CHAPTER 2

ACCOUNTING FOR EMPLOYEE STOCK OPTION

PLAN (ESOP)

(No. of Questions Covered – 11)

Series Particulars Page. No.

100 ESOP without Vesting Conditions 2.2
200 ESOP with Vesting Conditions 2.4
300 Misc. Category 2.12

All Time Important Questions for Practice before Exams

Q.ESP.101, 201, 202, 203, 205, 206, 207 & 301

2.1
 ESOP without Vesting Condition

Q.ESP.101 (RTP May20 & Similar in RTP Nov21, Exam May19, Nov19 & May22) (Inter and
IPCC MTP Oct20, May22)
st
On 1 April, 2019, a company offered 100 shares to each of its 400 employees at Rs 25 per share. The employees
are given a month to accept the shares. The shares issued under the plan shall be subject to lock-in to transfer
th
for three years from the grant date i.e., 30 April 2019. The market price of shares of the company on the
grant date is Rs 30 per share. Due to post-vesting restrictions on transfer, the fair value of shares issued under
the plan is estimated at Rs 28 per share.
th
Up to 30 April, 2019, 50% of employees accepted the offer and paid Rs 25 per share purchased. Nominal value of
each share is Rs 10.
You are required to record the issue of shares in the books of the company under the aforesaid plan.
SOLUTION:
Fair value of an option = Rs 28
Difference between Fair value and Issue Price =Rs 28 – Rs 25 = 3.
Number of employees accepting the offer = 400 employees x 50% = 200 employees
Number of shares issued = 200 employees x 100 shares/employee = 20,000 shares
Employee Compensation Expenses recognized in 2019-20 =20,000 shares x Rs 3 = Rs 60,000
Securities Premium A/c = Rs 28 – 10 = Rs 18 per share = 20,000 x 18 = Rs 3,60,000
Journal Entry
Date Particulars Rs Rs
30.04.2019 Bank (20,000 shares x Rs 25) Dr. 5,00,000
Employees compensation expense A/c Dr. 60,000
To Share Capital 2,00,000
To Securities Premium 3,60,000
(Being stock purchase option accepted by 200 employees
for 100 shares each at Rs 25 per share on a Fair Value of
Rs 28 per share)
Note: Employees compensation expenses amounting Rs 60,000 will ultimately be charged to profit & loss
account.

Q.ESP.102 (MTP May20, May22) (RTP May22)

Ganga Ltd. has its share capital divided into Equity Shares of Rs. 10 each. On 1st April, 2019, the company offered
250 shares to each of its 520 employees at Rs. 60 per share, when the market price was Rs. 150 per share. The
options were to be exercised between 01-03-2020 to 31-03-2020. 410 employees accepted the offer and paid Rs.
60 per share on purchased shares and the remaining options lapsed. The company closes its books on 31st March
every year.
You are required to show Journal Entries (with narrations) as would appear in the books of Ganga Ltd. for the
year ended 31st March, 2020 with regard to employee stock options.

2.2
SOLUTION:
Journal Entries in the books of Ganga Ltd.
Rs. Rs.
1.3.20 Bank A/c (1,02,500 x Rs.60) Dr. 61,50,000
To Employee compensation expense A/c Dr. 92,25,000
31.3.20 (1,02,500 x Rs.90)
To Equity share capital A/c (1,02,500 x Rs.10) 10,25,000
To Securities premium A/c (1,02,500 x Rs.140) 1,43,50,000
(Being shares issued to the employees against the options
vested to them in pursuance of Employee Stock Option
Plan)
31.3.20 Profit and Loss A/c Dr. 92,25,000
To Employee compensation expense A/c 92,25,000
(Being transfer of employee compensation expenses to
Profit and Loss Account)

