Two of the most common types of share based payments that companies grant to their employees are Employee Stock Option Plans (ESOPs) and Stock Appreciation Rights (SARs).
ESOPs are employee benefit schemes under which the company encourages its employees to participate in the ownership of the company by granting them options on its shares, usually at a rate lower than the prevailing market price. Companies use ESOPs as a strategy to align the interests of their employees with those of their shareholders and hence maximize the overall shareholder wealth.
On the other hand, Stock Appreciation Rights (SARs) entitle the employees to a payment in cash equal to the appreciation in the company's stock over a specified period. As in case of ESOPs, the employees tend to gain if the company's stock price rises and to that extent, SARs have the same effect in terms of aligning the interest of the employees with those of the shareholders. However, the settlement in case of SARs typically happens in cash and consequently does not result in employees owning shares of the Company.
Both ESOPs and SARs are methods for companies to motivate the employees to work towards maximizing the overall shareholder wealth and financially reward them for their contribution. However, the recognition, measurement (valuation) and disclosure (financial reporting) requirements under Ind AS 102 Share Based Payments vary significantly between these forms of share-based payments. Understanding these differences and the consequent financial implications for the company under the two schemes is an important consideration (amongst other factors) in choosing the right scheme for the company.
In this article, we discuss the measurement / valuation requirements of ESOPs and SARs. Note that this article does not comment on the relative attractiveness of the two schemes, which will depend upon a number of factors in addition to the financial considerations highlighted in this article.
The first important aspect to note is the difference in the basic nature of the instrument from accounting perspective i.e. creation of equity vs. creation of liability.
ESOPs, as highlighted above, aim at sharing the ownership of the organization with its employees and thus, the issue of ESOPs is recorded as an increase in the equity of the organization, with the carrying value of ESOPs at a given reporting date being disclosed in the balance sheet as a separate line item under Equities.
On the other hand, SARs primarily aim at rewarding employees and motivating them to work towards increasing the value of the company (rather than sharing ownership with them). Given that the settlements of SARs happen through pay outs being made by the Company, the issue of SARs is seen as an increase in the liability of the company. Accordingly, the organization issuing SARs holds a provision for payment of SARs and discloses the same in the balance sheet as a separate line item under Current Liabilities and Provisions.
The valuation of ESOPs and SARs determines the amount to be charged to the income statement each year and consequently the carrying value of these in the balance sheet. We discuss below the requirements of Ind AS 102 Share Based Payments with respect to valuing such transactions and what that means for ESOPs and SARs.
Measurement requirements with regards to ESOP as per IND AS 102
As per IND AS 102, equity-settled share-based payment transactions with employees are required to be valued on fair value basis, with the fair value being determined as on the date of grant of such instruments. The fair value, once determined at the date of grant, is not re-measured at each reporting date.
Having determined the fair value of grants, the expenses are recognised as a charge to Income Statement (with corresponding increase in equity) over the vesting period. In determining the charge for each period till the end of the vesting period, the entity is required to estimate the number of ESOPs expected to vest. The charge to income statement is made only with respect to the number of ESOPs that the entity expects to eventually vest (and hence no charge is made for the instruments expected to lapse due to early exits / attrition etc.).
Given that the fair value is determined only at the grant date (and not subsequently), the charge to Income Statement over the vesting period is largely stable in case of grants of ESOPs. The only variation that is expected to come is due to change in company’s expectation of the number of ESOPs that it expects to vest eventually (as explained in previous paragraph).
The above measurement and reporting requirements are determined based on various paragraphs of the standard, which are quoted below:
i) Reference to fair value of equity instruments granted
This requirement is explained in Para 10 and 11 of the Standard, which requires that “for equity-settled share-based payment transactions, the entity shall measure the goods or services received, and the corresponding increase in equity, directly, at the fair value of the goods or services received, unless that fair value cannot be estimated reliably.”
ii) Using fair value of the instruments as at grant date
This requirement follows from Para 10 of the Standard, which requires that “…..the fair value of those equity instruments shall be measured at grant date” and from Appendix A of the standard which defines measurement date as “the date at which the fair value of the equity instruments granted is measured for the purposes of this Ind AS. For transactions with employees…..the measurement date is grant date…”
iii) Reference to vesting period and number of instruments that are expected to vest
This follows from Para 19 and 20 of the Standard, which requires that “..…Vesting conditions, other than market conditions, shall not be taken into account when estimating the fair value of the shares or share options at the measurement date. Instead, vesting conditions shall be taken into account by adjusting the number of equity instruments included in the measurement………”
IND AS 102, Para 20: “To apply the requirements of paragraph 19, the entity shall recognize an amount for the goods or services received during the vesting period based on the best available estimate of the number of equity instruments expected to vest and shall revise that estimate, if necessary, if subsequent information indicates that the number of equity instruments expected to vest differs from previous estimates. On vesting date, the entity shall revise the estimate to equal the number of equity instruments that ultimately vested”
As mentioned above, it is important to note here that the valuation of ESOPs is not impacted by change in fair value of options between the reporting dates. Instead, only change in number of options expected to vest leads to a change in the valuation of ESOPs. This is in line with the treatment of equity shares issued by the Company whose value at any reporting date is based on the price at which they were originally issued and are not the current market price of the shares.
