Please see the post titled Warrants and Employee Stock Options to understand the basic concepts
Note that I have changed certain notations used in my previous post on warrants and employee stock options, in order to conform to those used in the Consolidated Financial Statements of Dabur Limited. For this case study, I have used the statements for 2011-12
1. Paid in Capital in Excess of Par to Share Premium
2. Common Stock to Total Shares Issued for ESOP
3. Paid in Capital-ESOP to ESOP Scheme Outstanding
I don't need to emphasize the need for ESOP schemes in a growing company. But as we will see, ESOPs incur a cost on the company, specifically on it's shareholders. The following is disclosed in the 2011-12 report of the company.
1. Number of Options granted : 1557412
2. Pricing formula : Each option carries the right to the holder to apply for one equity share of the Company at par/discount to market value.
3. Options vested : 1377056
4. Options exercised : 1377056
5. Total number of shares arising as a result of exercise of option
6. Options lapsed/cancelled : 1520376
7. Variation in terms of options : None
8. Money realized by exercise of options : Rs. 672721/-
9. Total number of options in force : 18287210
The fair value of the options under intrinsic value method is 111.90 as mentioned in the AR. Fair value under this method is the difference between the exercise price and the market price of the share at that time. We can also use the Black scholes Model for evaluating the options.
The formula used for recording the cost of the options based on the intrinsic value method in the balance sheet is as follows
The maximum of
1. (Fair value of options MINUS a percentage of market price of the shares) x no of options granted.
2. (Fairvalue of options X no of options granted) MINUS (a percentage of total empoyee compensation for that year)
So when the options are granted, they are recorded using the above formula, as per indian accounting standards. From the balance sheet, we can find that the options granted in the year 2011-12, is recorded at a cost of 928 lacs. And we can find that the cancelled options is recorded at a total of 802 lacs.
Options are a liability to the company. But they are also long term liabilities. The opposite entry will naturally be a capitalised expense, which will be amortized over the life of the options.
The following is the journal entry for granting options
Deferred ESOP Scheme Outstanding expense 928
ESOP Scheme Outstanding liability 928
As you can see, the expense for the liability is deferred, which makes it a capitalized asset. This asset can be found under non current assets in the balance sheet. The entry for cancelled options is as follows.
Deferred ESOP Scheme Outstanding expense 802
ESOP Scheme Outstanding liability 802
This capitalised asset, needs to be amortized over the life of the options. The balance in the Deferred ESOP Scheme Outstanding expense account at the beginning is Rs 8295 lacs. the amortization entry is as follows.
Amortization Expense 3037
Deferred ESOP Scheme Outstanding expense 3037
The balance in the ESOP Scheme Outstanding liability account is Rs 11681 lacs at the beginning. This was accumulated over time, This liability gets reduced only when the options gets exercised.
The total no of options exercised is 1377056. An equivalent amount of share is issued in leu of the options exercised ie 1377056. The value of the options exercised is 1219 lacs, which is calculated using the formula mentioned above that conforms to Indian Accounting standards. The weighted average exercise price (per option) is Rs 50.90. So the company should receive a cash of
1377056 X 50.90 = 700.9 lacs from the employees for exercising the options. But it has received only
Rs 672721/- in total, which is only Rs 0.48/- per options. I don't know the terms and conditions of ESOP scheme at Dabur Limited, but this seems an excess amount of compensation to the employees, especially to the promoters, who are also directors on the board.
For the year 2011-12, the average price of shares was Rs 100/-. The total benefit for the employees under ESOP scheme = (100 X 1377056)-672721=13.7 crore. This is in additional to all other salaries and remunerations.
The journal entry for options exercise is as follows
PL Account 7
ESOP Scheme Outstanding liability 1219
Total Shares issued for ESOP 14
Share Premium 1219
For the company there was also a transition adjustment of 79 lacs in the ESOP Scheme Outstanding liability account. This is a one time compliance adjustment and can be ignored.
The summary of the ESOP Scheme Outstanding Liability account is as follows
ESOP Scheme Outstanding
|Previous Year Balance||11681|
|Addition during this year||928|
|Allotted during this year||-1219|
|Cancellation during this year||-802|
|End of Year Balance||10509|
The Summary of Deferred ESOP Scheme Outstanding expense account is as follows
ESOP Scheme Outstanding expense account
|Previous Year Balance||8295|
|Addition during the year||928|
|Less : Cancelled during the year||-802|
|Less: Amortised during the year||-3037|
|End of Year Balance||5384|
The issue of 14 lac shares is financed partly from PL account and partly with cash received from employees. The irony is that even the par value of Rs 1 per share is not paid for by the employees and had to be partly financed from PL Account.
The liability of ESOP Scheme Outstanding is reduced by 1219 lac and the shareholder's equity of share premium is increased by the same amount. This equity is created from charging the profit of the company regularly through amortization. This is equivalent to siphoning retained profits (surplus) to create the liability first, and then the equity, as the options are exercised.