EMPLOYEES STOCK OPTION SCHEME (ESOS)
According to Section 2(15A) of the Companies (Amendment) Act 2000 “employees 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 benefit or right to purchase or subscribe at a future date, the securities offered by the company at a pre-determined price:
Securities and Exchange Board of India (SEBI) has issued guidelines for accounting of employees stock option. These guidelines are effective from 19.6.1999. Some of the significant terms and other provisions as per guidelines are:
- “Share” means equity shares and securities convertible into equity shares and shall include American Depository Receipts (ADRs). Global Depository Receipts (GDRs) or other depository receipts representing underlying equity shares or securities convertible into equity shares.
- “Option” means a right but not an obligation granted to an employee in pursuance of ESOS to apply for shares of the company at a pre-determined price.
- “Grant” means issue of option to employee under ESOS.
- “Vesting” means 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 ESOS.
- “Vesting period” means the period during which the vesting of the option granted to the employee in pursuance of ESOS takes place.
- “Exercise” means making of an application by the employee to the company for issue of share against option vested in him in pursuance of the ESOS.
- “Exercise Period” means 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 ESOS.
- “Exercise price” means the price payable by the employee for exercising the option granted to him in pursuance of ESOS.
- “Market Price” of a share on a given date means the closing price of the shares on that date on the stock exchange on which the shares of the company are listed.
- “Independent director” means a director of the company, not being a whole time director and who is neither a promoter nor belongs to the promoter group.
Explanation: If the shares are listed on more than one stock exchange, but quoted only on one stock exchange on the give date, then the price on that stock exchange should be considered. If the price is quoted on more than one stock exchange, then the stock exchange where there is highest trading volume on that date should be considered. If share price is not quoted on the given date, then the share price on the next trading day should be considered.
Eligibility to participate in ESOS
- An employee shall be eligible to participate in ESOS of the company.
- An employee who is a promoter or belongs to the promoter group shall not be eligible to participate in the ESOS.
- A director who either by himself or through his relative or through any body corporate, directly or indirectly holds more than 10% of the outstanding equity shares of the company shall not be eligible to participate in the ESOS.
Shareholder approval: No ESOS can be offered to employees of a company unless the shareholders of the company approve ESOS by passing a special resolution in the general meeting.
Pricing: The companies granting option to its employees pursuant to ESOS will have the freedom to determine the exercise price subject to conforming to the accounting policies.
Lock-in period and rights of the option-holder
- There shall be a minimum period of one year between the grant of options and vesting of option.
- The company shall have the freedom to specify the lock-in period for the shares issued pursuant to exercise of option.
- The employee shall not have right to receive an dividend or to vote or in any manner enjoy the benefits of a shareholder in respect of option granted to him, till shares are issued on exercise of option.
Non-transferability of option: Option granted to an employee shall not be transferable to any person.
Disclosure in the Directors Report: The Board of Directors, shall, inter alia, disclose either in the Directors Report or in the annexure to the Director Report, the following details of the ESOS.
- Options granted
- The pricing formula
- Options vested
- The total number of shares arising as a result of exercise of option
- Options lapsed
- Variation of terms of options
- Money realized by exercise of option
- Total number of option in force
- Employee-wise details of options granted to
- senior managerial personal;
- any other employee who were granted option, during one year of option amounting to 5% or more of option granted during that year;
- identified employees who were granted option, during any one year, equal to or exceeding 1% of the issued capital (excluding outstanding warrants and conversions) of the company at the time of grant;
- Diluted Earnings Per Rule (EPS) pursuant to issue of shares on exercise of option.
Accounting Policies for ESOS
- 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 aggregate, over all employee stock options granted during the accounting period, of the fair value of the option.
- Fair value means the option discount, or, if the company so choose, the value of the option using the Black Scholes formula or other similar valuation method.
- Option discount means the excess of the market price of the share at the date of grant of the option under ESOS over the exercise price of the option (including up-front payment, if any).
- Where the accounting value is accounted for as employee compensation in accordance with ‘b’, the amount shall be amortised on a straight-line basis over the vesting period.
- When an invested 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 option lapses on expiry of the exercise period, after the fair value of the option has already been accounted for as employee compensation, this accounting treatment shall be reversed by a credit to employee compensation expenses.
Raman Ltd. granted 1000 options on April 01, 2014 at Rs. 40 (nominal value Rs. 10 each) when the market price was Rs. 120, and the vesting period was 2.5 years. The maximum exercise period was one year. On Oct 1, 2016, 200 unvested options lapsed and 600 options were exercised. On 30th Oct, 2017 remaining 200 options lapsed at the end of exercise period.
