IFRS 2 Share-Based Payments: Equity-Settled Awards and ESOP Accounting

IFRS 2 Share-Based Payments: Equity-Settled Awards and ESOP Accounting

By Sai Manikanta Pedamallu (ACCA, CMA US, CSCA US, CGMA, ACMA, Dip IFRS, M.Com, MBA, MA)

Lead Instructor, Global Fin X | www.globalfinx.in/manikanta

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IFRS 2 rests on a single deceptively simple idea: when a company gives an employee shares or options instead of cash, it has still paid for something, and that something needs to be expensed, exactly as a cash salary would be. For years, plenty of companies (and plenty of investors) treated ESOP grants as if they were free, a clever way to reward people without touching the P&L. IFRS 2 closed that gap permanently. Every equity-settled grant carries a genuine cost, measured at grant date, and spread across the period the company is actually buying with that grant, the employee's future service.

This post covers equity-settled awards, which is where the vast majority of Indian ESOP schemes sit. Post 60 covers cash-settled awards, modifications, and group share plans in depth.

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Scope: What IFRS 2 Actually Captures

IFRS 2 applies to any transaction in which an entity receives goods or services in exchange for equity instruments of the entity, or incurs a liability for amounts based on the price of its equity instruments (or those of another group entity). This is broader than most people initially assume: it captures not just employee stock options, but restricted stock units, stock appreciation rights, sweat equity, and even certain supplier or consultant arrangements settled in shares.

For the purposes of this post, the focus is squarely on equity-settled employee share-based payment transactions, since these represent the overwhelming majority of real-world ESOP practice in India, whether at listed IT majors, unlisted startups, or PE-backed growth companies.

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The Core Recognition Principle

An entity recognises the goods or services received or acquired in a share-based payment transaction when it obtains those goods or as the services are received. For services received from employees over a vesting period, this means the expense is spread across that vesting period, not recognised all at once on the grant date and not deferred until the option is actually exercised.

The corresponding credit for an equity-settled transaction goes to equity, not to a liability. This is one of the defining features that separates equity-settled from cash-settled treatment: once the fair value of the equity instruments has been fixed at grant date, the entity's obligation is to deliver shares (or share options), not cash, and the accounting reflects a genuine equity transaction rather than the incurrence of a monetary liability.

Why Fair Value Is Measured at the Equity Instrument, Not the Service

IFRS 2 explicitly states that where equity-settled share-based payments are made to employees, it is generally not possible to reliably measure the fair value of the services received directly (how do you put a reliable number on "future service from this software engineer"?), so the entity instead measures the transaction, and the corresponding increase in equity, by reference to the fair value of the equity instruments granted, at the grant date.

This is the foundational assumption running through the entire standard for employee awards: the fair value of the equity instrument on grant date is treated as a reasonable proxy for the fair value of the services the company expects to receive in exchange for it.

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Grant Date: Why the Exact Date Matters

The grant date is the date at which the entity and the employee (or other party) have a shared understanding of the terms and conditions of the arrangement, and crucially, if the arrangement is subject to an approval process (a board or shareholder vote, for instance), the grant date is the date that approval is obtained, not the earlier date on which the terms were first communicated or agreed in principle.

This distinction genuinely matters because fair value is fixed once, at grant date, for equity-settled awards, and share prices move. IFRS 2's own implementation guidance illustrates this precisely: where a company's management board announces a share award plan on 1 January with all terms and conditions specified, but the plan requires supervisory board approval that is not obtained until 20 February, the grant date is 20 February, and the fair value used for the entire accounting exercise is measured as at that later date, even though the expense recognition period (the vesting period) is deemed to have commenced from 1 January, since that is when the employee actually began providing the relevant service under the arrangement.

For Indian listed companies, where SEBI's Share Based Employee Benefits and Sweat Equity (SBEB) Regulations, 2021, mandate that ESOP schemes for listed entities require both compensation committee oversight and shareholder approval via special resolution, the grant date question is not academic. A scheme approved in principle by the compensation committee in one quarter but only ratified by shareholders in a later quarter has its true IFRS 2 grant date, and therefore its fair value measurement date, fixed at the later shareholder approval date, not the earlier committee recommendation date.

