ESPP accounting under ASC 718 and IFRS 2: 5% safe harbor and look-back expense
An employee stock purchase plan (ESPP) lets employees buy company shares through payroll deductions, usually at a discount to the market price and often with a look-back feature that sets the purchase price on the lower of the share price at the start or at the end of the offering period. Under US GAAP, ASC 718 treats an ESPP as noncompensatory, with no expense at all, only when the discount is 5% or less, substantially all employees can participate on an equitable basis, and the plan has no option features beyond a short enrollment window and a purchase price fixed at the purchase date. A typical US plan with a 15% discount and a look-back fails those criteria and produces stock compensation expense measured at grant date.
IFRS 2 Share-based Payment has no equivalent exemption. Any discount granted to employees in exchange for their services is a share-based payment, so even a broad-based plan with a 5% discount, which US GAAP would treat as costless, generates an expense under IFRS. For groups that report under both frameworks, or US subsidiaries of IFRS parents, the same plan can therefore show zero expense in one set of books and a recognized charge in the other.
The difference in expense is often material. In the worked example below, a six-month plan with a 15% discount and a look-back on $1,020,000 of expected contributions produces $289,200 of compensation cost, about 24% of the grant-date share price for every share the contributions would buy at the start of the offering.
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WHEN AN ESPP IS NONCOMPENSATORY UNDER ASC 718-50.
The US GAAP guidance on employee share purchase plans sits in ASC 718-50, which carried forward the criteria first set out in paragraph 12 of FASB Statement No. 123 (revised 2004), Share-Based Payment. A plan is noncompensatory only if it meets all three conditions at once.
The first condition concerns price. The terms must be no more favorable than those available to all holders of the same class of shares, or any purchase discount must not exceed the per-share issuance costs the company would have incurred in a significant public offering. The standard states that a discount of 5 percent or less from the market price complies with this condition without further justification. A larger discount has to be justified by reference to actual offering costs, and if it cannot be, the entire discount is compensation cost, including the first 5%.
The second condition is broad participation: substantially all employees who meet limited employment qualifications may participate on an equitable basis. Plans restricted to executives or to a selected group fail this test regardless of the discount.
The third condition limits option features. Employees may be given a short enrollment period, not exceeding 31 days after the purchase price is fixed, and the purchase price may be based solely on the market price at the purchase date, with employees free to cancel and receive a refund of their contributions. Statement 123(R) gives the look-back as its example of an option feature that makes a plan compensatory, because a purchase price based on the lesser of the grant-date and purchase-date price gives the employee the upside of a call option for free.
In practice this means that the widely used plan design permitted by Section 423 of the Internal Revenue Code, with a discount of up to 15% and a look-back, is almost always compensatory for financial reporting. A tax-qualified plan and a noncompensatory plan are separate questions: Section 423 qualification governs the employee's tax treatment, while ASC 718-50 governs the expense.
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HOW IFRS 2 TREATS EMPLOYEE SHARE PURCHASE PLANS.
IFRS 2 applies to all share-based payment transactions in which an entity receives goods or services, including services from employees, in exchange for its equity instruments. Employee share purchase plans fall within that scope, and the standard contains no carve-out for broad-based plans or for small discounts. The International Accounting Standards Board considered an exemption for employee share purchase plans when it developed IFRS 2 and decided against it.
For equity-settled transactions with employees, IFRS 2 measures the services received by reference to the fair value of the equity instruments granted, at grant date, and recognizes that amount over the vesting period. For an ESPP the grant date is generally the date on which the entity and the employee agree to the plan terms, which for an offering-based plan is usually the start of the offering period when the employee enrolls. The vesting period runs to the purchase date, because the employee must remain employed and keep contributing to receive the shares.
The continued-contribution requirement creates an IFRS-specific complication. Saving through payroll deductions is a condition the employee chooses to meet or not, and IFRS 2 classifies it as a non-vesting condition. When an employee stops contributing and withdraws while remaining employed, IFRS 2 treats the withdrawal as a cancellation, so any unrecognized cost for that employee is recognized immediately. When an employee leaves the company before the purchase date, the service condition is not met and the cost recognized for that employee is reversed.
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HOW A LOOK-BACK ESPP IS VALUED AT GRANT DATE.
Both frameworks measure a compensatory ESPP at grant-date fair value, and neither remeasures it for later share price movements. The valuation question is what the employee actually receives. With a 15% discount and a look-back, the purchase price is 85% of the lower of the price at grant (S0) and the price at the purchase date (ST), and the number of shares bought depends on the total contributions divided by that price.
