Accounting of stock options
Employee Stock Option Plans/Equity Incentive Plans (commonly referred to as ESOPs) have been in practice for a long time, and are being increasingly used as a compensation tool by both multi-national and Indian companies

WHY ESOPS

by PwC and the National Association of Stock Plan Professionals. who said that “for capitalism to survive. • Wealth creation for employees • Retention tool • Motivation through feeling of ownership • According to a recent survey.WHY ESOPS • ESOPs were the brainchild of a visionary economist named Louis Kelso. there needed to be more capitalists”. Global Equity Incentives. . the need to attract and retain talent made India Inc give 35% more equity grants in 2012 compared with 2011.

1961 SEBI guidelines are mandatory for listed companies. however. 1956 Foreign exchange management act 1999 SEBI guidelines. 1999 Income tax act. non listed companies also follow them voluntarily .Legal provisions relating to ESOPs • • • • • The companies Act.

foreign exchange .Important issues • Impact on company’s financials – shareholding dilution. accounting implications • Regulatory issues – company law. SEBI. tax implication on employer or employee.

employees can exercise the options to get shares. by paying the pre-determined exercise price . Upon vesting of options. requiring continued service over a specified period of time.TYPES OF STOCK OPTIONS • Employee Stock Option Scheme (ESOS) An ESOS is a right to buy shares at a pre-determined price. The option granted under the plan confers a right but not an obligation on the employee. Stock options are subject to vesting.

An employee can choose how much of his salary he wants to contribute by himself. The plan term determines the date and price at which the employee is entitled to purchase company stock In an ESPP plan.• Employee Stock Purchase Plan (ESPP) An ESPP allows employees to purchase company shares. The discount usually ranges upto 15%. However in general its the minimum of the prices in the start of the EPSS plan and at the end of the ESPP plan. stocks are purchased for him at some discounted price On what price the discount will be given depends on your company ESPP plan. an employee has to contribute a part of his salary in ESPP plan each month. It can range from 1% to 15% of his salary. . All the money which he contributes gets accumulated for few months and then in one go. often at a discount from FMV at grant or exercise.

• Stock Appreciation Right (SAR) / Phantom Equity Plan (PEP) Under SAR/PEP. appreciation in the price of underlying shares without any cash investment. the employees are allotted notional shares/ units at a predetermined price. the employee is paid cash equivalent of the net gain i. On completion of vesting conditions. These plans generally result in cash outflow for the company .e.

The employee is considered to be the owner of the shares from the date of award with entitlement to receive dividends and voting rights. The forfeiture conditions may be based on continued service over a specified period of time. an employee receives an award of stock subject to certain underlying conditions. . the shares are forfeited.• Restricted Stock Award (RSA) Under RSA. If the underlying conditions are not met. The employee may be required to pay for RSA at grant which may be at a discount or more usually is awarded the stock at no cost.

It will be all yours and you are free to keep them or sell them after that. The Company gives company Stock to an employee without any conditions. RSUs are generally entitled to quasi-dividends . So if a company gives you 100 RSU vesting in 2 yrs. however there is a vesting period involved. RSU’s are also a great way to reward the employees Until shares are actually delivered. That simply means that after 2 yrs. but a promise to give shares in the future.• • Restricted Stock Unit (RSU) RSU or Restricted Stocks units are very simple to understand. you will get 100 stocks of the company. the employee is not a shareholder and does not have voting rights or rights to receive dividends. It is important to note that RSU is not an immediate transfer of shares subject to forfeiture. before you can claim those shares. Vesting Period is the tenure for which you will have to wait.

They can include service conditions. which require the employee to complete a specified period of service and performance conditions which require specified performance targets to be met. Exercise date: date on which empolyee exercises the stock option Exercise period: it’s the time period after vesting within which the employee should exercise his right to apply for shares against the option vested in him in pursuance of the stock option plan • • . If that agreement is subject to an approval process grant date is date on which this approval is obtained Exercise price: price payable by the employee for exercising the option granted Vesting date: it’s the date when an employee becomes entitled to receive cash or shares on satisfaction of any specified vesting conditions Vesting period: it is the period between the grant date and the date on which all the specified vesting conditions of the stock option plan are to be satisfied Vesting conditions: these are the conditions that must be satisfied for the employee to become entitled to receive cash or shares of the entreprise pursuant to the plan.Key terms • • • • • Grant date: the date at which the enterprise and its employees agree to the terms of an employee share based payment plan.

• Intrinsic value: The amount by which the quoted market price of the underlying share in case of listed enterprise or value of underlying share determined by an independent valuer in case of unlisted enterprise exceeds the exercise price of the option on the grant date .

which were designed in accordance with prescribed ESOP Guidelines. They were generally taxed as a perquisite in the hands of the employees on the difference between the FMV of the stock on the date of vesting of the options and the exercise price. • Unqualified ESOPs were taxable as a perquisite on the difference between the FMV on the date of vesting/exercise and the exercise price. Till FY ending March 1999. During the period April 2007 to March 2009. there were no specific provisions for taxing the benefits arising from ESOPs. there was a concessional tax treatment for ESOPs. The taxation triggered only at the time of sale of the shares for such qualified ESOPs. • Subsequently. The employer was allowed to recover such FBT from the employees .Tax implication in india • Taxation of ESOPs in India has witnessed continuous change. employer was required to pay Fringe Benefit Tax (FBT) on benefit derived by employee from ESOPs.

