Valuation for Financial Reporting
ESOP Valuation under Ind AS 102 for a Listed Indian Company: Valuing a Graded Vesting Grant Tranche by Tranche
- Ind AS 102 Compliant
- Tranche-wise Black-Scholes
A listed Indian company granted employee stock options that vested in three annual instalments. Under Ind AS 102, that single grant could not be valued as a single option. This is how we broke it into tranches, built a separate set of Black-Scholes inputs for each, and delivered a grant-date fair value the auditors could trace end to end.
Client details and all monetary figures have been withheld. The methodology, inputs and judgements described below are reproduced exactly as applied.Engagement snapshot
| Particulars | Details |
|---|---|
| Client | Company listed on an Indian stock exchange (identity withheld) |
| Purpose | Financial reporting - measurement of share-based payment expense |
| Standard applied | Ind AS 102, Share-based Payment, read with the ICAI Guidance Note on Accounting for Employee Share-based Payments |
| Instrument valued | Employee stock options granted under an approved ESOP scheme |
| Settlement | Equity-settled |
| Vesting pattern | Graded - three annual tranches in the ratio 25% : 50% : 25% |
| Exercise period | Three years from the respective vesting date |
| Valuation date | Grant date |
| Model used | Black-Scholes-Merton, applied separately to each vesting tranche |
| Deliverable | Valuation report with fair value per option per tranche, input derivation and a year-wise expense amortisation schedule |
Why the Engagement Arose
Ind AS 102 requires an equity-settled share-based payment to be measured at the fair value of the equity instruments granted, determined at the grant date. That fair value is then recognised as an employee benefit expense over the vesting period, with a corresponding credit to the share-based payment reserve. The charge is real, it hits reported profit, and it is never subsequently remeasured for changes in the share price - which is exactly why the grant-date number has to be right the first time.
The company had approved a fresh ESOP grant to a group of employees. Its finance team needed an independent, documented fair value per option so that the expense could be booked correctly from the year of grant, and so that the disclosures required under Ind AS 102 - the model used, the weighted average inputs, and how each input was determined - could be supported if questioned.
What Made This Valuation Non-Routine
Three features of the grant meant that a single application of Black-Scholes would not have produced a defensible answer.
- Graded vesting, not cliff vesting. Ind AS 102 treats each instalment of a graded vesting award as a separate grant with its own vesting period. Three tranches therefore meant three option valuations, not one - each with its own expected life, its own risk-free rate and its own volatility estimate.
- A traded but thinly traded share. The company's shares traded, but not deeply and not on every day at meaningful volume. Taking the closing price on a single day would have let one thin session drive the entire expense.
- Expected life had to be estimated, not assumed. Options are almost never held to contractual expiry, so contractual life overstates the option's value. Expected life had to be estimated, and it had to differ tranche by tranche.
Our Approach: Building Each Black-Scholes Input
Black-Scholes needs six inputs. Two of them - share price and exercise price - are common to all three tranches at the grant date. The other four change as the horizon lengthens, and it is the tranche-wise treatment of these that separates a compliant valuation from a superficial one.
1. Share price (S) - market price method, on a volume-weighted basis
Because the company is listed, the underlying share value was determined under the market price method rather than by a discounted cash flow or asset-based approach. To neutralise the effect of thin and irregular trading, we did not use the closing price on a single date. We computed a volume-weighted average price (VWAP) across the full twelve months of exchange-traded data preceding the grant date, dividing total traded value by total traded quantity for the period.
This gives a price that reflects where volume actually changed hands, not where a handful of low-volume trades happened to close. It is also the treatment most consistent with the fair value notion in Ind AS 102 - a price a market participant would transact at, rather than an isolated quote.
2. Exercise price (K)
Taken directly from the approved ESOP scheme documents. No estimation is involved; the strike is a contractual fact. We reconciled it to the board and shareholder approvals and to the grant letters.
3. Expected life (t) - the midpoint method, tranche by tranche
This is the input most often applied incorrectly. Expected life is not the vesting period, and it is not the contractual life. An employee cannot exercise before vesting and will not exercise after expiry, so the exercise window for each tranche runs from its vesting date to the end of the exercise period.
We applied the midpoint (simplified) method: expected life equals the midpoint of the minimum time to exercise and the maximum time to exercise, measured from the grant date. With annual vesting and a three-year exercise period, this produced a distinct expected life for each tranche.
| Tranche | Proportion vesting | Earliest exercise (years from grant) | Latest exercise (years from grant) | Expected life applied |
|---|---|---|---|---|
| Tranche 1 | 25% | 1.0 | 4.0 | 2.5 years |
| Tranche 2 | 50% | 2.0 | 5.0 | 3.5 years |
| Tranche 3 | 25% | 3.0 | 6.0 | 4.5 years |
4. Risk-free rate (r) - tenor-matched government securities
We used the Government of India sovereign yield curve published by Financial Benchmarks India Pvt. Ltd. (FBIL) as at the grant date, taking the annualised yield-to-maturity at the tenor corresponding to each tranche's expected life - not a single ten-year benchmark applied across all three.
