Skip to content

Corporate Accounting and Auditing · Issue, Forfeiture, Rights, Bonus, Sweat Equity, ESOP and Buy-back of Shares

Employee Stock Option Plan (ESOP): Accounting Entries and Expense Calculation

Updated 10 October 2026 · Fact-checked

An Employee Stock Option Plan gives employees the right to buy shares at a fixed exercise price after a vesting period. You spread the total cost (options expected to vest × value per option) over the vesting period as employee compensation expense, credit ESOP Outstanding, and on exercise transfer it to share capital and securities premium.

Understand Employee Stock Option Plan (ESOP)

An Employee Stock Option Plan (ESOP) gives employees an option, not an obligation, to buy the company's shares at a fixed exercise price in the future. The company usually sets this price below the market price, so the employee gains. That gain is a cost of employing them, so the company must record it as an expense.

Four dates matter. Grant date is when the company and employee agree on the plan. Vesting period is the time the employee must serve before the option becomes exercisable. Exercise period is the window in which the employee may buy the shares. Lapse happens when options are not exercised in the window, and forfeiture happens when the employee leaves before vesting.

The expense is measured on the grant date and charged over the vesting period. Under the fair value method, you use the option's fair value (from an option-pricing model; the question will give it). Under the intrinsic value method, you use market price of the share on grant date minus the exercise price. If market price is not above exercise price, intrinsic value is nil. The Guidance Note on accounting for employee share-based payments allows both, while Ind AS 102 requires fair value. Always follow what the question states.

The credit side of the expense is Employee Stock Options Outstanding (ESOP Outstanding), shown under equity. It is not a liability, because the company settles in shares, not cash. When options are exercised, the company receives cash, and the ESOP Outstanding balance moves to share capital and securities premium. If options lapse unexercised after vesting, the balance moves to a General Reserve or similar reserve. If options are forfeited before vesting, the expense already charged is reversed.

Each year you re-estimate how many options will vest. The change in estimate is adjusted through the current year's expense, so the cumulative expense always equals the proportion of time elapsed × the latest estimate of total cost.

Key rules to remember

Total cost of the plan
Options expected to vest × (Fair value or intrinsic value per option)
Value per option is fixed at grant date and not changed later. Only the number of options is re-estimated.
Intrinsic value per option
Market price on grant date − Exercise price
If the result is zero or negative, intrinsic value is nil and no expense arises.
Cumulative expense to date (straight line)
Total cost × (Years elapsed ÷ Vesting period)
Use the latest estimate of options expected to vest.
Expense for the year
Cumulative expense to date − Expense already charged in earlier years
This can be negative if estimates fall; then you reverse the excess.
Cash received on exercise
Options exercised × Exercise price
Credit share capital for face value and securities premium for the balance.

How to solve Employee Stock Option Plan (ESOP) questions

Use this order for any ESOP problem. Keep a small year-wise table so the cumulative figure is never lost.

  1. 1Note the method asked: fair value or intrinsic value. Fix the value per option at grant date.
  2. 2Find the vesting period and whether vesting is straight line (usually equal each year unless the question says graded).
  3. 3Each year, estimate options expected to vest = options granted − options forfeited so far − further expected forfeitures.
  4. 4Compute total cost = expected options × value per option, then cumulative expense = total cost × years elapsed ÷ vesting period.
  5. 5Expense for the year = cumulative expense − earlier expense. Journal: Employee Compensation Expense Dr, To ESOP Outstanding.
  6. 6On exercise: Bank Dr (options × exercise price), ESOP Outstanding Dr (options × value per option), To Share Capital (face value), To Securities Premium (balancing figure).
  7. 7On lapse after vesting: ESOP Outstanding Dr, To General Reserve. On forfeiture before vesting: reverse through the expense by the year's adjustment.

Quickest way: Cumulative table method

When to use it: Use it for multi-year problems where employees leave and estimates change.

  1. Draw columns: Year, Expected options, Value per option, Cumulative expense, Earlier expense, Year's expense.
  2. Fill cumulative expense as (expected options × value × n ÷ vesting years).
  3. Subtract the previous cumulative figure to get each year's expense.
  4. Write one journal per year for the expense and one for exercise or lapse.
  5. Check that final ESOP Outstanding equals actual vested options × value per option.

Common mistakes in Employee Stock Option Plan (ESOP)

  • Charging the whole cost in the grant year.

    Students forget the cost is spread over the vesting period.

    Fix: Divide by vesting years and charge only the cumulative portion each year.

  • Re-measuring value per option every year.

    Students confuse the number of options with their value.