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Vesting Conditions: The Distinction That Drives Everything

IFRS 2 splits vesting conditions into two fundamentally different categories, and getting this classification right is the single most consequential judgment in the entire equity-settled accounting model, because the two categories are treated in opposite ways.

Non-Market Vesting Conditions (and Service Conditions)

Service conditions (the employee must simply remain employed for a specified period) and non-market performance conditions (the employee must remain employed and the entity, or the employee, must achieve a specific target such as an EBITDA growth rate, a revenue milestone, or a specific number of new client contracts signed) are not built into the grant-date fair value calculation itself. Instead, they affect the entity's estimate of how many awards are actually expected to vest.

Critically, this estimate is trued up. At each reporting date, the entity revises its estimate of the number of equity instruments expected to vest based on the latest available information, and any change in that estimate is recognised, with the cumulative expense at any reporting date always representing what the total expense would have been to that date had the current, revised estimate been used from the very beginning of the vesting period. If, in a later period, the target ultimately fails to be achieved (or the employee leaves before satisfying the service condition), the amount already recognised as an expense is reversed.

Market Conditions

A market condition is a performance target that is related to the market price of the entity's own equity instruments, such as a specified share price target, a specified amount of intrinsic value on exercise, or achieving a total shareholder return (TSR) ranking relative to a peer group of comparable companies over a specified period.

Market conditions are treated completely differently: they are built directly into the grant-date fair value calculation of the equity instrument itself (a market-condition award is inherently worth less at grant date than an otherwise identical award without such a condition, since achieving the market condition is genuinely uncertain, and the valuation model, typically a Monte Carlo simulation for TSR-based awards, prices that uncertainty directly into the fair value). Once that fair value is fixed, there is no subsequent true-up for whether the market condition is actually achieved or not. An entity recognises the expense for an award with a market condition, provided all other vesting conditions (such as the underlying service condition) are satisfied, irrespective of whether that market condition is ever met.

This produces a genuinely counterintuitive but deliberate outcome: an employee could remain in service for the full vesting period, the market condition target could be completely missed, and the expense is still recognised in full, because the market condition's probability of achievement was already priced into the grant-date fair value from day one.

Non-Vesting Conditions

A small but important third category exists: non-vesting conditions, other conditions that do not relate to service or to the entity's own performance at all, and that are not vesting conditions under IFRS 2's specific definition (a requirement that the employee contribute towards the cost of the award, for instance, or a condition based on a non-market index unrelated to the entity itself). These are also factored into the grant-date fair value measurement, similarly to market conditions, with no subsequent true-up for whether they are actually satisfied.

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Worked Example: Non-Market Performance Condition with a Changing Estimate

An Indian technology company grants share options to 500 employees on 1 April 2024, with a three-year service-based vesting condition (employees must remain employed until 31 March 2027). The grant-date fair value of each option is Rs. 90.

At grant date, management estimates that 20% of employees will leave before the options vest, so 400 employees (80% of 500) are expected to receive their options in full.

Year 1 (FY 2024-25): No change in the estimate; 20% attrition still expected.

Cumulative expense to be recognised by end of Year 1 = 500 employees x 80% expected to vest x Rs. 90 x (1/3 years elapsed) = 400 x Rs. 90 x 1/3 = Rs. 12,000 (illustrative small numbers for clarity of mechanics; in practice this would be scaled to actual option counts and would run into lakhs or crores).

Year 2 (FY 2025-26): Actual attrition has been higher than expected. Management revises its estimate: only 350 employees (70% of 500) are now expected to remain and vest.

Cumulative expense that should have been recognised by end of Year 2, using the revised estimate applied from the start = 500 x 70% x Rs. 90 x (2/3 years elapsed) = 350 x Rs. 90 x 2/3 = Rs. 21,000.

Expense already recognised in Year 1 = Rs. 12,000.

Expense to recognise in Year 2 = Rs. 21,000 - Rs. 12,000 = Rs. 9,000.