Pass necessary journal entries.
|
Date
|
Particulars
|
Amount (Rs.)
|
Amount (Rs.)
|
|
2014 April 1
|
Deferred Employee Compensation Expense A/c Dr. To Employee Stock Options Outstanding A/c
(Being grant of 1,000 options at a discount of Rs. 80, i.e., Rs. 120 - Rs.40)
|
80,000
|
80,000
|
|
2015 March 31
|
Employee Compensation Expense A/c Dr
. To Deferred Employee Compensation Expense A/c (Being amortization of Deferred Compensation, i.e., Rs. 80,000 / 2.5)
|
32,000
|
32,000
|
|
2016 March 31
|
Employee Compensation Expense A/c Dr.
To Deferred Employee Compensation Expense A/c (Being amortization of Deferred Compensation, i.e., Rs. 80,000 / 2.5)
|
32,000
|
32,000
|
|
2016 Oct 1
|
Employee Stock Options Outstanding A/c Dr.
To Employee Compensation Expense A/c [(200 * Rs.80) * 2/2.5]
To Deferred Employee Compensation Expense A/c [(200 * Rs.80) * 0.5/2.5] (Being reversal of compensation accounting on lapse of 200 unvested options
|
16,000
|
12,800
3,200
|
|
2016 Oct 1
|
Employee Compensation Expense A/c Dr.
To Deferred Employee Compensation Expense A/c (Being amortization of Deferred Compensation) (800*80*0.5/2.5)
|
12,800
|
12,800
|
|
2016 Oct 1
|
Bank A/c Dr. (600 *40)
Employee Stock Options Outstanding A/c Dr.
[Rs. 600 * (Rs. 120 - Rs. 40)]
To Equity Share Capital A/c (600 * 10)
To Securities Premium A/c [Rs.600 *(Rs. 120 - Rs. 10)]
(Being excise of 600 options at an excise price of Rs. 20 each and an accounting value of Rs. 60 each )
|
24,000
48,000
|
6,000
66,000
|
|
2017 Oct. 30
|
Employee Stock Options Outstanding A/c Dr.
To Employee Compensation Expense A/c (Being reversal of compensation accounting on lapse of 200 vested options at the end of the excise period i.e., Rs.200 * 80 )
|
16,000
|
16,000
|
Employee Stock Options
There are two methods of accounting for Employee Share Based Payments viz, intrinsic value method or fair value method.
”intrinsic value” means the excess of the market price of the share under ESOS over the exercise price of the option (including up-front payment, if any).
“market price" means the latest available closing price, prior to the date of the meeting of the Board of Directors in which options are granted/ shares are issued, on the stock exchange on which the shares of the company are listed. If the shares are listed on more than one stock exchange, then the stock
“employee stock option scheme (ESOS)” means a scheme under which a company grants employee stock option.]
"employee stock purchase scheme (ESPS)" means a scheme under which the company offers shares to employees as part of a public issue or otherwise.
Graded Vesting
Graded vesting refers to a situation where options under a plan vest on different dates. For example, a plan may provide that shares offered to an employee shall vest in proportion of 2:3:5 in three years commencing from fourth year. Thus if an employee is offered 100 shares under the plan, 20 shares shall vest in year 4, 30 shares shall vest in year 5 and 50 shares shall vest in year 6. In these cases, based on vesting dates, the plan is segregated in into different groups. Each of these groups is then treated as a separate plan with specific vesting period and expected life.
As an alternative to the accounting treatment specified above, in case the options/shares are granted under graded vesting plan with only service conditions, an enterprise has an option to recognise the share based
compensation cost on a straight-line basis over the requisite service period for the entire award (i.e., over the requisite service period of the last separately vesting portion of the award). However, the amount of compensation cost recognised at any date must at least equal the portion of the grant-date value of the award that is vested at that date.
ISSUE OF SWEAT EQUITY SHARES
Sweat equity shares refer to equity shares which are given to the company’s employees on favourable terms, in recognition of their work. Sweat equity shares are one of the modes of making share-based payments to employees. Sweat equity shares rewards the beneficiaries by giving them incentives in lieu of their contribution towards development of the company. Further, sweat equity shares facilitate greater employee stakes as well as interest in company’s growth and encourages employees to add more value towards the company.
