ESOP Accounting, Valuation and Tax Treatment

• Accounting & Bookkeeping
• ||
• October 1, 2021

Employee Stock Option Plan is an employee benefit plan that gives ownership interests to the employees. Companies often use ESOP as a corporate finance strategy to align the interest of employees with that of the shareholders.

Accounting for ESOP

The company books expense for Employee Stock Option Plan during the vesting period based on employees expected to complete, for example:

• Vesting period: 3 years
• Expected Period: 4 Years
• Expected Life: 6 Years
• Exercise Price: Rs.15
• Market Price on exercise Date: Rs.25
• Fair Value of Option: Rs.8/- (Option Pricing Model)
• No of Employees – 300
• Option per employee – 1000 Expected exercise Ratio – 90%

The fair value of Option Expected to Vest during the Vesting Period

1000 options per employee X 300 Employees X 90% Expected Exercise Ratio X Rs.8 Fair Value of Option = Rs.21,60,000. The Expense of Rs. 21,60,000 would be booked over the vesting tenure, i.e. 3 years. The expense for each year would be Rs. 7,20,000 (Rs 21,60,000/3 years).

Accounting Entry

Year 1

Year 2

Year 3

At the time of Exercise of Option by employees:

The value for the three years is to be charged to the profit and loss account.

ESOP is taxed in two situations in the hands of the employee

Situation-1

As a prerequisite at the time of exercise

When the employee has exercised the option, the difference between the fair value on the exercise date and the exercise price is taxed. The employer also deducts TDS on this prerequisite.

SITUATION -2

At the time of sale of a share in the market by an employee as a capital gain

The difference between the sales price and the fair value of the share on the exercise date is taxed. The rate of taxing depends upon the holding period and whether the claim is listed or unlisted.

For listed shares

• If for less than one year, then Short Term Capital Gain is taxable at the rate of 15%.
• If more than 1 year, then long term capital gain. LTCG is exempt up to Rs. 1 Lakh and is taxable at the rate of 10% taxable over and above Rs. 1 Lakh.

For unlisted shares

• If for less than 24 months, then short term capital gain at regular slab rates.
• If more than 24 months, then long term capital gain is taxable at the rate of twenty per cent after indexation of cost.

At AJSH, we assist our clients in bookkeeping, payroll, auditing, taxation, secretarial compliances and preparation of financial statements ensuring compliance with applicable standards. If you have any questions or wish to know more about ESOP accounting, valuation and tax treatment, kindly contact us.