Group wide Share based payment arrangements - Diversity in accounting practice under IGAAP

Background

In the current scenario, it is very common that corporates are having and coming up with employee stock options plans in order to retain and motivate the human capital of the organizations to achieve the target performance. Retaining and motivating the human capital of the company is quite imperative for an organization to be successful in the long run.

Large corporate groups have such an employee stock plan for the group, whereby employees of the Group Company are eligible for such a plan. These are called group-wide share-based payment arrangements.

Indian old financial reporting framework (IGAAP) does have much explicit accounting guidance for such transactions, hence the diversity of the accounting practice is in place.

This article aims to explain the diversity of the accounting practice in place for such group-wide share-based payment arrangements.

Description of the Plan:

Shareholders of the Parent entity approved the performance stock grant plan (the ' Plan' ). The plan provides for granting of the stock options to the employees of the Group (Group means Parent entity and its directly or indirectly controlled companies, herein referred to as the 'Group' ) in order to motivate them to reach the Group's goals and improve their loyalty towards the Group. As per the Plan, the parent entity granted stock options to certain employees of the Indian subsidiary entity.

Salient features of the Plan are outlined below:

1. Shares for the purpose of the Plan are ordinary shares of the parent entity listed on the stock exchange of the country where the parent entity is domiciled. The board of directors of the parent entity has identified eligible employees of the Group.

2. Vesting conditions: The vesting period is the period between the grant of rights and the grant of the shares. The vesting of rights and allotment of shares is subject to the beneficiary holder being an employee of any of the companies of the Group and shall not be serving notice period subsequent to on the date of grant of shares.

3. Exercise period and Exercise price: The exercise period is 3 years period between the date of the grant of shares. The Plan provides for the free assignment of rights that grant the free allocation of the shares of the parent entity. Hence, the exercise price is zero.

4. Inter-company recharge: Group has an arrangement stating that Parent Company shall charge the beneficiary Company an amount equal to the fair value of share assigned to the employee, as calculated at the date of granting the rights (i.e. grant date fair value).  Inter-company charge invoice will be raised within one month from the date employee exercises its right and payment shall be made within one month from the date of receipt of invoice.

Available accounting guidance:

Exposure Draft on Guidance Note on Accounting for Share-based payments (June 2020) (“GN 2020”) does not provide much guidance for accounting for group-wide share-based payment transactions. Therefore, the practice varied for accounting for the cost of any share-based payments granted by a parent to employees of a subsidiary or vice versa.  Such understanding is also called for attention in the GN 2020 and GN 2020 deals extensively with groupwide share-based payment transactions.

As per para 4 of the Guidance Note on Accounting for Share-based Payments (2005) ("GN 2005” or the “Guidance Note") , the scope covers the transactions where shares or stock options of the parent of a company or any other enterprise in the group are transferred to the employees of the company unless the purpose of payment is other than payment for services rendered to the company.

This implies that a transaction wherein a parent grants its own shares or stock options to the employees of subsidiaries is covered under the scope of the Guidance Note. Therefore, in the instant case where the parent entity has granted its right to shares to the employees of the Indian Subsidiary entity is covered by the Guidance Note. The Guidance Note shall be referred for the purpose of determining appropriate accounting treatment in the financial statements of the Company.

The issue under consideration:

What shall be the appropriate accounting treatment of the stock options granted by the parent entity to the employees of the subsidiary Indian Entity and the amount recharged by the parent entity to the Company in the financial statements of the Company under Indian GAAP?

Analysis:

Accounting for the grant of rights by Parent entity in the financial statements of the Indian Subsidiary Entity:

Applicability of the Guidance Note on Accounting for Share-based Payments (2005) (“GN 2005” or the “Guidance Note”)

As per para 4 of the Guidance Note, the scope covers the transactions where shares or stock options of the parent of a company or any other enterprise in the group are transferred to the employees of the company unless the purpose of payment is other than payment for services rendered to the company.