The payoff can be split into three components that standard option pricing models can value. Expressed per share that the expected contributions would buy at 85% of the grant-date price, the award is worth 15% of a share, plus 85% of an at-the-money call option on the share, plus 15% of an at-the-money put option. The call captures the upside the employee keeps if the share price rises. The put captures the extra shares the employee buys if the price falls, because the fixed contributions then purchase more shares at the lower price. Statement 123(R) included an illustration on look-back share options, now part of the Codification, and companies commonly apply a component valuation of this kind under both ASC 718 and IFRS 2.
The decomposition is exact under its assumptions. With no dividends, put-call parity reduces the three components to the present value of 15% of the grant-date price plus one full call option, which provides an arithmetic check on the model output.
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WORKED EXAMPLE: A 15% LOOK-BACK ESPP WITH JOURNAL ENTRIES.
The following data are illustrative. A US company starts a six-month ESPP offering on January 1 and ends it on June 30, with quarterly reporting. Employees may buy shares at 85% of the lower of the price on January 1 and the price on June 30. Expected payroll contributions for the offering total $1,020,000, withheld evenly over the two quarters. The share price at grant is $40.00, par value is $0.01, and the valuation inputs below are assumptions for the example.
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Input | Value |
Share price at grant (S0) | $40.00 |
Discount | 15% |
Offering period | 6 months (0.5 years) |
Expected volatility | 30% |
Risk-free rate | 4.0% |
Expected dividends | None |
Expected contributions | $1,020,000 |
Shares at 85% of grant price | 30,000 |
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The 30,000 shares are $1,020,000 divided by $34.00, which is 85% of $40.00. Black-Scholes values for a six-month at-the-money option on these inputs are $3.7562 for the call and $2.9641 for the put, all computed in Python.
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Component | Calculation | Value per share |
15% of a share | 0.15 x $40.00 | $6.0000 |
85% of a call | 0.85 x $3.7562 | $3.1927 |
15% of a put | 0.15 x $2.9641 | $0.4446 |
Fair value per share | Sum | $9.6374 |
Rounded fair value | $9.64 | |
Total compensation cost | 30,000 x $9.64 | $289,200 |
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The check through put-call parity gives the same figure: the present value of $6.00 over six months at 4.0% is $5.8812, and adding the $3.7562 call returns $9.6374. Assuming no forfeitures, the company recognizes $144,600 of expense in each quarter, because the requisite service period for an ESPP is the period over which the employee participates in the plan and pays for the shares. The same amount applies under IFRS 2 in this example, since both frameworks measure the award at grant-date fair value.
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Date | Account | Debit | Credit |
Q1 payrolls | Salaries payable | $510,000 | |
Q1 payrolls | ESPP contributions liability | $510,000 | |
March 31 | Stock compensation expense | $144,600 | |
March 31 | Additional paid-in capital | $144,600 | |
Q2 payrolls | Salaries payable | $510,000 | |
Q2 payrolls | ESPP contributions liability | $510,000 | |
June 30 | Stock compensation expense | $144,600 | |
June 30 | Additional paid-in capital | $144,600 |
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The payroll entries reclassify part of salaries already expensed into a liability to employees, so they carry no additional expense. At the purchase date the outcome depends on the share price, but the expense does not.
In scenario A the June 30 price is $46.00. The purchase price is $34.00, which is 85% of the lower grant-date price, and the contributions buy exactly 30,000 shares. In scenario B the June 30 price is $36.00. The purchase price becomes $30.60, which is 85% of $36.00, so the contributions buy 33,333 whole shares for $1,019,989.80 and $10.20 is refunded to employees.
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Purchase entry | Account | Debit | Credit |
Scenario A, $46.00 | ESPP contributions liability | $1,020,000.00 | |
Scenario A, $46.00 | Common stock (30,000 x $0.01) | $300.00 | |
Scenario A, $46.00 | Additional paid-in capital | $1,019,700.00 | |
Scenario B, $36.00 | ESPP contributions liability | $1,020,000.00 | |
Scenario B, $36.00 | Common stock (33,333 x $0.01) | $333.33 | |
Scenario B, $36.00 | Additional paid-in capital | $1,019,656.47 | |
Scenario B, $36.00 | Cash refunded to employees | $10.20 |
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The intrinsic benefit employees receive is $360,000 in scenario A, which is $12.00 on each of 30,000 shares, and $179,998.20 in scenario B, which is $5.40 on each of 33,333 shares. The recognized expense stays at $289,200 in both cases. Grant-date measurement prices the range of outcomes once, and the result is not trued up to the actual discount.
The contrast with a plan that offers only a 5% discount on the purchase-date price is sharper. Under ASC 718-50 that plan is noncompensatory, with no expense, if it also meets the participation and option-feature conditions. Under IFRS 2 the discount is a share-based payment: on the same $1,020,000 of contributions, employees would receive shares worth $1,020,000 divided by 0.95, so the benefit is about $53,684 before any adjustment for the timing of contributions, and that amount is expensed over the offering period.