Year 3 (FY 2026-27, vesting date): 340 employees actually remain and vest (attrition was slightly worse than the Year 2 revised estimate).

Total expense that should have been recognised over the full three years, based on the final actual outcome = 340 x Rs. 90 = Rs. 30,600.

Expense already recognised across Years 1 and 2 = Rs. 12,000 + Rs. 9,000 = Rs. 21,000.

Expense to recognise in Year 3 = Rs. 30,600 - Rs. 21,000 = Rs. 9,600.

Notice what never changes throughout this entire process: the Rs. 90 grant-date fair value per option. Only the number of awards expected to vest is trued up period by period; the fair value itself, once fixed at grant date, is never revisited for equity-settled awards, no matter how the company's own share price moves over the vesting period.

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Fair Value Measurement Techniques

IFRS 2 does not mandate a specific valuation model, but it does require the model chosen to be consistent with generally accepted valuation methodologies for financial instruments and to incorporate, at a minimum, the exercise price of the option, the expected life of the option, the current price of the underlying shares, the expected volatility of the share price, any expected dividends, the risk-free interest rate over the life of the option, and any market condition attached to the award.

In practice, thematic reviews of listed company disclosures find that Black-Scholes is the standard model used where there is no market condition attached to the award, while a Monte Carlo simulation model is typically used specifically where the award includes a market condition such as a relative TSR target, since Black-Scholes alone cannot adequately price a condition dependent on relative performance against a peer group over time.

For unlisted Indian companies and startups, where no observable market price exists for the underlying shares at all, the exercise price cannot simply be compared against a quoted share price; the fair value of the underlying equity itself must first be established, typically through a valuation performed by a SEBI-registered Category I merchant banker using discounted cash flow or net asset value methodology, before an option pricing model can even be applied on top of that underlying equity value.

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Equity-Settled ESOP Accounting in the Indian Context

The Regulatory Layers Sitting Alongside Ind AS 102

A single ESOP grant in India genuinely sits at the intersection of several distinct regulatory frameworks simultaneously, and it is worth being explicit that these frameworks address different questions entirely; getting the Ind AS 102 accounting right does not automatically mean the company's tax, company law, or securities law obligations have been addressed, and vice versa.

Companies Act 2013. Section 62(1)(b) governs the issuance of ESOPs by both listed and unlisted companies, requiring shareholder approval through a special resolution, among other procedural conditions.

SEBI SBEB Regulations, 2021. These replaced the earlier 2014 regulations and the older 2002 sweat equity regulations, and specifically govern listed company ESOP schemes, mandating compensation committee oversight, shareholder approval, and expanded employee eligibility that now specifically includes non-permanent employees such as contractual and gig workers, alongside separate regulatory treatment for RSUs, stock appreciation rights, and phantom stock arrangements.

Ind AS 102. Governs the accounting expense recognised in the financial statements, following the grant-date fair value and vesting-period expense mechanics described above.

Income tax. ESOP taxation in India operates in two distinct stages regardless of the Ind AS 102 accounting treatment: a perquisite tax at the point of exercise (calculated as the fair market value of the shares on the exercise date, less the exercise price actually paid, taxed as salary income under Section 17(2)(vi) of the Income Tax Act, 1961, with the Income Tax Act, 2025 renumbering but not substantively changing this position from the point it comes into force), and subsequently a capital gains tax when the shares are eventually sold. For DPIIT-recognised eligible startups meeting the conditions under Section 80-IAC, a specific tax deferral is available, allowing the employee to defer paying the perquisite tax until the earliest of the sale of the shares, cessation of employment, or 48 months from the end of the assessment year in which the shares were allotted, rather than paying tax immediately on exercise.

The critical point for anyone learning IFRS 2 in an Indian context: none of this tax mechanism affects the Ind AS 102 accounting expense in any way. The company recognises its grant-date fair value expense over the vesting period regardless of when, or whether, the employee's own perquisite tax liability crystallises; the accounting standard and the tax code are answering entirely separate questions, using entirely separate valuation dates and entirely separate figures.