Sweat Equity Shares: As per Section 2(88) of the Companies Act, 2013 “sweat equity shares” means such equity shares as are issued by a company to its directors or employees at a discount or for consideration, other than cash, for providing their know-how or making available rights in the nature of intellectual property rights or value additions, by whatever name called;
For the purposes of above
(i) the expressions ‘‘Employee’’ means
(a) a permanent employee of the company who has been working in India or outside India; or
(b) a director of the company, whether a whole time director or not; or
(c) an employee or a director as defined in sub-clauses (a) or (b) above of a subsidiary, in India or outside India, or of a holding company of the company;
(ii) the expression ‘Value additions’ means actual or anticipated economic benefits derived or to be derived by the company from an expert or a professional for providing know-how or making available rights in the nature of intellectual property rights, by such person to whom sweat equity is being issued for which the consideration is not paid or included in the normal remuneration payable under the contract of employment, in the case of an employee.
Accounting treatment of sweat equity share issued
(1) Where sweat equity shares are issued for a non-cash consideration on the basis of a valuation report in respect thereof obtained from the registered valuer, such non-cash consideration shall be treated in the following manner in the books of account of the company
(a) where the non-cash consideration takes the form of a depreciable or amortizable asset, it shall be carried to the balance sheet of the company in accordance with the accounting standards; or
(b) where clause (a) is not applicable, it shall be expensed as provided in the accounting standards.
(2) The amount of sweat equity shares issued shall be treated as part of managerial remuneration for the purposes of sections 197 and 198 of the Act, if the following conditions are fulfilled, namely. (i) the sweat equity shares are issued to any director or manager; and (ii) they are issued for consideration other than cash, which does not take the form of an asset which can be carried to the balance sheet of the company in accordance with the applicable accounting standards.
(3) In respect of sweat equity shares issued during an accounting period, the accounting value of sweat equity shares shall be treated as a form of compensation to the employee or the director in the financial statements of the company, if the sweat equity shares are not issued as pursuant to the acquisition of an asset.
(4) If the shares are issued as pursuant to the acquisition of an asset, the value of the asset, as determined by the valuation report, shall be carried in the balance sheet as per the Accounting Standards, and such amount of the accounting value of the sweat equity shares that is in excess of the value of the asset acquired, as per the valuation report, shall be treated as a form of compensation to the employee or the director in the financial statements of the company.
Phantom Shares: Under this plan the managers are allotted shares (notional shares) for book keeping purpose only: At the end of the. specified period the manager receives an award equal to appreciation in the market value of the shares since allotment. This award may be in cash, in shares or a mix of both. The main advantage of this plan over the stock option plan is that it involves no transaction cost, there is no risk of decrease in market price of shares, purchased (during lock in period) and interest cost associated with holding the stock is absent.
Stock Appreciation Rights: Under this plan the manager is entitled to receive cash payment based or share based payment on the increase in value of the stock from the time of award until a specified future date.
The stock appreciation rights and phantom shares are a form of deferred cash bonus in which the amount of bonus is a function of the market Price of the 'company's share and both of these plans involve uncertainty regarding the amount of bonus.
Performance Shares: Under this plan the managers are awarded a specified number of shares when specific long term goals have been met.: Usually the goal is to achieve a specific increase in earning per share spanned over a period of three to five years. The merit of this plan is that the award is based on performance measures that can be at least partially controlled by the manager concerned. One of the drawback of this plan is that the bonus is based on performance measured by accounting measures which may not always bring out the true economic worth of the firm.
Performance units; In performance unit plan a cash bonus is paid on achieving specific long term targets. This plan is a combination of Stock Appreciation Rights and Performance shares. This type of plans are used by companies either in case , when they are, not listed on stock exchanges or if listed the trading is very thin. The success of this plan largely depends on how well the long term targets have been established.
Restricted Stock Unit (RSU)?
A restricted stock unit (RSU) is a form of compensation given by an employer to an employee in the form of company shares. Restricted stock units are issued to an employee through a vesting plan and distribution schedule after achieving required required performance levels or upon being with their employer for a particular time tenure.
RSUs give an employee interest in company stock but they have no tangible value until vesting is complete. The restricted stock units are assigned a fair market value when they vest. Upon vesting, they are considered income, and a portion of the shares is withheld to pay income taxes. The employee receives the remaining shares and can sell them at his or her discretion.
Stock options or warrants may expire without any underlying value while Restricted Stock Units have a value.
Issuance and working of RSU’s is regulated by SEBI
ESOPS can be implemented through the following modes-
• Direct Route
• Trust Route
For ESOPs, there are basically 2 types of Valuations:
Accounting Valuation: This Valuation is required for calculating Employee Compensation Cost during the vesting period.
Accounting valuation can be performed by any valuer
Perquisite Valuation: This Valuation would be conducted only in case of unlisted Companies, at the time of Exercise of Options by the Employee to know the value of the perquisite in employee’s hands.
Perquisite valuation is performed by Merchant Banker