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ESPP DIFFERENCES BETWEEN ASC 718 AND IFRS 2.
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Issue | US GAAP (ASC 718) | IFRS 2 |
Discount of 5% or less, broad-based | Noncompensatory, no expense | Expense recognized |
Look-back feature | Makes plan compensatory | Included in fair value |
Measurement date | Grant date | Grant date |
Attribution period | Participation and payment period | Vesting period to purchase |
Employee withdraws, still employed | Policy and plan analysis | Cancellation, accelerate cost |
Employee leaves before purchase | Forfeiture, cost reversed | Service condition failed, reversed |
Forfeitures | Estimate or record as they occur | Estimate, true up to actual |
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On forfeitures, US GAAP lets entities make an accounting policy election to estimate the number of awards expected to vest or to account for forfeitures when they occur. IFRS 2 requires an estimate of the number of instruments expected to vest, revised as information changes and trued up to the actual outcome. For broader background on how both frameworks measure and attribute equity awards, see the Data Studios explainer on how share-based payment transactions are accounted for under IFRS 2 and ASC 718.
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PRESENTATION, DISCLOSURE AND TAX EFFECTS OF ESPP EXPENSE.
ESPP expense is presented with other stock compensation, allocated to the same income statement lines as the cash pay of the participating employees. The treatment follows the general approach covered in how stock-based compensation expense is reported in the income statement. Contributions withheld and not yet used to buy shares are a liability to employees, refundable on withdrawal, and are not part of equity until shares are issued.
Disclosure follows the general share-based payment requirements of each framework: a description of the plan, the number of shares issued in the period, the valuation method and its main assumptions, and the compensation cost recognized. Plans that are noncompensatory under ASC 718-50 still result in share issuances that appear in the statement of changes in equity.
On income taxes, a plan that qualifies under Section 423 generally gives the employer a tax deduction only when an employee makes a disqualifying disposition of the shares. Many US companies therefore record no deferred tax asset on qualified ESPP expense and recognize the tax benefit when a disqualifying disposition occurs, while nonqualified plans follow the ordinary deferred tax approach for stock compensation under ASC 740. Under IFRS, IAS 12 Income Taxes compares the tax deduction expected to the cumulative expense, with any excess recognized in equity.
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COMMON ERRORS IN ESPP ACCOUNTING.
The most frequent error is treating a tax-qualified Section 423 plan as automatically noncompensatory. Qualification under the tax code says nothing about the 5% condition or the look-back, and a 15% look-back plan is compensatory under ASC 718-50.
A second error is valuing a look-back ESPP as if the discount were the only benefit, recording 15% of the grant-date price and ignoring the call and put components. In the worked example that approach would record $180,000, which is 30,000 x $6.00, against a fair value of $289,200. The volatility and the length of the offering period drive the option components, so the understatement grows with longer offerings and more volatile shares; the logic of option-based measurement is the same as in share-based payments with market conditions under IFRS 2 and ASC 718.
Other recurring issues include remeasuring the award at the purchase date, which neither framework permits for equity-settled awards; ignoring IFRS 2 for a broad-based 5% plan in a US subsidiary of an IFRS group; and failing to treat an employee's withdrawal as a cancellation under IFRS 2. Plans with multiple purchase dates within one offering, reset features when the share price falls, or changes in contribution rates during the offering need plan-specific analysis, because each feature changes the valuation or creates a modification.
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ESPP ACCOUNTING UNDER ASC 718 AND IFRS 2: PRACTICAL CHECKLIST.
Start by testing the plan against the three ASC 718-50 conditions: a discount of 5% or less or a justified larger discount, participation by substantially all qualifying employees on an equitable basis, and no option features beyond a 31-day enrollment window and a purchase-date price. If any condition fails, the plan is compensatory under US GAAP. For IFRS reporting, assume the plan is within IFRS 2 whatever its discount.
For a compensatory plan, fix the grant date at enrollment, estimate expected contributions, and value the award with a component approach that covers the discount share, the call and, for contribution-based plans, the put. Recognize the cost over the offering period, apply the forfeiture policy for leavers, and under IFRS 2 accelerate the cost for employees who withdraw while still employed. At the purchase date, move the contributions liability to common stock and additional paid-in capital without adjusting the expense.
The firm conclusions are the 5% safe harbor and the look-back test under US GAAP, the absence of any exemption under IFRS 2, and grant-date measurement under both. The areas that depend on facts and policy choices are the valuation inputs, the treatment of withdrawals under US GAAP, the tax position of qualified plans, and plans with resets or multiple purchase dates.
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