Employee Stock Option Plans (ESOPs) are not just compensation tools—they also have important accounting implications for companies. From an accounting perspective, ESOPs represent a non‑cash employee compensation expense that must be recognized over time in accordance with applicable accounting standards.
In India, ESOP accounting is governed mainly by Ind AS 102 – Share‑based Payment (and earlier by SEBI guidelines / Guidance Note for non‑Ind AS companies). This article explains how ESOP expenses are measured, recognized, and recorded in the books of accounts, step by step.
What Is ESOP Expense?
ESOP expense is the fair value of stock options granted to employees, recognized as an employee benefit expense over the vesting period.
Even though no immediate cash outflow occurs, the company incurs a cost by issuing equity instruments at a concessional price. Accounting standards require this cost to be reflected in the profit and loss statement.
Applicable Accounting Standards
1. Ind AS 102 – Share‑based Payment
Applicable to companies following Ind AS (mostly medium and large companies, listed entities).
2. Guidance Note on Accounting for Employee Share‑based Payments (ICAI)
Applicable to non‑Ind AS companies (SMEs, unlisted entities not following Ind AS).
Core principle under both frameworks: ESOPs are measured at fair value on the grant date and expensed over the vesting period.
Step‑by‑Step Accounting of ESOP Expense
Step 1: Identify the Grant Date
The grant date is the date on which:
- The company and employee agree to the ESOP terms, and
- The employee has a clear understanding of vesting conditions
Fair value is determined only once, on this date.
Step 2: Measure Fair Value of Options
ESOPs are measured at fair value of the option, not the share price.
Common Valuation Models Used:
- Black‑Scholes Model
- Binomial Model
These models consider factors such as:
- Market price of shares
- Exercise price
- Expected volatility
- Risk‑free interest rate
- Expected life of the option
- Dividend expectations
For unlisted companies, valuation is typically done by a registered valuer or merchant banker.
Step 3: Determine Total ESOP Compensation Cost
Total ESOP Expense = Fair value per option × Number of options expected to vest
The company must estimate employee attrition and revise the estimate at each reporting date.
Step 4: Allocate Expense Over Vesting Period
The total ESOP expense is recognized:
- On a straight‑line basis
- Over the vesting period (e.g., 4 years)
Each year, a portion of the expense is charged to the Profit & Loss Account.
Accounting Entries for ESOP Expense
During the Vesting Period
At the end of each accounting period:
Journal Entry:
- Employee Compensation Expense A/c
Dr - To ESOP Outstanding A/c (Equity)
This entry reflects the proportionate expense for the year.
On Exercise of Options
When employees exercise their options:
- Bank A/c
Dr (Exercise price received) - ESOP Outstanding A/c
Dr (Accumulated expense) - To Equity Share Capital A/c
- To Securities Premium A/c
This converts the ESOP outstanding balance into share capital and premium.
If Options Lapse or Are Forfeited
If employees leave before vesting:
- Previously recognized ESOP expense relating to unvested options is reversed
- Expense is adjusted prospectively based on revised vesting estimates
No expense is recognized for options that ultimately do not vest.
Impact on Financial Statements
Profit & Loss Statement
- ESOP expense reduces reported profits
- Classified under Employee Benefit Expenses
Balance Sheet
- ESOP Outstanding A/c shown under Equity (not liability)
Cash Flow Statement
- ESOP expense is a non‑cash item
- Added back under operating activities (indirect method)
Disclosure Requirements
Companies must disclose:
- Description of ESOP schemes
- Number of options granted, vested, exercised, lapsed
- Weighted average exercise prices
- Valuation methodology and assumptions
- Expense recognized during the year
These disclosures improve transparency for investors and stakeholders.