Q.ESP.103 (Exam Jan21 Similar in MTP May19, Nov21, RTP May19, Nov20)
Raja Ltd. has its share capital divided into equity shares of ₹ 10 each. On 01-08-2019, it granted 2,500
employees stock options at ₹ 50 per share, when the market price was ₹ 140 per share. The options were to be
exercised between 1-10-2019 to 31-03-2020. The employees exercised their options for 2,400 shares only and the
remaining options lapsed. Raja Ltd. closes its books of accounts on 31st March, every year.
You are to required to pass the necessary Journal Entries (including narration) for the year ended 31-03-2020,
with regard to employees' stock options and give working notes also.
SOLUTION:
Journal Entries in the books of Raja Ltd.
₹ ₹
1.10.19 Bank A/c Dr. 1,20,000
to Employee compensation expense A/c To Equity share capital A/c Dr. 2,16,000
31.3.20 To Securities premium A/c 24,000
(Being shares issued to the employees against the options vested to them in pursuance of
3,12,000
Employee Stock Option Plan)
31.3.20 Profit and Loss A/c Dr. 2,16,000
To Employee compensation expense A/c 2,16,000
(Being transfer of employee compensation expenses to Profit and Loss Account)
No entry is passed when stock options are granted to employees. Hence, no entry will be passed on 1st August,
2019;
Working Note:
Market Price = ₹ 140 per share and stock option price = 50, Hence, the difference 140 – 50 = ₹ 90 per share is
equivalent to employee cost or employee compensation expense and will be charged to P&L Account as such for
the number of options exercised i.e., 2,400 shares. Hence, Employee compensation expenses will be 2,400 shares X
₹ 90 = ₹ 2,16,000

2.3
 ESOP with Vesting Conditions

Q.ESP.201 (RTP May 2018)

PQ Ltd. grants 100 stock options to each of its 1,000 employees on 1-4-2015, conditional upon the employee
remaining in the company for 2 years. The fair value of the option is Rs. 18 on the grant date and the exercise
price is Rs. 55 per share. The other information is given as under:
i) Number of employees expected to satisfy service condition are 930 in the 1st year and 850 in the 2nd year.
ii) 40 employees left the company in the 1st year of service and 880 employees have actually completed 2-year
vesting period.
You are required to calculate ESOP cost to be amortized by PQ Ltd. in the years 2015-2016 and 2016-2017.
SOLUTION:
Calculation of ESOP cost to be amortized
2015-2016 2016-2017
Fair value of options per share Rs. 18 Rs. 18
No. of options expected to vest under the
scheme 93,000 (930 x 100) 88,000 (880 x 100)
Fair value of options Rs. 16,74,000 Rs. 15,84,000
Value of options recognized as expenses (Rs. 16,74,000 / 2) (Rs. 15,84,000 – Rs. 8,37,000)
8,37,000 7,47,000

Q.ESP.202 (RTP Nov. 18)

At the beginning of year 1, the enterprise grants 1,000 stock options to each member of its sales team, conditional
upon the employees remaining in the employment of the enterprise for three years, and the team selling more
than 50,000 units of a particular product over the three-year period. The fair value of the stock options is Rs 15
per option at the date of grant.
During year 2, the enterprise increases the sales target to 1,00,000 units. By the end of year 3, the enterprise has
sold 55,000 units, and the stock options do not vest.
Twelve members of the sales team have remained in service for the three-year period. You are required to
examine and give comment in light of the relevant Guidance Note that whether the company should recognise the
expenses on the base of options granted or not.
Also, state will your answer differ if, instead of modifying the performance target, the enterprise had increased
the number of years of service required for the stock options to vest from three years to ten years.
SOLUTION:
Paragraph 19 of the Guidance Note on Share Based Payments requires, for a performance condition that is not a
market condition, the enterprise to recognize the services received during the vesting period based on the best
available estimate of the number of shares or stock options expected to vest and to revise that estimate, if
necessary, if subsequent information indicates that the number of shares or stock options expected to vest differs
from previous estimates. On vesting date, the enterprise revises the estimate to equal the number of instruments
that ultimately vested. However, paragraph 24 of the Guidance Note requires, irrespective of any modifications to
the terms and conditions on which the instruments were granted, or a cancellation or settlement of that grant of
instruments, the enterprise to recognize, as a minimum, the services received, measured at the grant date fair
value of the instruments granted, unless those instruments do not vest because of failure to satisfy a vesting
condition (other than a market condition) that was specified at grant date.