    Fix: Fix the value at grant date. Only revise the expected number of options.

  • Taking the year's expense as cumulative expense.

    Students skip subtracting the amounts already charged.

    Fix: Always compute cumulative first, then deduct the earlier years' total.

  • Crediting securities premium with only cash premium on exercise.

    Students ignore the ESOP Outstanding balance being transferred.

    Fix: Premium = (exercise price − face value) × options + ESOP Outstanding transferred − nothing else; equivalently the balancing figure of the entry.

  • Showing ESOP Outstanding as a liability or reversing it to profit on lapse.

    Students treat it like a provision.

    Fix: It is an equity item. On lapse after vesting, transfer it to General Reserve; do not credit profit and loss.

  • Charging an expense under the intrinsic method when market price is below exercise price.

    Students use the absolute difference.

    Fix: Intrinsic value is nil if market price is not above exercise price.

Worked examples

Example 1

On 1 April 2025, Veda Ltd granted 10,000 options to employees at an exercise price of ₹60. Face value is ₹10. Market price on grant date is ₹90. Vesting period is 3 years; all options are expected to vest and do vest. Using the intrinsic value method, find the yearly expense and give entries for exercise of all options in year 4.

Show the solution
  1. Intrinsic value per option = 90 − 60 = ₹30.
  2. Total cost = 10,000 × 30 = ₹3,00,000.
  3. Expense each year = 3,00,000 ÷ 3 = ₹1,00,000.
  4. Each year: Employee Compensation Expense Dr ₹1,00,000, To ESOP Outstanding ₹1,00,000.
  5. On exercise: Bank = 10,000 × 60 = ₹6,00,000. ESOP Outstanding Dr ₹3,00,000. Share Capital = 10,000 × 10 = ₹1,00,000.
  6. Securities premium = 6,00,000 + 3,00,000 − 1,00,000 = ₹8,00,000.

Answer: Expense is ₹1,00,000 for each of 3 years. On exercise: Bank Dr ₹6,00,000 and ESOP Outstanding Dr ₹3,00,000; Share Capital Cr ₹1,00,000 and Securities Premium Cr ₹8,00,000.

Example 2

Rao Ltd granted 1,000 options on 1 April 2024 to employees with a 3-year vesting period. Fair value per option is ₹40. At the end of year 1, the company expects 900 options to vest. At the end of year 2 it expects 850. At the end of year 3, 800 options actually vest. Calculate the expense for each year.

Show the solution
  1. Year 1: cumulative = 900 × 40 × 1/3 = ₹12,000. Expense = ₹12,000.
  2. Year 2: cumulative = 850 × 40 × 2/3 = 34,000 × 2/3 = ₹22,666.67, rounded to ₹22,667. Expense = 22,667 − 12,000 = ₹10,667.
  3. Year 3: cumulative = 800 × 40 = ₹32,000. Expense = 32,000 − 22,667 = ₹9,333.
  4. Check: 12,000 + 10,667 + 9,333 = ₹32,000.

Answer: Expense: Year 1 ₹12,000; Year 2 ₹10,667; Year 3 ₹9,333. ESOP Outstanding at the end of year 3 is ₹32,000.

Exam tips

  • Read whether the question wants fair value or intrinsic value before calculating anything.
  • Show a year-wise table. Even if the final figure is wrong, you earn step marks for the layout.
  • Write the full journal with narration, including the exercise entry with a clear securities premium working.
  • For MCQs, check for traps: nil intrinsic value, forfeiture before vesting, or lapse after vesting going to General Reserve.
  • Check that total expense equals the actual vested options × value per option.

Practice questions from Issue, Forfeiture, Rights, Bonus, Sweat Equity, ESOP and Buy-back of Shares

Employee Stock Option Plan (ESOP) in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Employee Stock Option Plan (ESOP): frequently asked questions

What is the difference between the intrinsic value method and the fair value method?

Intrinsic value is the market price on grant date minus the exercise price. Fair value is the option's value from a pricing model and includes time value, so it is usually higher. Ind AS 102 requires the fair value method.

How do I calculate ESOP expense per year?

Compute total cost as expected vesting options × value per option. Multiply by years elapsed ÷ vesting period to get cumulative expense, then subtract expense charged earlier. The result is that year's expense.

What happens to ESOP Outstanding if options lapse?

If vested options are not exercised in the exercise period, the ESOP Outstanding balance is transferred to General Reserve. No gain goes to profit and loss.

What happens if an employee leaves before vesting?

The options are forfeited. You reduce the expected number of options and reverse the excess expense already charged through the current year's expense.