Why Listed Indian IT Companies Rely Heavily on RSUs Rather Than Options

For Infosys, TCS, Wipro, and similar listed IT majors, restricted stock units (RSUs) have become the dominant form of equity compensation, rather than traditional stock options with a separate exercise price. An RSU is structurally simpler from the employee's perspective (no strike price, no exercise step; the shares are simply delivered on vesting, subject to the vesting conditions being met) and from an Ind AS 102 accounting perspective, the fair value of an RSU at grant date is typically simpler to determine than an option, since there is no option-pricing model complexity layered on top; the grant-date fair value is generally the market price of the underlying share itself (adjusted for factors such as expected dividends the RSU holder will not receive during the vesting period, where relevant), rather than requiring a full Black-Scholes or Monte Carlo calculation.

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Group Share-Based Payment Arrangements: A Preview

Where an employee of an Indian subsidiary receives options or RSUs in the shares of an overseas ultimate parent company (extremely common for Indian subsidiaries of US-listed technology companies, and increasingly common the other direction as well, where Indian-listed groups grant awards across subsidiaries in different jurisdictions), specific group share-based payment guidance under IFRS 2 governs which entity within the group recognises the expense and how any recharge arrangement between the subsidiary and the parent is accounted for. This is covered in full in Post 60, alongside cash-settled awards and modifications, since it connects directly to those topics.

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Ind AS 102 vs IFRS 2: Key Differences

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What Big 4 Auditors Focus On

Grant date determination where shareholder or committee approval is required. Auditors specifically test whether the entity has used the correct grant date (the date final approval, such as shareholder ratification under SEBI SBEB Regulations, was actually obtained) for fair value measurement purposes, rather than an earlier date on which terms were merely proposed or recommended.

Classification of vesting conditions as market versus non-market. Given how differently the two categories are treated (true-up versus no true-up), auditors test whether conditions genuinely linked to the entity's own share price (TSR targets, share price hurdles) have been correctly classified as market conditions and priced into grant-date fair value via an appropriate model, rather than being incorrectly treated as non-market conditions subject to a probability-based true-up.

Attrition and vesting estimate support. Auditors test whether the entity's estimate of the number of awards expected to vest is genuinely supported by historical attrition data and current workforce information, rather than an unsupported assumption, since this estimate directly drives the cumulative expense recognised at each reporting date.

Valuation model appropriateness and input reasonableness. For awards requiring an option-pricing model, auditors (often engaging their own valuation specialists) test whether the volatility, risk-free rate, expected life, and dividend yield assumptions used are reasonable and consistent with market data, and specifically test whether a Monte Carlo (rather than Black-Scholes) model has been used wherever a genuine market condition is present.

Consistency between the accounting expense and unrelated tax and regulatory processes. Auditors confirm that management has not, even inadvertently, conflated the Ind AS 102 grant-date fair value expense with the entirely separate perquisite tax valuation (which uses the exercise-date fair market value, not the grant-date fair value, and follows entirely different rules under Rule 3(8) and Rule 3(9) of the Income Tax Rules).

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Dip IFRS Exam Angle

IFRS 2 equity-settled questions are a Dip IFRS staple, almost always requiring a multi-year expense calculation with a changing vesting estimate, exactly the structure of the worked example above.

Most tested areas:

Grant date identification: correctly identifying the grant date where an approval process is required, and understanding that fair value is fixed at that date, not an earlier announcement date.

Building the multi-year expense schedule for a non-market condition award: cumulative expense at each reporting date equals the number of awards currently expected to vest, multiplied by grant-date fair value, multiplied by the proportion of the vesting period elapsed, with the current year's charge being the difference between this cumulative figure and the amount already recognised in prior years.

Distinguishing market from non-market conditions and applying the correct treatment to each: market conditions are priced into fair value with no subsequent true-up; non-market conditions affect the vesting estimate with full period-by-period true-up.

Understanding that the fair value figure itself, once fixed at grant date, is never remeasured for equity-settled awards regardless of subsequent share price movements.