Measurement requirements with regards to SARs as per IND AS 102
As per IND AS 102, SARs are cash-settled payment transactions with employees, which are required to be valued on fair value basis at each reporting date. Thus, the SARs are required to be re-valued at each reporting date till the date of settlement of the liability.
Having determined the fair value of grants at each reporting date, the expenses are recognised as a charge to Income Statement (with corresponding increase in liability) over the vesting period. As in case of ESOPs, in determining the charge for each period within the vesting period, the entity is required to estimate the number of SARs that the entity expects to vest (and hence get settled). Thus, no charge to income statement is made with respect to the number of SARs that the entity expects to lapse due to early exits / attrition etc.
Given that in case of SARs, the fair value is determined at each reporting date till the date of settlement, the charge to Income Statement is relatively more volatile and is impacted by both - the change in the fair value of underlying instrument till the settlement date and a change in the company’s expectation on the number of SARs expected to vest (or actually vested) till the end of the vesting period.
The above measurement and reporting requirements are determined based on various paragraphs of the standard, which are quoted below:
i) Reference to fair value of the liability
It follows from Para 30 of the Standard, which requires that “For cash-settled share-based payment transactions, the entity shall measure the goods or services acquired and the liability incurred at the fair value of the liability….”
ii) Using fair value of the instruments at end of each reporting period till the date of settlement
It follows from Para 30 of the Standard, which requires that “….Until the liability is settled, the entity shall remeasure the fair value of the liability at the end of each reporting period and at the date of settlement, with any changes in fair value recognised in profit or loss for the period.”
iii) Reference to vesting period and number of instruments that are expected to vest
It follows from Para 33 of the Standard, which requires that “the liability shall be measured….at the fair value of the share appreciation rights…taking into account the terms and conditions on which the share appreciation rights were granted, and the extent to which the employees have rendered service to date.”
Having understood how the charge to Income statement is determined in each year, it is important to analyze how the magnitude of charge can vary year on year under ESOPs and SARs.
As explained above, under both the schemes, the charge at the grant date is based on the fair value of the underlying instruments. However, in case of ESOPs, the fair value once determined is not restated at each reporting date whilst for SARs, the fair value is re-stated at each reporting date. As a consequence, under SARs, the charge to the Income statement eventually converges to the intrinsic value of the option (i.e. difference between the actual share price on date of settlement and the share price on the date of grant). Depending upon how the final share prices moves versus the price at grant date, the cumulative charge under SARs may turn out to be lower or higher than that under ESOPs.
For example, consider a Company contemplating issuing either 1000 ESOPs or SARs to its employees with a vesting period of 1 year. Assume that as on the date of grant, the share price of the Company is Rs. 10, the exercise price is also Rs. 10 and fair value of options is Rs. 3. Assume further that the Company expects its share price at the end of 1 year to be Rs. 12.
In case of ESOPs, assuming all options vest, the Company will recognize a total charge of Rs. 3000 (i.e. 1000 ESOPs * Rs. 3, being fair value of ESOPs as on the grant date) in its Income statement over the 1-year period irrespective of the actual share price at the time of exercise of the option.
In case of SARs also, the initial charge would be same as that under ESOPs, being based on fair value of Rs. 3. However, assuming the actual share price at the time of settlement is indeed Rs. 12 per share, the cumulative charge would turn out to be Rs. 2000 (i.e. Rs. 2, being the difference between share price at price at grant * 1000 SARs). As such, the charge in this case would be lower than that under ESOPs, albeit the quarter on quarter charge may be more volatile.
Thus, one of the financial considerations impacting the choice between SAR and ESOP for a company is one of accepting volatility for a lower ‘expected’ overall charge over accepting higher overall charge for lower volatility in profits.
Note that the actual charge under SAR may turn out to be higher than ESOPs in the above example if the actual share price on settlement turns out to be higher than Rs. 13. Thus, the expectation of how the share price will perform in future is an important consideration in determining what the cumulative charge is likely to be under the two schemes.
The following table summarises the key differences in measurement between ESOPs and SARs as per Ind AS 102:

We hope you found the above article helpful. Please do share your feedback, observations or comments on the article and continue to watch this space for more articles on employee stock option solutions
Vichitra Malhotra, FIAI Founder and Consulting Actuary
v.malhotra@veritas-india.com
+91-9372876627
Disclaimer: The above content has been furnished solely for information and must not be reproduced or redistributed. It should be noted that we are not soliciting any action based upon it. Also, it does not constitute any recommendation. In particular, the information above is for general purposes only and is not an advice on employee stock option solutions valuations or preference of one scheme over another. The information given above is in summary form and does not purport to be complete. We have reviewed the above and in so far as it includes information or facts, it is believed to be reliable though its accuracy or completeness cannot be guaranteed.
The information contained in the above report should be construed as non-discretionary in nature and the recipient of this material should rely on their own investigations and take their own professional advice. Neither Veritas Actuaries and Consultants nor any person connected with it accepts any liability arising from the use of this document. The recipient(s) before acting on any information herein should make his/her/their own investigation and seek appropriate professional advice and shall alone be fully responsible / liable for any decision taken on the basis of information contained herein.