the FMV shall be the closing price of the share on any recognised stock exchange on a date closest to the date of exercise of option and immediately preceding such date of exercise of option. if on the date of exercise of option there is no trading in shares. The perquisite value is computed as the difference between the FMV of the share on the date of exercise and the exercise price. The employer is required to withhold tax at source in respect of such Perquisite. ESOP benefits are taxable as perquisite and form part of employees salary income. • Unlisted companies need to determine the FMV by a Category I Merchant Banker registered with SEBI.• Currently. • Where shares in the company are listed on a single recognised stock exchange then FMV shall be the average of opening and closing price of shares on the date of exercise of option. Specified date means the date of exercise of option or any date earlier than the date of exercise of option. . not being a date which is more than 180 days earlier than the date of exercise of option. • There are specific valuation rules prescribed for listed and unlisted companies. However.

e. .• The incremental gain (i. The capital gains tax treatment further depends on the holding period and whether the shares are sold on a recognised stock exchange in India. difference between sale consideration and the FMV on the date of exercise). on sale of shares is considered a capital gain for the employee. Hence the deduction is allowable in the year in which the option is exercised by the employees i. when the liability became certain and not proportionately over the vesting period as claimed by the employee. • For computing capital gains.e. the FMV on the date of exercise becomes the cost base. • The deductor can claim deduction for the compensation (as well as other expenses) is from firm’s gross income to arrive at its taxable income.

he can pay Rs 100 a share and get the shares. suppose the company grants him 100 shares.• Let's see how an employee can gain from ESOPs. he need not exercise the option. he can sell the shares and make a neat profit. . if the market price is Rs 50. which is also the market price that day. He can instead wait for the stock price to rise. However. Let's assume that the vesting period is two years. at an exercise price of Rs 100 per share. On April 1 2010. If the market price on 1 August 2012 is Rs 200. At any point after 1 April 2012.

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Listed/ Gain Type Stocks listed on indian stock exchage Stock listed on foregin stock exchanbe Short term capital gain (less than 1 year) 15% tax on profits Profit will be treated as your tax slab Long term capital gain (more than 1 year) No tax 20% with indexation .

Hence the employers engaged in such arrangements with employees recognize the cost of services received over the requisite service period. had it been traded in the market. Fair value of an option means the market price of the option. . Intrinsic value means the excess of the fair value of the share at the date of grant of the option over the exercise price of the option. • The accounting value is determined by finding either fair value of the option or intrinsic value of the option.• Employers use share-based payments as a part of remuneration package for their employees.

• When we account for employee stock options. Share Premium or General Reserves. • Deferred employee compensation expense – This account is created at the time of grant of options for the total amount of compensation expense to be accounted. 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 transferred to Share Capital. . following new accounts come into existence: • Employee compensation expense account – It forms part of the compensation expense account and is taken in the profit and loss account. Amortized employee stock compensation expenses are taken in the Profit and loss account.

An explicit service condition is explicitly stated in the terms of share-based arrangements (e.. 2012). three years of continuous employee service from January 3. which is generally the service condition. and is revised during the requisite service period to reflect subsequent information.• • • • Calculation of Compensation Expense / Cost: The total compensation cost is the fair value of the instruments issued multiplied by the number of instruments that actually vest. This cost is recognized over the requisite service period with a corresponding credit to Employee Stock Options Outstanding account.g. The objective of accounting for transactions under share-based arrangements with employees is to recognize compensation costs related to employee services received in exchange for equity instruments issued. The requirement that an individual remain an employee for that period is a service condition. Employees earn the right to exercise the option after the completion of the vesting period. . Total compensation cost is also revised accordingly. The number of instruments expected to vest is estimated at the service inception date.

the accounting value of the shares so issued shall be treated as another form of employee compensation in the financial statements of the company.ESPP accounting • The details of the shares issued under the ESPP and the terms and conditions thereof shall be disclosed in the Directors’ report or in an annexure thereto. The accounting value of shares issued under ESPP shall be the excess of the fmv over the purchase price granted to the employee . • In respect of shares issued under an ESPP during any accounting period.

300 options are exercized on 30/6/2002 and 50 vested options lapse at the end of exercise period. • accounting value of the shares being the maximum of: • A)500 x [(160-40) = 60.Illustration • Suppose a company issues 500 shares on 1/4/1999 under an ESPP at Rs 40 when the market price is Rs 160 and the total employee compensation for the year 1999-2000 is Rs 900.000 .000. Also supposed that 150 unvested options lapse on 1/5/2001.

5 yrs) • 31/3/2001 Employee compensation expense Dr 24000 • deferred employee compensation expense 24000 • (amortization of def empl compensation exp over 2.Esop • 1/4/1999 Deferred empl compensation dr 60000 • to employee stock options outstanding 60000 • (Grant of options) • 31/3/2000 Employee compensation expense Dr 24000 • deferred employee compensation expense 24000 • (amortization of def empl compensation exp over 2.5 yrs) .

• 1/5/2001 employee stock option outstadning acct dr 18000 • to empl compensation expense 14400 • To deffered employee compensation exp 3600 • (reversal of compensation accounting on lapse of 150 unvested options) • 31/3/2002 employee compensation exp 8400 • to deferred empl compensation exp 8400 • • • • • 30/6/2002 cash 12000 Empl stock option outstanding 36000 to paid up equity capital 3000 To share premium 45000 (exercise of 300 options at rs 40 each. accoutning value rs 80 each) .

• 1/10/2002 employee stock option outstanding 6000 • To employee compensation expense 6000 .

Employee stock options outstanding account .

Deferred employee compensation expense .

• Employee Stock Options Outstanding will appear in the Balance Sheet as part of Net Worth or Shareholders' Equity . Deferred Employee Compensation will appear in the Balance Sheet as a negative item as part of Net Worth or Shareholders' Equity .

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