose of accounting, employee share based payment plans are classified into: Equity settled: Employee receives equity shares Cash settled: Employee receives cash based on the price of shares Employee share based payment plans with cash alternatives: There is choice that settlement could be in the form of shares or cash
Guidance Note - Accounting Policy An enterprise should recognize as an expense the services received in an equity settled employee share based payment plan when it receives the services, with a corresponding credit to an appropriate equity account, say, Stock options outstanding account. For cash settled employee share based payment plans, the enterprise should measure the services received and the liability incurred at fair value of the liability. Until the liability is settled, the enterprise is required to re measure the fair value of the liability at each reporting date and at the date of settlement, with any changes in the value recognized in profit and loss for the period.
Guidance Note - Accounting Policy In the case of ESOP which provides an option for equity settlement or cash settlement, then the Company should account for that transaction, or the components for that transaction, as a cash settled share based payment plan if and to the extent that the enterprise has incurred liability to settle in cash, or as an equity settled share based payment plan if, and to the extent that, no such liability has been incurred
Accounting entries Employee stock option expenses account Dr To Employee stock options outstanding account (With proportionate of the services received, being recognized as an expense) Bank account.. Dr Employee stock option outstanding account.. Dr To Equity Share Capital Account To Securities Premium account (Being accounting for options exercised)
Accounting entries Employee stock options outstanding account Dr To employee compensation expenses account (Being options lapsed entry reversed) Profit and loss account. Dr To Employee compensation expenses account (Being net expense transferred to profit and loss account)
Illustration 1 A Company has its share capital divided into shares of Rs 10 each. On 1 st April, 2010 it granted 10,000 employees stock options at Rs 40, when the market price was Rs 130. the options were to be exercised between 16 th December 2011 and 15 March 2012. The employees exercised their options for 9500 shares only; the remaining options lapsed. The company closes its books on 31 March every year. Show journal entries
Solution (1/2) Date Particulars Debit (Rs) Credit (Rs) April 1 2011 Employee compensation expenses account. Dr To ESOP outstanding account 9,00,000 9,00,000 (Being grant of 10,000 stock options to employees at Rs 40 when the market price is Rs 130) 16 Dec 2011 to 15 Mar 12 Bank account. Dr ESOP outstanding account. Dr To Equity Share Capital Account To Securities Premium Account 3,80,000 8,55,000 95,000 11,40,000 (Being allotment to employees of 9,500 equity shares of Rs 10 each at a premium of Rs 120 per share in exercise of stock options by employees)
Solution (2/2) Date Particulars Debit Credit Mar 16, 2012 ESOP outstanding account Dr To employee compensation expense account 45,000 45,000 (Being entry for lapse of stock options for 500 shares) Mar 31 Profit and loss account. Dr To employee compensation expense account 8,55,000 8,55,000 (Being transfer of employee compensation expense to Profit and loss account)
Illustration 2 ABC Ltd grants 1,000 employees stock options on 1.4. 2007 at Rs 40, when the market price is Rs 160. The vesting period is 2.5 years and the maximum exercise period is one year. 300 unvested options lapse on 1.5.2009. 600 options are exercised on 30.6.2010. 100 vested options lapse at the end of exercise period. Journalize
Solution (1/4) Date Particulars Debit Credit 31.3.2008 Employee compensation expense account. Dr To ESOP outstanding account 48,000 48,000 (Being grant of 1,000 stock options to employees at Rs 40 when the market price is Rs 160 amortized on straight line basis over 2.5 years ) 31.3.2008 Profit and loss account. Dr To employee compensation expense account (Being expenses transferred to P/L account at the year end) 31.3.2009 Employee compensation expense account. Dr To ESOP outstanding account (Being grant of 1,000 stock options to employees at Rs 40 when the market price is Rs 160 amortized on straight line basis over 2.5 years ) 48,000 48,000 48,000 48,000
Solution (2/4) Date Particulars Debit Credit 31.3.2009 Profit and loss account. Dr To employee compensation expense account 48,000 48,000 (Being expenses transferred to P/L account at the year end) 31.3.2010 ESOP outstanding account.. Dr To General Reserve account ( Being excess of employees compensation transferred to general reserve account) 12,000 12,000
Solution (3/4) Date Particulars Debit Credit 30.6.2010 Bank account (600 * Rs 40) Dr ESOP outstanding account.. Dr To Equity Share Capital Account To Securities Premium Account 24,000 72,000 6,000 90,000 (Being 600 employee stock options exercised) 1.10.2010 ESOP outstanding account.. Dr To General Reserve account ( Being excess of employees compensation transferred to general reserve account on lapse of 100 options) 12,000 12,000
