ESOP expense: meaning, how it works in India and examples

ESOP expense is the accounting cost of employee stock options. When a company gives options, it is paying part of the employee's reward in equity instead of cash. Accounting rules say that pay is a cost whether it is paid in cash or in shares, so the company records an expense in the profit and loss statement.

The charge is non-cash. The company does not write a cheque, and the matching entry goes to a reserve in equity. That is why profit goes down while the bank balance does not.

Under Ind AS 102, the standard for share-based payment, the company works out the fair value of each option on the grant date, using a pricing model such as Black-Scholes or a binomial model. It then multiplies by the number of options expected to vest and spreads the total over the vesting period.

The fair value per option stays fixed after the grant date for equity-settled awards. What is revised each year is the number of options expected to vest. If employees leave before vesting and their options lapse, the expense already booked for them is reversed. If more options vest than expected, the expense rises.

• Step 1: fix the grant date fair value per option.
• Step 2: estimate how many options will vest.
• Step 3: spread the total over the vesting period.
• Step 4: record the expense in the profit and loss and a credit to the ESOP reserve in equity.
• Step 5: update the number expected to vest each year, not the per-option value.

Options are not free for the shareholders. When an employee exercises, new shares are issued, usually at a price below market value, and the existing owners are diluted. The expense captures that cost in the year the employee earns the option.

Leaving it out would flatter profits, and it would make companies that pay in cash look worse than those that pay in options for the same work. Indian companies that follow Ind AS, which covers listed companies and larger unlisted ones above a net worth threshold, must book the charge. Many unlisted startups on the older Indian standards follow the ICAI guidance note on employee share-based payments, which has allowed an intrinsic value method, giving a lower charge. As of November 2026, a startup's choice depends on whether Ind AS applies to it, so check the notes.

The accounting treatment comes from Ind AS 102, which is aligned to the international standard on share-based payments. For listed companies, the Securities and Exchange Board of India (Share Based Employee Benefits and Sweat Equity) Regulations, 2021 govern how plans are designed, approved and disclosed. The Companies Act, 2013 and its share capital rules decide who can receive options and how a plan is passed.

Cash-settled plans, such as stock appreciation rights paid in cash, are treated differently. They create a liability that is remeasured at each reporting date, so the expense moves with the share price. Equity-settled plans, the common kind in startups, keep the grant date value.

ESOP expense often jumps around an IPO. Options that vest only on a listing, or that are granted at a high valuation after a funding round, can create a large charge in the year the condition is met. Some companies also accelerate vesting before a listing and book the remaining cost at once, which can turn a modest loss into a large one for that year.

Readers of a draft red herring prospectus can see the plan, the number of options outstanding, the exercise prices and the yearly charge in the notes. Comparing the charge with total employee cost shows how heavily the company relies on equity as pay. It also shows how much dilution future holders face when the options are exercised.

Many startups report adjusted EBITDA, which adds back the ESOP expense. Their argument is that the charge is non-cash and depends on a valuation model, so it does not describe the running business. The size of the charge can also swing when the share price or a funding round changes the fair value of new grants.

The counter-argument is that ESOP expense is a real cost of hiring. If a company stopped giving options, it would have to pay more cash salary. A company with a large gap between EBITDA and EBITDA before ESOP cost is using equity to pay for a big part of its workforce.

The tax side is separate from the accounting charge. In India, an employee is generally taxed as salary income on the gap between the market value and the exercise price when the options are exercised, and again on any gain when the shares are sold. Startups recognised by the government have a relief that lets eligible employees defer the first tax payment, with conditions that change, so the current rules should be checked.

The company's own tax deduction for the cost follows its own rules and can fall in a different year from the accounting expense. That gap is one more reason a startup's deferred tax line can move when it has a large ESOP charge.

The expense does not reduce operating cash flow, and the cash flow statement adds it back as a non-cash item. Cash comes in only when employees pay the exercise price, and some companies buy back shares or fund taxes on exercise, which uses cash. Free cash flow therefore looks better than profit in a company with heavy option grants.

A company can show a large loss after ESOP cost and a much smaller cash burn. Both numbers are right. They measure different things, and a fair reading uses both.

Check whether a quoted profit or EBITDA is before or after ESOP expense, and find the ESOP line in the notes. Compare it with revenue and with total employee cost across years. A sudden jump may come from new grants, a one-time accelerated vesting before an IPO or the cost of a past plan being booked at once.

This guide is general information, not accounting or tax advice, so check with a chartered accountant before relying on it.