This implies that a transaction wherein a parent grants its own shares or stock options to the employees of subsidiaries is covered under the scope of the Guidance Note. Therefore, in the instant case where the parent entity has granted its right to shares to the employees of the Indian Subsidiary entity is covered by the Guidance Note. The Guidance Note shall be referred for the purpose of determining appropriate accounting treatment in the financial statements of the Company.

Accounting treatment of the share-based payment transaction in the financial statements of the Indian Subsidiary Entity:

The Guidance Note prescribes accounting to be followed by the company granting the shares or stock options to its employees. Further, while the Guidance Note covers the group share-based payment transactions, however, it does not prescribe any specific accounting for the beneficiary entity.

Applying this to the instant case, the Guidance Note does not prescribe any specific accounting to be followed by the Indian Subsidiary Company as the stock options are granted by the parent entity to the employees of the Indian Subsidiary entity. As a result of the lack of any specific accounting guidance, there is diversity in the practice of how different companies account for such transactions under Indian GAAP. Following two accounting approaches are widely followed and acceptable under Indian GAAP for accounting by the companies not granting share-based payment and receiving the benefit:

Approach 1 - apply the guidance prescribed in the Guidance Note for the entities granting the share-based payment

Under this approach, an enterprise should recognize as an expense the services received when it receives the services, with a corresponding credit to an appropriate equity account, say, 'Stock Options Outstanding Account'.

Approach 2 - no accounting of the share-based payment transaction in the books of the company receiving the benefit, accounting to be done only for management recharge as and when recharge invoice is received from the parent entity.

Accounting for inter-company recharge by Parent entity in the financial statements of the Indian Subsidiary Entity

Where a subsidiary is recharged by the parent for a share-based payment, the subsidiary must determine when a liability should be recorded for the amount that is expected to be recharged in the future (for example, when the award vests or the employees exercise their options).

Further, it is pertinent to note that the Guidance Note does not prescribe any specific accounting treatment for recharge between the group companies in scenarios of group share-based payment transactions. Therefore, in absence of any specific guidance, there is diversity in practice.

In the instant case, considering the right to receive shares will always be in the money as the exercise price is NIL and there is a clear link between the amount of recharge and the share-based payment charge, the following two approaches could be acceptable:

Approach 1 - The recharge liability shall not be accrued rather recognized when the right to receive shares vests. This is major because of the following reasons:

• As per AS 29 "Provisions, Contingent Liabilities and Contingent Assets", the Company does not have any present obligation as a result of past events until the right to receive shares vest. The right to receive cannot be exercised until they have vested and unless it is certain that the options will be exercised, the Company has no liability, and also, therefore, it is not probable that an outflow of economic resources will be required.

• However, once the options have vested, these are deeply in the money as the exercise price is zero. Consequently, employees will exercise the options which trigger the recharge to the Company. Therefore, it can be said that upon vesting of options, the Indian subsidiary has a present obligation as a result of past events (i.e. vesting of options) and settlement of which is expected to result in an outflow for the Indian Subsidiary. Also, the amount is measurable as of the vesting date as the amount to be recharged is the fair value of the option determined as on the grant date.

Approach 2 - The liability shall be accrued over the vesting period on the basis that the recharge payment arises from the share-based payment arrangement in which employees are providing services to the Indian Subsidiary.

Conclusion:

Accounting for the share-based payment transaction - There is no specific guidance in the Guidance Note for accounting by the companies not granting stock options and receiving services. This results in diversity in practice. The Company may either choose to account for the transaction following the guidelines prescribed for companies granting the shared based payment award or may choose not to account for the transaction in its financial statements.

Accounting for recharge - Similarly, there is no specific guidance in the Guidance Note for the accounting of recharges. This results in diversity in practice. As the options are deeply in the money once they have vested and there is a clear link between recharge and share-based payment charge, the Company may choose either to account for the inter-company recharge liability as of the date of vesting or over the vesting period.