Sweat Equity Shares and Employee’s Stock Option

In this article we will discuss about the Sweat Equity Shares and Employee’s Stock Option in a Joint Stock Company.

Sweat Equity Shares:

The Companies (Amendment) Act, 1999 introduced through section 79-A a new type of equity shares called ‘Sweat Equity Shares’. The expression ‘sweat equity shares’ means equity shares issued at a discount or for consideration other than cash for providing know-how or making available rights in the nature of intellectual property rights or value additions by whatever name called

Not withstanding anything contained in section 79, which deals with the power of a company to issue shares at a discount, a company may issue sweat equity shares of a class of shares already issued if the following conditions are fulfilled, namely:

(i) The issue of sweat equity shares is authorized by a special resolution passed by the company in the general meeting;

(ii) The resolution specifies the number of shares, current market price, the consideration, if any, and the class or classes of directors or employees to whom such equity shares are to be issued;

(iii) Not less than one year has, at the time of the issue, elapsed since the date on which the company was entitled to commence business;

(iv) The sweat equity shares of company, whose equity shares are listed on a stock exchange, are issued in accordance with the regulations made by the Securities and Exchange Board of India in this behalf. But in the case of company whose equity shares are not listed on any stock exchange, the sweat equity shares are issued in accordance with the guidelines as may be prescribed.

All the limitations, restrictions and provisions relating to equity shares are applicable to sweat equity shares also.

The entries for issue of these shares are the same as for issue of any other equity shares.

Employees’ Stock Option:

The scheme of employees’ stock option was introduced by the Companies (Amendment) Act, 2000 through section 2 (15A). Employees’ Stock Option means the option given to the whole-time directors, officers or employees of a company, which gives such directors officers or employees the benefit or right to purchase or subscribe at a future date, the securities offered by the company at a predetermined price.

This is a voluntary scheme on the part of a company t0 encourage its employees to have a higher participation in the company. The company may reserve a suitable percentage of shares of an issue of shares for the employees. The shares issued to employees under this scheme may be non-transferable for a few years.

Accounting Treatment:

In order to understand the accounting treatment of employees stock option plan, it is necessary to know the meaning of various connected terms, which is briefly given below:

Grant of Option:

Grant of option means giving an option to employees of the concern to subscribe to the shares of the concerns.

Vesting:

Vesting is the process by which the employees are given the right to apply for the shares of the company in exercise of the options granted to them in pursuance of an employees stock option plan.

Vesting Period:

Vesting period is the time period during which the vesting of the options granted to the employees in pursuance of employees stock option scheme takes place.

Option Discount:

Option discount means the excess of the market price of the share at the date of grant of option under ESOS over the exercise price of the option.

It should be remembered that option means a right to the employee but not an obligation on his part to take up the shares.

The accounting value of the options granted under ESOS is treated as another form of employee- compensation in the financial statements of the company; the amount is amortized on a straight line basis over the vesting period. For the record of this transaction, Employee Compensation Expense Account is debited and Employee Stock Options Outstanding Account is credited.

If a vested option lapses on the expiry of the exercise period, the above-mentioned journal entry is reversed with the amount of lapsed option. After the fair value of the option has been accounted for as employee compensation, Employee Stock Options Outstanding Account is debited and General Reserve is credited with an appropriate amount.

Illustration 1:

The share capital of Carewell Ltd. is divided into equity shares of? 10 each. On 1st April 2009, it granted 4,000 employees stock options at ? 25 per share when the market price of the share was ? 125. The options were to be exercised between 1st December, 2009 and 28th February, 2010. The employees exercised their options for 3,900 shares only; the remaining options lapsed. Carewell Ltd. closes its books of account on 31st March, every year.

Pass journal entries for the above mentioned transactions related to the financial year ended 31st March, 2010.

If the vesting period covers more than one accounting year, the amount of employee compensation expense will be amortized on a straight line basis over the entire vesting period.

Illustration 2:

On 1st April, 2009 MN Ltd. granted 10,000 employee stock options at Rs 30 per share when the market price of a share was Rs 140. The vesting period was 2½ years and the maximum exercise period was 6 months. 3,000 unvested options lapsed on 1st July, 2011,6,500 options were exercised during the six months of exercise period; the remaining options lapsed. The company closed its books of account on 31st March every year.

Pass journal entries for all the transactions.

Illustration 3:

On 1st April 2008 Sunshine Ltd. granted 100 stock options to each one of its 500 employees @ 20 per share the options to be available to those still in employment of the company at the time Of vesting of options. The market value of fully paid equity share of Rs 10 of the company was Rs 80 on 1st April 2008.

The terms of the offer were that the options would vest at the end of year 1 it the earnings of the company increased by 9% or they would vest at the end of year 2 if the average increase in earnings of two years was 8% or lastly they would vest at the end of the year 3 if the average increase in earnings for three years was at least 6%.

The options were to be exercised by the employees within 6 months of the vesting. The conditions for year 1 and year 2 were not met but the condition was satisfied in year 3.

2,500 unvested options lapsed on 31st March, 2009; 2,000 unvested options lapsed on 31st March, 2010 while 1,500 unvested options lapsed on 31st March, 2011. During the exercise-period 425 employees exercised the option; other options lapsed.

The company closed its books of account on 31st March every year. You are required to pass journal entries and prepare Employee Stock Options Outstanding Account. Working notes be shown distinctly.