2.4
Furthermore, paragraph 26(c) of the Guidance Note specifies that, if the enterprise modifies the vesting
conditions in a manner that is not beneficial to the employee, the enterprise does not take the modified vesting
conditions into account when applying the requirements for treatment of vesting conditions as specified in
Guidance Note.

Therefore, because the modification to the performance condition made it less likely that the stock options will
vest, which was not beneficial to the employee, the enterprise takes no account of the modified performance
condition when recognizing the services received. Instead, it continues to recognize the services received over the
three-year period based on the original vesting conditions. Hence, the enterprise ultimately recognizes cumulative
remuneration expense of Rs 1,80,000 over the three-year period (12 employees × 1,000 options × Rs 15).

The same result would have occurred if, instead of modifying the performance target, the enterprise had
increased the number of years of service required for the stock options to vest from three years to ten years.
Because such a modification would make it less likely that the options will vest, which would not be beneficial to
the employees, the enterprise would take no account of the modified service condition when recognizing the
services received. Instead, it would recognize the services received from the twelve employees who remained in
service over the original three-year vesting period.

Q.ESP.203 (RTP November 2019)

The following particulars in respect of stock options granted by a company are available
Grant date April 1,2016
Number of employees covered 50
Number options granted per employee 1,000
Fair value of option per share on grant date (Rs.) 9
The options will vest to employees serving continuously for 3 years from grant date, provided the share price is Rs.
65 or above at the end of 2018-19.
The estimates of number employees satisfying the condition of continuous employment were 48 on 31/03/17, 47
on 31/03/18. The number of employees actually satisfying the condition of continuous employment was 45.
The share price at the end of 2018-19 was Rs. 68
Compute expenses to recognize in each year and show important accounts in books of the company.
SOLUTION:
The vesting of options is subject to satisfaction of two conditions viz. service condition of continuous employment
for 3 years and market condition that the share price at the end of 2018-19 is not less than 65/-. The company
should recognise value of option over 3-year vesting period from 2016-17 to 2018-19.
Year 2016-17
Fair value of option per share = Rs. 9
Number of shares expected to vest under the scheme = 48 × 1,000 = 48,000
Fair value = 48,000 × 9 = 4,32,000
Expected vesting period = 3 years
Value of option recognised as expense in 2016-17 = 4,32,000 /3 = 1,44,000

Year 2017-18
Fair value of option per share = 9

2.5
Number of shares expected to vest under the scheme = 47 × 1,000 = 47,000
Fair value = 47,000 × 9 = 4,23,000
Expected vesting period = 3 years
Cumulative value of option to recognise as expense in 2016-17 and 2017-18 = (4,23,000/ 3) × 2 = 2,82,000
Value of option recognised as expense in 2016-17 = 1,44,000
Value of option recognised as expense in 2017-18 = 2,82,000 – 1,44,000 = 1,38,000

Year 2018-19
Fair value of option per share = 9
Number of shares actually vested under the scheme = 45 × 1,000 = 45,000
Fair value = 45,000 × 9 = 4,05,000
Vesting period = 3 years
Cumulative value of option to recognise as expense in 2016-17, 2017-18 and 2018-19 = 4,05,000
Value of option recognised as expense in 2016-17 and 2017-18 = 2,82,000
Value of option recognised as expense in 2018-19 = 4,05,000 – 2,82,000 = 1,23,000

Q.ESP.204 (RTP Nov 22)

