Accounting for · PDF fileAccounting for ESOP IPCC Paper 5: Advanced Accounting Chapter 4 CA....
Transcript of Accounting for · PDF fileAccounting for ESOP IPCC Paper 5: Advanced Accounting Chapter 4 CA....
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• Understand the accounting treatment for ESOP
3• Understand the provisions of Guidance Note of the ICAI on ESOP
4• 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 pre‐determined price.
Important TerminologiesIt 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
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.
When we account for employee stock options, following new accounts come into existence (as per SEBI guidelines):
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 1st 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 16th 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…. DrTo ESOP outstanding account
(Being grant of 10,000 stock options to employees at Rs 40 when the market price is Rs 130)
9,00,0009,00,000
16 Dec 2011 to 15 Mar 12
Bank account …. DrESOP outstanding account …. DrTo Equity Share Capital AccountTo Securities Premium Account
(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)
3,80,0008,55,000
95,00011,40,000
Solution (2/2)
Date Particulars Debit Credit
Mar 16, 2012
ESOP outstanding account… DrTo employee compensation expense account
(Being entry for lapse of stock options for 500 shares)
45,00045,000
Mar 31 Profit and loss account …. DrTo employee compensation expense account
(Being transfer of employee compensation expense to Profit and loss account)
8,55,0008,55,000
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…. DrTo 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 )
48,00048,000
31.3.2008 Profit and loss account …. DrTo employee compensation expense account
(Being expenses transferred to P/L account at the year end)
48,00048,000
31.3.2009 Employee compensation expense account…. DrTo 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 )
48,00048,000
Solution (2/4)
Date Particulars Debit Credit
31.3.2009 Profit and loss account …. DrTo employee compensation expense account
(Being expenses transferred to P/L account at the year end)
48,00048,000
31.3.2010 ESOP outstanding account.. DrTo General Reserve account
( Being excess of employees compensation transferred to general reserve account)
12,00012,000
Solution (3/4)
Date Particulars Debit Credit
30.6.2010 Bank account (600 * Rs 40) … DrESOP outstanding account .. DrTo Equity Share Capital AccountTo Securities Premium Account
(Being 600 employee stock options exercised)
24,00072,000
6,00090,000
1.10.2010 ESOP outstanding account.. DrTo General Reserve account
( Being excess of employees compensation transferred to general reserve account on lapse of 100 options)
12,00012,000
Solution (Working note) (4/4)
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
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.
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)
2nd year 3rd year 3rd year
Number of options expected to vest
95,000 91,000 87,500
Total compensation expense
28,50,000 27,30,000 26,25,000
Compensation expense for the year
28,50,000*1/2 = 14,25,000
27,30,000*2/3= 18,20,000
26,25,000
Compensation expense recognized previously
Nil 14,25,000 18,20,000
Compensation expense to be recognized for the year
14,25,000 3,95,000 8,05,000
Solution (2/3)
Date Particulars Debit Credit
31.3.2009 Employee stock option expenses account…. DrTo ESOP outstanding account
(Being grant of 100 stock options each to 1000 employees at a discount of Rs 30 amortized on straight line basis over vesting years )
14,25,00014,25,000
31.3.2010 Employees stock option expenses account .. DrTo ESOP outstanding account
(Being compensation expense recognized in respect of the ESOP)
395,000395,000
31.3.2011 Employees compensation expenses account.. DrTo ESOP outstanding account
(Being compensation expense recognized in respect of the ESOP)
805,000805,000
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 AccountTo Securities Premium Account
(Being 85,000 options exercised at an exercise price of Rs 50 each)
17,00,00025,50,000
850,00034,00,000
ESOP outstanding account … DrTo General Reserve account
(Being balance in ESOP outstanding account transferred to general reserve account on lapse of 2500 options)
75,00075,000
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
Thank You
CA Shruthi BNBangalore