Accounting Standards
The Guidance Note allows either the fair value method or the
intrinsic method to account for employee share-based payments. The manner in
which the Guidance Note is drafted is based on the fair valuation principle
(more or less on the basis of IFRS). The intrinsic method is inadequately
covered by a sweeping paragraph (see below), without thought to the unintended
consequences that it may cause.
“Accounting for employee share-based payment plans dealt with
heretobefore is based on the fair value method. There is another method known as
the ‘Intrinsic Value Method’ for valuation of employee share-based payment
plans. Intrinsic value, in the case of a listed company, is the amount by which
the quoted market price of the underlying share exceeds the exercise price of an
option. For example, an option with an exercise price of Rs.100 on an equity
share whose current quoted market price is Rs.125, has an intrinsic value of
Rs.25 per share on the date of its valuation. If the quoted market price is not
available on the grant date, then the share price nearest to that date is taken.
In the case of a non-listed company, since the shares are not quoted on a stock
exchange, value of its shares is determined on the basis of a valuation report
from an independent valuer. For accounting for employee share-based payment
plans, the intrinsic value may be used, mutatis mutandis, in place of the
fair value.” (paragraph 40 of the Guidance Note)
When the above oversimplified paragraph is applied in the
context of some aspects of ESOP, it could result in certain unexpected results.
Let’s explain this with the help of a small example where a share settlement is
changed to cash settlement on vesting.
Now, let’s say one ESOP is granted that will vest at the end
of 3 years at an exercise price of Rs.90. At the date of grant the fair value of
the share is also Rs.90. The value of the option is estimated to be Rs.30. In
this example, if the fair value model is applied, Rs.10 will be charged in each
of the next three years. If the intrinsic model is applied, there will be no
charge.
So far so good, but now things will get a little complicated
as we move from a share-settled ESOP scheme to a cash-settled ESOP scheme. As
per the Guidance Note, “if an enterprise settles in cash, vested shares or stock
options, the payment made to the employee should be accounted for as a deduction
from the relevant equity account (e.g., Stock Options Outstanding
Account) except to the extent that the payment exceeds the fair value of the
shares or stock options, measured at the settlement date. Any such excess
should be recognised as an expense.” (paragraph 28 of the Guidance Note)
Assume in the above example, the share price is Rs.150 at
vesting date (end of the third year). The Company collects exercise price Rs.90
from the employee and pays Rs.150 (cash settlement). As already discussed above,
for accounting of employee share-based payment plans, the intrinsic value may be
used, mutatis mutandis, in place of the fair value. The requirement of
the Guidance Note will be changed as follows (if intrinsic rather than fair
value method is used) : “if an enterprise settles in cash, vested shares or
stock options, the payment made to the employee should be accounted for as a
deduction from the relevant equity account (e.g., Stock Options
Outstanding Account) except to the extent that the payment exceeds the intrinsic
value of the shares or stock options, measured at the settlement date.
Any such excess should be recognised as an expense.”
The payment of Rs.150 does not exceed the intrinsic value of
the shares at the settlement date, i.e. Rs.150. Hence the strange
conclusion is that there is no excess which needs to be recognised as an
expense.
This is strange because had the ESOP been a cash-settled
employee share-based payment plan from inception, the Company would have
charged Rs.60 as per the Guidance Note over 3 years of the scheme (see Appendix
IV of the Guidance Note). However, it appears that if a company has a
share-based plan to start with, but is then eventually settled in cash, no
charge is required in the profit and loss account.
The above dichotomy has arisen primarily because of an
unintended interplay between paragraph 28 and paragraph 40 of the Guidance Note,
which was predominantly written to provide guidance on fair value accounting of
ESOP, with the intrinsic method being inadequately addressed by a sweeping
paragraph (paragraph 40), which has caused a GAP in GAAP.
This issue needs to be immediately addressed by the Institute of Chartered
Accountants of India.