Mehta Ltd. grants 1,500 stock options to its employees on 1.4.2019 at Rs. 50. The vesting period is two and a half
years. The maximum exercise period is one year. Market price on that date is Rs. 80. Fair value per option is Rs.
30. All the options were exercised on 30.9.2022. Give the necessary journal entries if the face value of equity
share is Rs. 10 per share.
SOLUTION:
Books of Mehta Ltd.
Journal Entries
Date Particulars Debit Credit
Rs. Rs.
31.3.2020 Employees Compensation Expense Account Dr. 18,000
To Employees Stock Option Outstanding Account 18,000
(Being compensation expense recognized in respect of 1,500 options
granted to employees at discount of Rs. 30 each, amortized on straight
line basis over 2½ years) (WN 2)
Profit and Loss Account Dr. 18,000
To Employees Compensation Expense Account 18,000
(Being employees compensation expense of the year transferred to P&L
A/c)
31.3.2021 Employees Compensation Expense Account Dr. 18,000
To Employees Stock Option Outstanding Account 18,000
(Being compensation expense recognized in respect of 1,500 options
granted to employees at discount of Rs. 30 each, amortized on straight
line basis over 2½ years) (WN 2)
Profit and Loss Account Dr. 18,000
To Employees Compensation Expense Account 18,000
(Being employees compensation expense of the year transferred to P&L
A/c)

2.6
 31.3.2022 Employees Compensation Expense Account Dr. 9,000
To Employees Stock Option Outstanding Account 9,000
(Being balance of compensation expense amortized Rs. 45,000 less Rs.
36,000) (WN 2)
Profit and Loss Account Dr. 9,000
To Employees Compensation Expense Account 9,000
(Being employees compensation expense of the year transferred to P&L
A/c)
30.9.2022 Bank Account (Rs. 50 × 1,500) Dr. 75,000
To Equity Share Capital Account 15,000
To Securities Premium Account 60,000
(Being exercise of 1,500 options at an exercise price of Rs. 50)
30.9.2022 Stock Option Outstanding A/c (Rs. 30 x 1,500) Dr. 45,000
To Securities Premium Account 45,000
(Being the balance in the Employees Stock Option Outstanding
Account transferred to Securities Premium A/c)

Working Notes:
1. Total employee’s compensation expense = 1,500 x (Rs. 80 – Rs. 50) = Rs. 45,000
2. Employees compensation expense has been written off during 2½ years on straight line basis as under:
I year = Rs. 18,000 (for full year)
II year = Rs. 18,000 (for full year)
III year = Rs. 9,000 (for half year)

Q.ESP.205 (MTP Nov22 Similar in EXAM Nov22)

At the beginning of year 1, an enterprise grants 10,000 stock options to a senior executive, conditional upon the
executive remaining in the employment of the enterprise until the end of year 3. The exercise price is Rs. 40.
However, the exercise price drops to Rs. 30 if the earnings of the enterprise increase by at-least an average of 10
per cent per year over the three-year period.
On the grant date, the enterprise estimates that the fair value of the stock options, with an exercise price of Rs.
30, is Rs. 16 per option. If the exercise price is Rs. 40, the enterprise estimates that the stock options have a fair
value of Rs. 12 per option.
During year 1, the earnings of the enterprise increased by 12 per cent, and the enterprise expects that earnings
will continue to increase at this rate over the next two years. The enterprise, therefore, expects that the earnings
target will be achieved, and hence the stock options will have an exercise price of Rs. 30.
During year 2, the earnings of the enterprise increased by 13 per cent, and the enterprise continues to expect that
the earnings target will be achieved.
During year 3, the earnings of the enterprise increased by only 3 per cent, and therefore the earnings target was
not achieved. The executive completes three years’ service, and therefore satisfies the service condition. Because
the earnings target was not achieved, the 10,000 vested stock options have an exercise price of Rs. 40.
You are required to calculate the amount to be charged to Profit and Loss Account every year on account of
compensation expenses.