Because the curve was upward sloping over the relevant range, the longer tranches picked up slightly higher rates. The rates applied fell in a narrow band of roughly 6.5% to 6.9% across the three tranches. Using one rate for all three would have misstated the discount on the exercise price for two of them.
5. Expected volatility (σ) - the company's own share price history
Ind AS 102 looks first to the historical volatility of the entity's own shares over a period commensurate with the expected life of the option. Since the company is listed with a sufficient price history, there was no need to fall back on listed peers or a sector index - and doing so would have been the weaker choice, because an index blends away company-specific risk and typically understates the volatility of a single stock.
We therefore computed volatility from the company's own daily traded prices, and - critically - used a different lookback period for each tranche, matching the length of the historical window to that tranche's expected life. Daily logarithmic returns were computed, the standard deviation of those returns taken, and the result annualised over the number of trading days in a year. The three estimates clustered in the high-fifties to low-sixties percent range, easing slightly as the observation window lengthened.
6. Expected dividend yield (q)
Option holders under this scheme carried no entitlement to dividends before exercise, and the company had no established dividend track record. Dividend yield was accordingly taken as nil, with the basis documented in the report rather than left as a silent assumption.
The Result: Three Fair Values, Not One
With the inputs assembled, the Black-Scholes-Merton formula was applied separately to each tranche, computing d1 and d2, the cumulative normal distribution values N(d1) and N(d2), and the two components of the call value - the dividend-adjusted present value of the share less the present value of the exercise price.
The fair value per option rose modestly from Tranche 1 to Tranche 3. That direction is intuitive and worth stating in the report: a longer expected life means more time value and a larger discount on the exercise price, and here that effect outweighed the slight easing in volatility over the longer measurement windows. Had the three tranches been valued as one, the expense would have been misstated in both amount and timing.Expense Attribution: The Graded Vesting Trap
Getting the fair value right is only half the exercise. The recognition pattern is where graded vesting most often goes wrong in practice.
Under Ind AS 102, each tranche is expensed over its own vesting period, starting from the grant date. Tranche 1 is recognised entirely in Year 1. Tranche 2 is spread over Years 1 and 2. Tranche 3 is spread over Years 1, 2 and 3. The result is a front-loaded, accelerated expense profile - materially higher in Year 1 than a straight-line spread of the total cost would produce.
This is a genuine divergence from US GAAP, where ASC 718 permits an accounting policy election to recognise the cost of graded awards on a straight-line basis. Ind AS 102 offers no such election for these awards. Companies transitioning between frameworks, or working from templates built for US practice, frequently apply the wrong pattern here.
Our deliverable therefore included a year-wise amortisation schedule, tranche by tranche, that the finance team could post directly and reconcile in later periods.
| Recognition year | Tranche 1 (25%) | Tranche 2 (50%) | Tranche 3 (25%) |
|---|---|---|---|
| Year 1 | 100% of tranche cost | 50% of tranche cost | 33.3% of tranche cost |
| Year 2 | - | 50% of tranche cost | 33.3% of tranche cost |
| Year 3 | - | - | 33.3% of tranche cost |
What We Delivered
- An Ind AS 102 compliant valuation report setting out the grant details, model selection, and fair value per option for each vesting tranche.
- Full derivation of every input - share price computation, expected life workings, the tenor-matched risk-free rates with their source, and the volatility calculation with its underlying price series.
- A year-wise share-based payment expense schedule reflecting graded attribution, ready for posting and for the corresponding share-based payment reserve entries.
- Disclosure support covering the information Ind AS 102 requires an entity to disclose about how fair value was determined, including the model used, the weighted average inputs, and the basis for each.
- A working file structured so that an auditor can trace any figure in the report back to its source data without a further request.
Outcome
The company was able to recognise its share-based payment expense from the year of grant with a documented, independently prepared basis behind every input. Because the tranche-wise workings, the price series and the sovereign yield curve extract were supplied alongside the report, the audit review of the ESOP charge was completed without a second round of information requests - the outcome that actually matters to a finance team in a close.
Five things that commonly go wrong in ESOP valuations
Drawn from what we see in reviews of ESOP workings prepared elsewhere:- Valuing the whole grant as one option. Treating a graded vesting grant as a single option with one expected life. Each tranche is a separate grant under Ind AS 102.
- Using the vesting period, or the contractual life, as expected life. Expected life is the midpoint of the exercise window measured from the grant date, not the time to vesting and not the contractual expiry.
- Applying one risk-free rate to every tranche. A single ten-year benchmark applied to a 2.5-year option overstates the rate. Read the yield at the matching tenor from a published sovereign curve.
- Using an index for volatility when own-share data exists. For a listed entity with adequate history, the entity's own price history is the primary reference. A sector index suppresses company-specific risk and is at best a cross-check.
- Amortising on a straight-line basis. Straight-lining the total cost across the vesting period may be permissible under US GAAP; it is not the Ind AS 102 answer for graded awards.
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My Valuation is an IBBI Registered Valuer firm advising Indian companies on valuations for financial reporting, regulatory compliance and transactions. We prepare ESOP and share-based payment valuations under Ind AS 102 that are built to be audited - every input derived, sourced and traceable.