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January 2013

GAP in GAAP ESOP issued by parent to the employees of unlisted subsidiary

By Dolphy D’Souza, Chartered Accountant
Reading Time 5 mins
The accounting for employee share-based payments is determined by two authoritative pronouncements, namely, SEBI’s Employee Stock Option Scheme and Employee Stock Purchase Scheme Guidelines, 1999, and ICAI’s guidance note on Employee Share-based Payments. Clause 3 of the SEBI’s guidelines states as follows: “these Guidelines shall apply to any company whose shares are listed on any recognised stock exchange in India.” Unlike SEBI guidelines, ICAI’s guidance note applies to all reporting entities whether listed or unlisted.

Consider a scenario, where a parent company issues ESOP’s to employees of its subsidiary. The question is who records the ESOP cost; the parent, the subsidiary or no one. As per the SEBI guidelines (which are applicable to all listed entities) the parent recognises the ESOP compensation cost because under the SEBI guidelines, an employee of a subsidiary is treated as an employee of the parent company for this purpose. Thus, if the parent of a listed subsidiary issues ESOPs to the subsidiaries employees, the listed subsidiary should not recognise the ESOP expense. As per the SEBI guidelines, the parent company is required to record the compensation cost. Typically, the requirement with respect to the parent recognising the ESOP compensation cost can be enforced only when the parent itself is a listed entity in India within the jurisdiction of SEBI. However, it cannot be enforced when the parent is in a foreign jurisdiction or is in India but is an unlisted entity.

In contrast to the SEBI guidelines, the ICAI guidance note provides as follows:

“10. An enterprise should recognise as an expense (except where service received qualifies to be included as a part of the cost of an asset) 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’. This account is transitional in nature as it gets ultimately transferred to another equity account such as share capital, securities premium account and/or general reserve as recommended in the subsequent paragraphs of this Guidance Note.

The underlying principle of the ICAI guidance note is that the ESOP related compensation costs should be accounted for as expense in the books of the enterprise whose employees receive the ESOP’s.

Further, paragraph 4 of the ICAI’s guidance note states as below:

“For the purposes of this Guidance Note, a transfer of shares or stock options of an enterprise by its shareholders to its employees is also an employee share-based payment, unless the transfer is clearly for a purpose other than payment for services rendered to the enterprise. This also applies to transfers of shares or stock options of the parent of the enterprise, or shares or stock options of another enterprise in the same group as the enterprise, to the employees of the enterprise”.

It can be inferred from the basic principle discussed in paragraphs above, that the ICAI guidance note requires a subsidiary company to recognise share based options granted by the parent company to its employees, even if the subsidiary does not have to settle the cost by making a payment to the parent. This position is consistent with the requirements of International Financial Reporting Standards (IFRS). Under IFRS,the recipient of services will record the cost of those services or benefits.

What is the issue?

In India, legislation prevails over the requirements of the accounting standards and other accounting promulgations such as the guidance notes issued by ICAI. Thus, SEBI guidelines would prevail over the ICAI guidance notes. Therefore, a listed subsidiary will not record ESOP costs, if the ESOPs were issued by the parent company to the employees of the subsidiary company.

Now, in the above example, what happens if the subsidiary is not a listed company in India. In such a case, SEBI guidelines are not applicable to unlisted companies but ICAI guidance note would certainly apply. When the ESOPs are issued by the parent company to the employees of the subsidiary, is it fair to require expensing of ESOP compensation cost in the case of an unlisted subsidiary, but not in the case of a listed subsidiary?

Under the circumstances, the author’s view is that “what is good for the goose, should be good for the gander”. In other words, the author does not support different accounting consequences purely on the basis of the listing status of the reporting entity. Thus, the author believes that the unlisted subsidiary company may not record ESOP compensation cost. This view can also be supported by the fact that the unlisted subsidiary company does not have any settlement obligation with the parent company.

In practice, there is diversity and it is noticed that there are some unlisted subsidiary companies which have recognised the ESOP compensation costs whilst other unlisted subsidiary companies have not. One challenge faced by the subsidiary companies when they record the ESOP compensation cost is with respect to the utilisation of capital reserves. Since the shares issued under the ESOP are of the parent company, in the absence of a re-charge by the parent to the subsidiary, the corresponding credit will be given to the capital reserve (akin to an investment made by the parent company in the subsidiary). This reserve will accumulate over the years. However, the utilisation or remittance of this reserve back to its parent company in the future, would not be easy in the light of restrictions under Companies Act, 1956, the Income Tax Act, 1961, FEMA, etc.


At this juncture, there is an accounting arbitrage available to unlisted subsidiary companies because of different accounting rules under the SEBI guidelines and the ICAI guidance note. For the future, SEBI should withdraw its guidelines, so that the arbitrage is removed and the ICAI guidance note which is based on true and fair view principles and aligned to IFRS (in this case) should be given preference.

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