2.7
SOLUTION:
Since the exercise price varies depending on the outcome of a performance condition which is not a market
condition, the effect of that performance condition (i.e., the possibility that the exercise price might be Rs. 40
and the possibility that the exercise price might be Rs. 30) is not considered when estimating the fair value of
the stock options at the grant date. Instead, the enterprise estimates the fair value of the stock options at the
grant date under each scenario and revises the transaction amount to reflect the outcomes of that performance
condition at the end of every year based on the information available at that point of time.
Calculation of compensation expense to be charged every year
Year Calculation Expense for the year (Rs.) Cumulative expense (Rs.)
1 10,000 x Rs. 16 x 1/3 53,333 53,333
2 10,000 x Rs. 16 x 2/3 53,334 1,06,667
3 10,000 x Rs. 12 x 3/3 13,333 1,20,000

Q.ESP.206 (EXAM Nov 20)

Sun Ltd. grants 100 stock options to each of its 1200 employees on 01.04.2016 for Rs. 30, depending upon the
employees at the time of vesting of options. Options would be exercisable within a year it is vested. The market
price of the share is Rs. 60 each. These options will vest at the end of the year 1 if the earning of Sun Ltd. is 16%
or it will vest at the end of year 2 if the average earning of two years is 13%, or lastly it will vest at the end of
the third year, if the average earning of 3 years is 10%. 6000 unvested options lapsed on 31.3.2017, 5000 unvested
options lapsed on 31.03.2018 and finally 4000 unvested options lapsed on 31.03.2019. The earnings of Sun Ltd. for
the three financial years ended on 31st March, 2017, 2018 and 2019 are 15%, 10% and 6%, respectively. 1000
employees exercised their vested options within a year and remaining options were unexercised at the end of the
contractual life. You are requested to give the necessary journal entries for the above and prepare the statement
showing compensation expenses to be recognized at the end of each year.
SOLUTION:
Rs. Rs.
31.3.17 Employee compensation expense A/c Dr. 17,10,000
To ESOP Outstanding A/c 17,10,000
(Being compensation expense recognized in respect of
the ESOP i.e., 100 options each granted to 1,200 employees
at a discount of Rs. 30 each, amortized on straight line
basis over vesting years (Refer W.N.)
31.3.17 Profit and Loss A/c Dr. 17,10,000
To Employee compensation expense A/c 17,10,000
(Being expenses transferred to profit and Loss A/c)
31.3.2018 Employee compensation expense A/c Dr. 4,70,000
To ESOP Outstanding A/c 4,70,000
(Being compensation expense recognized in respect of the
ESOP - Refer W.N.)
31.3.2018 Profit and Loss A/c Dr. 4,70,000
To Employee compensation expense A/c 4,70,000
(Being expenses transferred to profit and Loss A/c)
31.3.2019 Employee compensation expense A/c Dr. 9,70,000
To ESOP Outstanding A/c 9,70,000
(Being compensation expense recognized in respect of the

2.8
 ESOP - Refer W.N.)
31.3.2019 Profit and Loss A/c Dr. 9,70,000
To Employee compensation expense A/c 9,70,000
(Being expenses transferred to profit and Loss A/c)
2019-20 Bank A/c (1,00,000 x Rs. 30) Dr. 30,00,000
ESOS outstanding A/c [(31,50,000/1,05,000) x 1,00,000] 30,00,000
To Equity share capital (1,00,000 x Rs. 10)
To Securities premium A/c (1,00,000 x Rs. 50) 10,00,000
(Being 1,00,000 options exercised at an exercise price of 50,00,000
Rs. 30 each)
31.3.2020 ESOS outstanding A/c Dr. 1,50,000
To General Reserve A/c 1,50,000
(Being ESOS outstanding A/c on lapse of 5,000 options at
the end of exercise of option period transferred to General
Reserve A/c)

