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Background
Currently, the accounting guidance under Indian GAAP for Employee Share Based Payment Plans (ESOPs) is contained in the Guidance Note on Accounting for Employee Share-based Payments. In the case of listed companies, guidance is also provided in the Securities and Exchange Board of India (Employee Stock Option Scheme and Employee Stock Purchase Scheme) Guidelines, 1999. There is no specific guidance currently under Indian GAAP for options granted to non-employees (for example, vendors or customers). Ind AS 102 deals with all types of share based payments, including share based payments made to non-employees.
Objective, scope and definitions
Ind AS 102 provides guidance with respect to the financial reporting by an entity, when it undertakes a share-based payment transaction. Ind AS 102 specifically excludes the below-mentioned share-based payment transactions from its scope, as the relevant guidance relating to these transactions are covered under other accounting standards:
• Share-based consideration paid in a business combination (Ind AS 103 – Business Combination)
• Certain contracts falling within the scope of Ind AS 32 “Financial Instruments: Presentation” or Ind AS 39 “Financial Instruments: Recognition and Measurement”.
Type of share based payment transactions
Under Ind AS 102, share based payment transactions are classified as follows:
Equity-settled share-based payment transactions. Under this the entity receives goods or services as Jamil Khatri Akeel Master Chartered Accountants IFRS consideration for equity instruments of the entity or another group entity. Cash-settled share-based payment transactions. Under this the entity acquires goods or services by incurring liabilities to the supplier of those goods or services for amounts that are based on the price (or value) of the entity’s shares or other equity instruments of the entity. Transactions with cash alternatives. Under this the entity receives or acquires goods or services and the terms of the arrangement, provide either the entity or the supplier of those goods or services with a choice of whether the entity settles the transaction in cash (or other assets) or by issuing equity instruments.
Measurement
Equity settled share based payment transactions Equity settled share based payment transactions are measured with reference to the fair value at the grant date (where options are granted to employees) or with reference to the fair value at the date at which the entity obtains the goods or receives the services (where options are granted to non-employees).
The measurement is at the fair value of the goods or services received, unless that fair value cannot be estimated reliably. If the fair value of the goods or services received cannot be estimated reliably, the entity shall measure the fair value by reference to the fair value of the equity instruments granted.
Typically, in the case of employees, fair value of equity instrument is considered since it is not possible to estimate reliably the fair value of the services received. However, in case of transactions with parties other than employees, there is a rebuttable presumption that the fair value of the goods or services can be estimated reliably.
The fair value of the instruments granted can generally be measured using the market prices (if available) or using a valuation technique (for example, option pricing models).
Example
Entity P grants 100 share options to each of its 200 employees which are conditional upon completing three years of service. Estimated fair value of each option on grant date is INR 10.
Year 1
Cumulative expense (100* 200* 10*1/3) = Rs. 66,667 Expense for the current period = Rs. 66,667 Entry – Expense Dr 66,667 To Equity 66,667
Year 2
Cumulative expense (100* 200* 10*2/3) = Rs. 133,333 Expense for the current period = Rs. 66,667 (133,333 – 66,667) Entry – Expense Dr 66,667 To Equity 66,667
Year 3
Cumulative expense (100* 200* 10*3/3) = Rs. 200,000 Expense for the current period = Rs. 66,667 (200,000-133,333) Entry – Expense Dr 66,667 To Equity 66,667
Cash settled transactions
Cash-settled share-based payment transactions are measured at the fair value of the liability. Further, at each reporting date, and ultimately at the settlement date, the fair value of the recognised liability is remeasured with any changes in the fair value recognised in the profit or loss account. It is to be noted that equity settled share based payment transactions are not required to be remeasured.
