Securities and Exchange Board of India issued ESOP guidelines in 1999. The idea behind this was to reward and motivate employees for their commitment and hard work. SEBI defines employee stock options as ¡§option given to the whole-time directors, officers or employees of a company which gives such Directors, officers or employees, the benefit or right to purchase or subscribe at a future date, the securities offered by the company at a predetermined price¡¨.
Before we go in the detail of ESOP accounting let us understand a few terms.
Vesting means the process by which the employee gets the right to apply for and be issued Shares of the company under the options granted to him.
Vesting period means the period over which the vesting of the options of the employee Takes place
Exercise period means the time period after vesting within which the employee should Exercise his right to buy the shares by payment of the option price on the options vested in Him. If the exercise period lapses the vested option lapses and no right shall accrue to the Employee thereafter
The act of exercise implies an application being made by the employee to the company to
Have the options vested in him issued as shares upon payment of the option price.
Exercise can take place as specified after vesting
The trust route is often adopted to route the ESOS scheme. It works like this: a company creates a trust for the employees and the trust receives its stock either by fresh allotment or by purchase from shareholders or the owner may sell shares of his holding to the trust. The trust obtains its finds through loans and allots shares to employees on exercise of their right in exchange for cash and repays its loans.
Applicability
These Guidelines applies to any company whose shares are listed on any stock exchange in
Accounting Policies
In respect of options granted during any Accounting period, the Accounting value of the options shall be treated as another form of employee compensation in the financial statements of the company. The Accounting value of options shall be equal to the maximum of:
a) The aggregate over all employee stock options granted during any Accounting period of the excess of the fair value of the option over the specified percentage of the market value of the share on the date of grant of the option; or
b) Excess of the aggregate of the option discounts on all employee stock options granted during any Accounting period over 20% of the total employee compensation as reported in the profit and loss account of that period.
c) Zero.
For this purpose:
1. Fair value means the option discount, or, if the company so chooses, the value of the option using the Black Scholes formula or other similar valuation method.
2. Option discount means the excess of the market price of the share at the time of grant of the option over the exercise price of the option (including up-front payment if any)
3. Specified percentage means 25% in case of options granted within 12 months of the effective date, 20% in case of options granted during the 13 to 24 months after the effective date, and 15% in case of options granted after 24 months of the effective date. Effective date is the date on which these guidelines come into effect.
Where the Accounting value is accounted for as employee compensation in accordance with the above stated , the amount should be amortized on a straight-line basis over the vesting period.
When an unvested employee stock option lapses by virtue of the employee not
conforming to the vesting conditions after the Accounting value of the option has already been accounted for as employee compensation, this Accounting treatment shall be reversed by a credit to employee compensation expense equal to the amortized portion of the Accounting value of the lapsed options and a credit to deferred employee compensation expense equal to the unamortized portion.
When a vested employee stock option lapses on expiry of the exercise period, after the Accounting value of the option has already been accounted for as employee compensation, this Accounting treatment shall be reversed by a credit to employee compensation expense.
The Accounting treatment prescribed above can be illustrated by the following numerical example. Suppose a company grants 500 options on 1/4/1999 at Rs 40 when
the market price is Rs 160, the vesting period is two and a half years, the maximum exercise period is one year and the total employee compensation for the year 1999-
2000 is Rs 900,000. Also supposed that 150 unvested options lapse on 1/5/2001, 300
options are exercised on 30/6/2002 and 50 vested options lapse at the end of the exercise period. The Accounting value of the option being the maximum of:
a) 500 x [(160-40) - 25% x 160] = 500 x [120 - 40] = 500 x 80 = 40,000
b) 500 x (160-40) - 10% x 900,000 = 60,000 - 90,000 = -30,000
c) Zero
would be equal to Rs 40,000.
The Accounting entries would be as follows:
1/4/1999 Deferred Employee Compensation Expense 40,000
Employee Stock Options Outstanding 40,000
(Grant of 500 options at an Accounting value of Rs 80 each)
31/3/2000 Employee Compensation Expense 16,000
Deferred Employee Compensation Expense 16,000
(Amortisation of the deferred compensation over two and a half years on straight-line basis)
31/3/2001 Employee Compensation Expense 16,000
Deferred Employee Compensation Expense 16,000
(Amortisation of the deferred compensation over two and a half years on straight-line basis)
1/5/2001 Employee Stock Options Outstanding 12,000
Employee Compensation Expense 9,600
Deferred Employee Compensation Expense 2,400
(Reversal of compensation Accounting on lapse of 150 unvested options)
31/3/2002 Employee Compensation Expense 5,600
Deferred Employee Compensation Expense 5,600
(Amortisation of the deferred compensation over two and a half years on straight-line basis)
30/6/2002 Cash 12,000
Employee Stock Options Outstanding 24,000
Paid Up Equity Capital 3,000
Share Premium Account 33,000
(Exercise of 300 options at an exercise price of Rs 40 each and an Accounting value of Rs 80 each)
1/10/2002 Employee Stock Options Outstanding 4,000
Employee Compensation Expense 4,000
(Reversal of compensation Accounting on lapse of 50 vested options at end of exercise period)
Employee stock option outstanding will appear in the Balance Sheet as part of net worth or share holder¡¦s equity. Deferred employee compensation will appear in the Balance Sheet as a negative item as part of net worth or share holders equity.
Disclosure in Directors¡¦ Report
The Board of Directors shall disclose either in the Directors Report or in the annexure to
the Director¡¦s Report, the following details of the Stock option plan:
a) The total number of shares covered by the Employee Stock Option scheme as
approved by the shareholders
b) The Pricing formula
c) Options granted
d) Options vested
e) Options exercised
f) Options forfeited
g) Extinguishment or modification of options
h) Money realised by exercise of options
i) Total number of options in force
j) Employee wise details of options granted to
i) Senior managerial personnel
ƒnƒnƒnƒnii) any other employee who receives a grant in any one year of options amounting to 5% or more of options granted during that year.
k) Diluted Earnings Per Share (EPS) calculated in accordance with International Accounting Standard (IAS)
In today¡¦s world ESOPs have been increasingly used as a motivating weapon by the management to retain its most efficient employees. Employees of blue chip companies like Infosys, Wipro, ITC and others become millionaires overnight. But the tool meant for rewarding employees commitment is being misused by few senior managers to serve their self-interest by manipulating the market price. Some investors are unhappy with the scheme as it dilutes their level of participation in company¡¦s affairs. Also the very purpose of ESOPs will get defeated if the employees sell their shares in the market. The scheme also has an uncertainty hidden due to the fluctuating stock prices. Despite the disadvantages ESOP¡¦s is still a popular tool to attract and retain the best talent and hence the management must draw a scheme suiting the employees¡¦ expectations and must study the dynamic changes in stock market to ensure its success.
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