Accounting Standards for ESOPs: What Companies Need to Know

1. Which accounting standard governs ESOPs?

The accounting treatment of an ESOP depends on how the scheme is structured. It may fall under either IFRS 2 or IAS 19, depending on whether a clear share-based payment arrangement exists:

• IFRS 2: Share-based Payment applies where employees are granted shares, options, or rights that are linked to the company’s share price or equity.
• IAS 19: Employee Benefits often occur in dividend-based “evergreen” ESOP structures.

2. What is agency accounting, and why is it typically applied to ESOPs? 

Agency accounting is applied when the ESOP acts on behalf of the company, in this arrangement, the ESOP vehicle is treated as an agent. This approach ensures that the economic substance of the ESOP, being the provision of benefit to employees, is accurately reflected in the company’s financial statements, even if the ESOP vehicle appears separate. 

3. Can agency accounting be applied under both IFRS 2 and IAS 19?

Yes – Agency accounting can be applied under both standards. The test for the application of agency accounting is the same: if the ESOP Trust or SPV acts on behalf of the company, and the company retains control and economic risk, then the ESOP is treated as an agent—regardless of whether the underlying accounting falls under IFRS 2 or IAS 19. 

4. How are options valued under IFRS 2?

Under IFRS 2, options are valued at the grant date using an option pricing model. In most ESOPs—especially those with performance or market conditions, Monte Carlo simulation is used. The Black-Scholes Model is only suitable in limited cases, typically where the scheme has time-based vesting and the company is not dividend-paying. The fair value is based on factors like share price, volatility, expected option life, dividend yield, and the risk-free rate. 

5. Over what period should the share-based payment expense be recognized? 

The expense related to share-based payments must be recognized over the vesting period—being the period over which employees provide services in exchange for the share-based payment.   

6. What are the key differences between equity-settled and cash-settled share-based payments?

There are two primary types of share-based payments:  

1. Equity-settled ESOPs – Employees receive shares, or shares are sold in the market at vesting. The Share-based Payment is recognised as an expense, determined using the grant-date fair value, with a corresponding increase in equity, which is not subsequently remeasured.  
2. Cash-settled ESOPs – Employees receive a cash payment linked to the company’s share price., i.e.  there is a cash obligation on the company. The fair value is remeasured at each reporting date until settlement, recognizing fair value fluctuations as an expense, with a corresponding  increase in liabilities. 

7. Why do companies generally prefer equity-settled share-based payments over cash-settled schemes?

Equity-settled schemes offer accounting certainty: the cost is fixed at grant date, with no ongoing remeasurement of a liability. By contrast, cash-settled schemes require annual revaluation, create P&L volatility, and may result in large balance sheet liabilities—making them more complex and less attractive to stakeholders. 

Read More