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Esop Fables: New accounting norms to hit dole-happy cos
April, 15th 2008

Companies giving stock options to their employees to retain them are expected to see a drop in their profits as they adopt international accounting standards.

The International Financial Reporting Standards (IFRS) that companies have to adopt from April 2010 require them to value the cost of employee stock options as per their fair value and charge for it over the service period. That is, if the share price moves above the price at which the employee is given a right to purchase, then the option value, multiplied by the number of shares, has to be shown in the companys profit-and-loss account as a cost, explained PricewaterhouseCoopers partner Sunder Iyer. This has the potential to reduce the companys profitability and earnings per share significantly, accounting experts said.

Companies now have the option to value their Esops as per their fair value, but most of them do not do that since they have the option not to. But once the IFRS becomes mandatory, they lose this option.

Although the right to purchase the share was given at a price close to the market price on that date, they did appreciate over a period of time. This appreciation has made the employee stay with the company. Although the company has not given any discount on the date when the employee has exercised the option, he did benefit from its appreciation.

This is reckoned as a cost as per global norms and has to be reflected in the companys profits and loss account.
The proposed fair value accounting norms are part of International Financial Reporting Standards 2 on group and treasury share transaction.

Although IFRS compliance becomes compulsory from April 2011, the balance sheet for the preceding year too has to be in the IFRS format so that both could be compared. This makes the effective compliance date April 2010. The accounting regulator ICAI also want companies to adopt IFRS as early as possible. Once the new norms come into play, the Central Board of Direct Taxes valuation norms for tax treatment of Esops would also become redundant as the actual cost of the options to the employer would be reflected in their profit and loss statement.

Accounting of acquisitions, Esops, derivatives and restatement of profits are the major areas where the new accounting norms will impact the financial statements of companies, IFRS expert and KPMG executive director Jamil Khatri said.

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