Example
Entity A granted 60 Share Appreciation Rights (SAR) to each of its 200 employees with three years service condition. The SAR will be ultimately settled by Entity A making cash payments to the employees based on the value of the SAR. Fair value of options at the end of: Year 1 – Rs. 15 Year 2 – Rs. 20 Year 3 – Rs. 22
At the end of Year 1
Cumulative expense (60* 200* 15*1/3) = Rs. 60,000 Expense for the current period = Rs. 60,000 Entry – Expense Dr 60,000 To Liability 60,000
At the end of Year 2
Cumulative expense (60* 200* 20*2/3) = Rs. 160,000 Expense for the current period = Rs. 100,000 (160,000 – 60,000) Entry – Expense Dr 100,000 To Liability 100,000
At the end of Year 3
Cumulative expense (60 * 200* 22 *3/3) = Rs. 264,000
Expense for the current period = Rs. 104,000 (264,000-160,000)
Entry – Expense Dr 104,000
To Liability 104,000
Conditions affecting the recognition and fair value
Conditions that determine whether the counterparty receives the share-based payment are separated into vesting conditions and non-vesting conditions.
Service conditions are those conditions which require counterparty to complete specified period of service, whereas performance conditions require the counterparty to meet specified performance targets in addition to service conditions. Performance conditions could either be market conditions where vesting is related to the market price of entity’s equity instruments or nonmarket performance conditions where vesting is related to specific performance targets unrelated to market price (for example, specified increase in sales, net profit or EPS).
Service conditions and non-market performance conditions are not reflected in the grant date fair valuation and a true up is required for failure to satisfy such condition. Market conditions and non-vesting conditions are reflected in grant date fair valuation and no true up is required subsequently for failure to satisfy such conditions.
Accordingly, no charge is recognised for goods or services received if the equity instruments granted do not vest because of failure to satisfy a service condition/non-market performance condition. On the other hand, in the case of grants of equity instruments with market conditions, the entity shall recognise the charge for goods or services received from a counterparty who satisfies all other vesting conditions (for example, services received from an employee who remains in service for the specified period of service), irrespective of whether that market condition is satisfied.
In other words, market conditions are reflected as an adjustment to the initial estimate of fair value at grant date of the instrument to be received and no adjustments are made as a result of differences between estimated and actual vesting due to market conditions.
Non-vesting conditions
Non-vesting conditions are similar to market conditions and are reflected in measuring the grant-date fair value of the share-based payment. No adjustment is made for any differences between expected and actual outcome of non-vesting conditions.
Therefore, if all service and non-market performance conditions are met, then the entity will recognise the share-based payment as a cost even if the counter-party does not receive the share-based payment due to a failure to meet a non-vesting condition.
In practice, most Indian ESOP plans have service vesting conditions, while some plans may contain performance conditions. Non-vesting conditions are rare.
Forfeiture
A grant is forfeited when the vesting conditions are not satisfied.
The amount recognised for goods or services received during the vesting period shall be based on the number of share options expected to vest considering options estimated to be forfeited.
When the goods or services received are recognised with a corresponding increase in equity, then entity shall not make any adjustment to total equity after the vesting date. An entity shall not subsequently reverse the amount recognised for services received from an employee if the vested equity instruments are later forfeited or, in the case of share options, the options are not exercised.
Estimated share-based payment cost is trued up for forfeitures or estimated forfeitures on account of an employee failing to provide the required service.
Group share-based payment arrangements
A share-based payment in which the receiving entity and the settling entity are in the same group from the perspective of the ultimate parent and which is settled either by an entity in that group or by an external shareholder of any entity in that group is a group share-based payment transaction from the perspective of the receiving and the settling entities.
In a group share -based payment transaction in which the parent grants a share-based payment to the employees of its subsidiary, the share-based payment is recognised in the consolidated financial statements of the parent, in the separate financial statements of the parent and in the financial statements of the subsidiary.
Examples
Parent P grants its own equity instruments or a cash payment based on its own equity instruments to the employees of Subsidiary S as a consideration for the services provided to S, wherein P has an obligation towards the employees of S; or
Subsidiary S grants equity instruments of Parent P or a cash payment based on the equity instruments to its own employees as a consideration for the services provided to S. Here S has an obligation towards its employees.
Let us understand the accounting treatment in case of group share based payment.
