Stock Options - Measurement, Accounting & Disclosure

A. Stock Options

Stock Options are getting more prevalent as part of compensation package in many entities in India especially MNCs that are listed on Stock Exchanges in India and abroad, either directly or through the stock of its holding Company. This approach of packaging employee remuneration is also now prevalent in unlisted companies by linking the remuneration to the performance of the Company.

Companies that do not want part cash, opt for Stock Options schemes wherein they issue equity shares. Some entities do not issue equity shares but instead allot Stock Appreciation Rights (SARs). Under this model, the entity remunerates the employee by settling the difference between exercise price and market value on the date of exercise, in cash. SARs model is adopted mostly by unlisted companies because if the shares are issues, the same may not be liquid enough for the employee to realise his remuneration.    

There are a few terms that are used in measurement, accounting & disclosure of stock options,   which are as follows:

Grant date: It is the date at which the enterprise and its employees agree to the terms of an employee share-based payment plan. If that agreement is subject to an approval process, (for example, by shareholders), grant date is the date when that approval is obtained.

Exercise price: it is the price payable by the employee for exercising the option granted to him / her.

Vesting date: It is 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 enterprise, pursuant to the plan. Vesting conditions 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 (such as a specified increase in the enterprise’s share price over a specified period of time).

Exercise date: Date on which the employee exercises the Stock option.

Exercise period: It is 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.

Intrinsic Value: It is the amount by which the quoted market price of the underlying share in case of a listed enterprise or the value of the underlying share determined by an independent valuer in case of an unlisted enterprise, exceeds the exercise price of an option at the grant date.

Expected life of an option: It is the period of time from grant date, to the date on which an option is expected to be exercised.

B. Operation of Schemes:

SARs are to be settled by the Company without issuing equity shares. This scheme is issued for entities that are not listed on any stock exchanges and hence not easily tradable.

Similarly, ESOS is issued for all listed entities. The schemes are many times administered by a Trust and the benefit to the employees in this scheme will be passed on by issuing additional equity shares. There is no cash obligation to the company, though the employees can ask for Cash less option wherein the Trust will sell the vested shares to the individual in open market and settle the difference with him in cash.  Cash less exercise option will follow accounting as per accounting requirements of Equity settled scheme. This is because the entity issues the shares to the trust, but employee settles the transaction net with the trust.

C. Governing frame works

1. Indian GAAP

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, on the other hand, have an option to follow the SEBI guidelines or the guidance note on ‘Employee Share Based payments’ issued by the Institute of Chartered Accountants of India.

2. IFRS 2 and Ind AS 102

The accounting of such incentives is prescribed under IFRS 2 – Share Based Payments and the sane is adopted by Indian GAAP in its proposed draft of Ind AS 102 – Share Based payments.

Under IFRS 2, fair value approach is mandatory except in rare cases where an entity is unable to estimate reliably the fair value of the equity instruments granted at the measurement date, in which case intrinsic value method should be adopted.

The key differences under the existing accounting frameworks are as follows:

D. Accounting approaches

1.Intrinsic Value

As per Intrinsic value method, the difference between the exercise value and the market price as on the date of grant of option will be accounted as expenses over the vesting period.

In the existing case, the exercise price and market price at the Grant date are same and hence there is no expense to be recognized under this approach.

At the actual settlement date, the Company will account for issuance of equity shares and debit bank account with the exercise value.

There will be no mark to market under this approach.

2.Fair value approach

Fair value is defined as the amount for which stock options granted or a share offered to be purchased can be exchanged between knowledgeable, willing parties in an arm’s length transaction. The compensation cost arrived at using such ‘fair value’ is known as fair value compensation cost.

Under the Guidance note, for unlisted entities, valuation by an independent valuer is mandatory however under IFRS there is no such requirement.

Para 10 of IFRS 2 – share based payment.

“For equity-settled share-based payment transactions, the entity shall measure the goods or services received, and the corresponding increase in equity, directly, at the fair value of the goods or services received, unless that fair value cannot be estimated reliably.  If the entity cannot estimate reliably the fair value of the goods or services received, the entity shall measure their value, and the corresponding increase in equity, indirectly, by reference to the fair value of the equity instruments granted.”

i. Cash Settled

The entity should measure the services received and the liability incurred at the fair value of the liability.

The entity should re-measure the fair value of the liability at each reporting date and at the date of the settlement, with any changes in fair value recognized in profit or loss for the period.

The liability should be measured, initially and at each reporting date until settled, at the fair value of the stock appreciation rights, by applying an option pricing model taking into account the terms and conditions on which the stock appreciation rights were granted, and the extent to which the employees have rendered service to date

ii. Equity Settled

The entity should measure the fair value of the employee services received by reference to the fair value of the shares or stock options granted.

An entity should measure the fair value of shares or stock options granted at the grant date, based on market prices if available, taking into account the terms and conditions upon which those shares or stock options were granted. Such fair value at initial date is not remeased at any subsequent date and is expensed over the vesting period.

If market prices are not available, the enterprise should estimate the fair value of the instruments granted using a valuation technique. It should be consistent with generally accepted valuation methodologies for pricing financial instruments and should incorporate all factors and assumptions that knowledgeable, willing market participants would consider in setting the price. The common models used by entities include Binomial, Monte Carlo and Black Scholes model.

E. New Accounts Involved

Accounting for ESOS, required following new accounts as per SEBI guidelines

i. Employee compensation expense account – This account forms part of the compensation expense account and is taken in the Profit and loss account

ii. 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.

iii. 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.

For accounting under IFRS, only 1^st and 3^rd account is required.

F.ESOS administered through Trust

If the ESOS is administered through a trust route, the accounts are to be prepared as if the company itself is administering the ESOP. Hence all the aforementioned accounts will then be prepared in the books of the company and not the trust set up for the purpose.

The Guidance note also states that for consolidation of accounts under AS 21, this trust should not be considered since consolidation is done for only those entities which provide economic benefits. Trust being set up with the sole objective of administering the ESOP does not fall in this category.

However, under IFRS, SIC 12 requires such trusts to be consolidated with the entity.

G. Disclosures

The SEBI Guidelines, the Guidance note and IFRS 2, specify disclosures in respect of ESOPs.

The listed entities will have to follow SEBI guidelines, though they can also follow the Guidance note over and above the SEBI guidelines. The unlisted entities have an option to follow any guidelines.

The SEBI guidelines require a disclosure in the Director’s report consisting of the following items:

i. options granted;

ii.the pricing formula used;

iii. options vested, exercised and lapsed

iv. total number of shares arising on exercise of options and money realized thereon

v. total number of options in force

vi. variation of the terms of options if any

vii. options granted to senior managerial personnel

viii. employee receiving more than 5% of the options granted in the particular year

ix. employees who were granted more than 1% of the total issued capital of the company

x. diluted EPS

xi. the method of accounting used and if the company uses intrinsic value accounting then the difference between the cost computed using intrinsic value and that which had been recognized if the company had used fair value. The impact of this difference on the profits and EPS also needs to be disclosed

xii. Weighted average exercise prices and weighted average fair values

xiii. A description of the assumptions and inputs used during the year for arriving at the fair values of the options

Refer the file with example on /share_files/esop-accounting-example-48806.asp

CA Sanjay Chauhan