Working Note:
Statement showing compensation expense to be recognized at the end of:
Particulars Year 1 Year 2 Year 3
(31.3.2017) (31.3.2018) (31.3.2019)
Number of options expected to vest 1,14,000 options 1,09,000 1,05,000
Total compensation expense accrued (60-30) Rs. 34,20,000 Rs. 32,70,000 Rs. 31,50,00
Compensation expense of the year 34,20,000 x 1/2 = 32,70,000 x 2/3 Rs. 31,50,000
Rs. 17,10,000 = Rs. 21,80,000
Compensation expense recognized previously Nil Rs. 17,10,000 Rs. 21,80,000
Compensation expenses to be recognized for the Rs. 17,10,000 Rs. 4,70,000 Rs. 9,70,000
year

Q.ESP.207 (Exam July 21)

At the beginning of the year 1, Harmony Limited grants 600 options to each of its 1000 employees. The
contractual life of option granted is 6 years.
Other relevant information is as follows:
Vesting Period 3 years
Exercise period 3 years
Expected Life 5 years
Exercise Price ₹ 100
Market Price ₹ 100
Expected Forfeitures per year 3%
The option granted vest according to a graded schedule of 25% at the end of the year 1, 25% at the end of the
year 2 and the remaining 50% at the end of the year 3.
You are required to calculate total compensation expenses for the options expected to vest and cost and
cumulative cost to be recognized at the end of all the three years assuming that expected forfeiture rate does not
change during the vesting period when the Intrinsic value of the options at the grant date is ₹ 7 per option.

2.9
SOLUTION:
Since the options granted have a graded vesting schedule, the enterprise segregates the total plan into different
groups, depending upon the vesting dates and treats each of these groups as a separate plan. The enterprise
determines the number of options expected to vest under each group as below:
Vesting Date Options expected to vest
(Year-end)
1 600 options x 1,000 employees x 25% x 0.97 1,45,500 options
2 600 options x 1,000 employees x 25% x 0.97 x 0.97 1,41,135 options
3 600 options x 1,000 employees x 50% x 0.97x 0.97 x 0.97 2,73,802 options
Total options expected to vest 5,60,437 options

In case of intrinsic value method, total compensation expense for the options expected to vest would be
Vesting Date Expected Vesting Value per Compensation
(End of year) (No. of Options) Option (₹) Expense (₹)
1 1,45,500 7 10,18,500
2 1,41,135 7 9,87,945
3 2,73,802 7 19,16,614
5,60,437 39,23,059
Total compensation expense of ₹ 39,23,059, determined at the grant date, would be attributed to the years 1, 2
and 3 as below:
Vesting Date Cost to be recognized
(End of year) Year 1 Year 2 Year 3
1 10,18,500
2 4,93,972.50* 4,93,972.50 6,38,872

3 6,38,871 6,38,871
Cost for the year 21,51,343.50 11,32,843.50 6,38,872
Cumulative cost 21,51,343.50 32,84,187 39,23,059

* Alternatively, it may be rounded off as ₹ 4,93,972 in year 1 and ₹ 4,93,973 in year 2

2.10
 Misc. Category
Q.ESP.301 (RTP Nov 21, May 22)
Define the following terms:
i. Vesting
ii. Exercise Period
iii. Grant date
iv. Exercise Price
SOLUTION:
(i) Vesting: It means the process by which the employee is given the right to apply for the shares of the
company against the option granted to him under the employees’ stock option plan.
(ii) Exercise Period: It is 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 employees’ stock option plan.
(iii) Grant Date: It is the date at which the enterprise and its employees agree to the terms of an employee
share-based payment plan. At grant date, the enterprise confers on the employees the right to cash or
shares of the enterprise, provided the specified vesting conditions, if any, are met.
(iv) Exercise Price: It is the price payable by the employee for exercising the option granted to him in pursuance
of employees’ stock option scheme.

2.11
Student Notes: -

2.12