Common traps:

Remeasuring the grant-date fair value in a later period because the entity's share price has changed. This never happens for equity-settled awards; only the estimated number of awards expected to vest is revised.

Reversing the cumulative expense for an award that fails to meet a market condition, provided the service condition was satisfied. No reversal is required for a missed market condition; the expense stands.

Recognising the expense as a liability rather than a credit to equity, for what is a genuinely equity-settled arrangement.

Using the exercise-date fair value (relevant for perquisite tax purposes in India) instead of the grant-date fair value (the figure required for the accounting expense) in a calculation.

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FAQ

Does the company get a corresponding tax deduction matching the IFRS 2 accounting expense?

Not necessarily, and this is a genuinely separate question from the accounting treatment itself. Tax deductibility of ESOP costs is governed by domestic tax law (in India, this involves its own specific rules under the Income Tax Act) and does not automatically mirror the Ind AS 102 grant-date fair value expense; this potential timing and quantum mismatch between accounting expense and tax deduction is itself a common source of deferred tax complexity, addressed under Ind AS 12.

If an employee leaves the company before the service condition is met, is the cumulative expense already recognised reversed?

Yes, for a failure to satisfy a service condition (or a non-market performance condition), the cumulative expense previously recognised for that specific employee's unvested awards is reversed, since those awards will now never vest. This is fundamentally different from the treatment of a missed market condition, where no reversal occurs provided the service condition itself was met.

Can an entity choose to expense equity-settled awards immediately at grant date rather than spreading the cost over the vesting period?

No, not where a vesting period genuinely exists. If the award vests immediately (no future service is required at all), the entity is deemed to have already received the service in full, and the entire expense is recognised immediately. Where a vesting period exists, however, the expense must be spread over that period as the service is deemed to be received, reflecting the future service the vesting condition is designed to secure.

How is the fair value of an unlisted Indian company's share options determined for Ind AS 102 purposes?

The underlying equity fair value first needs to be established, typically through a valuation performed by a SEBI-registered Category I merchant banker (commonly using discounted cash flow or net asset value methodology), since no observable market price exists. An appropriate option-pricing model is then applied using that underlying equity value as an input, alongside the other standard inputs (exercise price, expected life, volatility, risk-free rate, and expected dividends).

Does granting an RSU (with no exercise price at all) simplify the Ind AS 102 accounting compared to a traditional stock option?

Generally yes, from a fair value measurement perspective, since an RSU's fair value at grant date is typically based directly on the market price of the underlying share (adjusted for factors such as dividends the RSU holder will not receive during the vesting period), without requiring the more complex option-pricing model calculations needed for a traditional option with a separate exercise price.

Does the SEBI SBEB Regulations 2021 change how the Ind AS 102 expense itself is calculated?

No. SEBI's regulations govern the corporate governance and procedural requirements for listed company ESOP schemes (compensation committee oversight, shareholder approval, eligibility criteria, and specific scheme disclosures), not the accounting measurement itself; the Ind AS 102 grant-date fair value and vesting-period expense mechanics apply identically to a listed company's scheme regardless of these additional SEBI procedural requirements, though the grant date used for accounting purposes is directly affected by when the SEBI-mandated approval process actually concludes, as discussed above.

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Enroll with Global Fin X

IFRS 2 equity-settled questions reward candidates who can build a clean multi-year vesting schedule and correctly separate market from non-market condition treatment, exactly the mechanics tested in the worked example in this post. Post 60 builds directly on this foundation with cash-settled awards, modifications, and group share plan arrangements. Our programme covers both posts with detailed lectures, full worked examples grounded in Indian ESOP and RSU practice, exam-style MCQs, and a dedicated LMS for working professionals.

Enroll Now: Dip IFRS Programme

Faculty profile: www.globalfinx.in/manikanta

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This is Post 59 of the Global Fin X IFRS Series. Previous: IAS 19 vs Ind AS 19: Where India Diverges on Remeasurements. Next: Post 60: IFRS 2 Cash-Settled Awards, Modification of Terms and Group Share Plans.