Accounting by subsidiary, when parent grants shares to the employees/counter party of its subsidiary
Here a subsidiary has no obligation to settle the transaction with the counterparty. However, subsidiary is receiving service/goods and hence recognises an expense/asset and an increase in its equity for the contribution received from the parent.
Accounting by a subsidiary who grants rights to equity instruments of its parent to its employees
The subsidiary shall account for the transaction with its employees as cash-settled. This requirement applies irrespective of how the subsidiary obtains the equity instruments to satisfy its obligations to its employees.
Accounting by parent that settles the share-based payment directly
When a parent grants rights to its equity instruments to employees of a subsidiary, the parent receives goods or services indirectly through the subsidiary in the form of an increased investment in the subsidiary, i.e. the subsidiary receives services from employees that are paid for by the parent, thereby increasing the value of the subsidiary.
Therefore, the parent should recognise in equity the equity-settled share-based payment with a correspond-ing increase in its investment in the subsidiary in its financial statements. The amount recognised as an additional investment is based on the grant-date fair value of the share-based payment. An increase in investment and corresponding increase in equity for the equity-settled share-based payment should be recognised by the parent over the vesting period of the share-based payment.
In consolidated financial statements, the investment in the subsidiary mentioned above would be eliminated against equity contribution recognised by subsidiary in its standalone financial statements and accordingly, employee compensation expense would be recognised with corresponding credit to either equity or liability.
Treasury shares
Under Ind AS, a trust formed for administering an employee stock option plan generally meets the definition of a Special Purpose Entity, and hence is consolidated with the entity. Under this approach, cost will be recognised for all grants through the trust; shares held by the Trust will be considered as treasury shares of the company; and any loan given by the company to the trust will be eliminated on consolidation. As a result of this accounting treatment, cost of any shares bought by the Trust from the open market will be reduced from the reserves of the company. Any subsequent sales by b the trust (either to the employee or third parties) will result in an increase in the reserves.
Exit Mechanism
Sometimes, an award requires an exit event (e.g. sale of the business) as either a vesting or exercise condition. The requirement for an exit event affects share-based payments in different ways, depending on how the condition is expressed. If the condition is required to occur during the service period, then it would be a performance condition.
For example, a grant of share options has a three-year service condition. However, the options cannot be exercised until an IPO occurs.
If employees leaving the entity after the service period but before the IPO retain the options, then the condition of an IPO is a non-vesting condition.
If employees leaving the entity before an exit event are required to surrender the ‘vested’ options (or sell them back at a nominal amount) then the exit condition is in substance a vesting condition.
Let us take another example. If the options do not vest until an IPO occurs and employees leaving before the IPO forfeit the options, then this is an award that contains both a service condition and a non-market performance condition, assuming that there is no minimum IPO price. Such an arrangement should be accounted for as a grant with a variable vesting period (i.e. the length of the vesting period) varies depending on when a performance condition is satisfied, based on a non-market performance condition. Because the IPO has no minimum price and therefore is not a market condition, the condition would not be reflected in the grant-date measurement of fair value and the cost would be recognised over the expected vesting period and trued up to the actual vesting period and the actual number of equity instruments granted.
Conclusion
The accounting for share based payment under Ind AS 102 is much wider in scope as compared to the existing guidance. The guidance on accounting for group share based payment should be carefully evaluated to determine the appropriate accounting treatment for group entities. Ind AS 102 provides guidance on accounting for share based payments and mandates use of fair value for recognition of share based payments (intrinsic method is permitted only in very rare circumstances). This is likely to impact the employee compensation expense of many Indian companies who have issued stock options to employees and currently use intrinsic value method to account for these options. The use of fair value method to recognise share based payment would provide a more accurate picture to all stakeholders with respect to the true compensation cost. However, this will also bring in challenges since compensation cost will be recorded, based on a calculated ‘fair value’ of the option on the grant date, which in most situations will be significantly different from the actual gain (or no gain) for the employee at the time of the vesting/exercise.