Solution (Working note) (4/4) At 31. 3. 2010, ABC Ltd will examine its actual forfeitures and make necessary adjustments, if any to reflect expenses for the number of options that actually vested. Considering that 700 stock options have completed 2.5. yeas vesting period, the expense to be recognized during the year is negative. i.e. Particulars Rs No of options actually vested (700 * 120) 84,000 Less: expenses already recognized (48000 + 48000) 96,000 Excess expenses transferred to general reserve 12,000
Illustration 3 Choice Ltd grants 100 stock options to each of its 1000 employees on 1.4.2008 for Rs 20, depending upon the employees at the time of vesting of options. The market price of the share is Rs 50. These options will vest at the end of year 1 if the earning of Choice Ltd is 16%, or it will vest at the end of year 2 if the average earning of two years is 13% or lastly it will vest at the end of the third year if the average earning of 3 years will be 10%. 5,000 unvested options lapsed on 31.3.2009. 4,000 unvested options lapsed on 31.3.2010 and finally 3,500 unvested options lapsed on 31.3.2011. Following is the earning of Choice Ltd: Year ended 31.3.2009 14% earning Year ended 31.3.2010 10% earning Year ended 31.3.2011 7% earning 850 employees exercised their vested options within a year and remaining options were unexercised at the end of the contractual life. Pass journal entries
Solution (working note) (1/3) Particulars Year 1 Year 2 Year 3 Length of the expected vesting period (at the end of the year) Number of options expected to vest Total compensation expense Compensation expense for the year Compensation expense recognized previously Compensation expense to be recognized for the year 2 nd year 3 rd year 3 rd year 95,000 91,000 87,500 28,50,000 27,30,000 26,25,000 28,50,000*1/2 = 14,25,000 27,30,000*2/3 = 18,20,000 26,25,000 Nil 14,25,000 18,20,000 14,25,000 3,95,000 8,05,000
Solution (2/3) Date Particulars Debit Credit 31.3.2009 Employee stock option expenses account. Dr To ESOP outstanding account 14,25,000 14,25,000 (Being grant of 100 stock options each to 1000 employees at a discount of Rs 30 amortized on straight line basis over vesting years ) 31.3.2010 Employees stock option expenses account.. Dr To ESOP outstanding account (Being compensation expense recognized in respect of the ESOP) 31.3.2011 Employees compensation expenses account.. Dr To ESOP outstanding account (Being compensation expense recognized in respect of the ESOP) 395,000 805,000 395,000 805,000
Solution (3/3) Date Particulars Debit Credit 31.3.2012 Bank account.. Dr ESOP outstanding account.. Dr (26,25,000/87,500*85,000) To Equity Share Capital Account To Securities Premium Account 17,00,000 25,50,000 850,000 34,00,000 (Being 85,000 options exercised at an exercise price of Rs 50 each) ESOP outstanding account Dr To General Reserve account (Being balance in ESOP outstanding account transferred to general reserve account on lapse of 2500 options) 75,000 75,000
Equity shares with differential voting rights A differential voting right share is like an ordinary equity share, but it provides fewer voting rights to the shareholder. So, for instance, while a normal shareholder can vote as many times as the number of company shares he/she holds, someone who holds the company s differential voting rights shares will need to hold, say 100 differential voting rights shares to cast one vote. The number of differential voting rights shares required to be held will differ from one company to another. Every company limited by shares may issue shares with differential rights as to dividend, voting or otherwise Section 86 of the Companies Act permits the issue of equity shares with differential voting rights, subject to conditions prescribed under the Companies (Issue of Share Capital with Differential Voting Rights) Rules, 2002.
Equity shares with differential voting rights - Conditions 1 It has distributable profits in terms of section 205 of the Companies Act, 1956 for three financial years preceding the year in which it was decided to issue such shares. 2 The issue of such shares cannot exceed 25% of the total issued share capital of the company. 3 The company has not defaulted in filing its annual accounts and annual returns for the three (3) preceding financial years prior to the year in which shares with differential rights are to be issued; 4 The company has not failed to repay on due dates, deposits or interest on deposits, or failed to redeem its debentures or pay dividend thereon; 5 The company has not been convicted of any offence under the Securities and Exchange Board of India Act, 1992, Securities Contracts (Regulations) Act, 1956, and the Foreign Exchange Management Act, 1999
Lesson Summary Issue of ESOP by a Company would need to be recognized as an expense over the vesting period Corresponding credit is established in an intermediary equity account called ESOP outstanding account Upon issue of shares, balance in ESOP outstanding account would be transferred to share capital and securities premium account Expenses already recognized in respect of unutilized option would be written back to the profit and loss account/general reserve account A company can issue equity shares with differential voting rights
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