Testing ESOP expense computation against the vesting schedule means rebuilding, grant by grant, the fair-value-at-grant-date times the number of options expected to vest, spread over the vesting period on a straight-line or graded basis, and then checking that forfeitures and performance-condition reassessments were applied as a change in estimate rather than folded silently into the current period's charge.
Where the charge usually breaks
The grant-date fair value is fixed once and never revisited for market-condition options, which trips up preparers who try to true it up like a performance condition. Service and non-market performance conditions, by contrast, are revisited every period, and failing to revisit them is the more common error in practice.
The testing sequence
- 01Obtain the grant register and tie each grant to its board or committee approvalGrant date, number of options, exercise price, vesting conditions and vesting period should all be traceable to an approved document, not just the accounting schedule.
- 02Test the fair value used at grant dateFor options valued using Black-Scholes or a similar model, check the inputs — volatility, risk-free rate, expected life — against what an independent valuer or a reasonable market proxy would support, rather than accepting the output alone.
- 03Classify each vesting condition as service, performance (market or non-market), or a combinationThis classification determines how re-estimation works through the vesting period and is the single most consequential judgement in the file.
- 04Recompute the period charge independentlyFair value at grant date, multiplied by the current best estimate of options expected to vest, spread over the vesting period, less cumulative expense already recognised. Compare to the client's computation line by line.
- 05Test the forfeiture estimate against actual attrition dataAn estimate that has not moved in several periods despite real attrition in the employee base is a sign the re-estimation step is not actually being performed.
- 06Trace a sample of actual forfeitures and exercises to the cumulative expense reversal or transfer to securities premiumConfirms the balance sheet entries, not just the P&L charge, were updated correctly.
- 07Reconcile the ESOP reserve movement for the year end to endOpening balance, plus the charge for the year, less transfers on exercise or forfeiture, should equal the closing balance with no unexplained residue.
| Line | Basis |
|---|---|
| Fair value per option at grant date | Valuation report or model, with inputs independently assessed |
| Options expected to vest, current estimate | Current attrition and performance data, not the grant-date assumption carried forward |
| Cumulative expense to date | Fair value × expected-to-vest options × elapsed vesting fraction |
| Current period charge | Cumulative expense this period less cumulative expense recognised to date |
| ESOP reserve rollforward | Opening balance, plus charge, less exercise/forfeiture transfers, equals closing balance |
Common practice, not a requirement
Building a single schedule that tracks every open grant by tranche, rather than relying on the client's summary journal entry, is not required by any standard but is the only practical way to catch a mis-classified performance condition before it compounds over several years.
How we think about this
The amortisation arithmetic — spreading a fixed fair value across a vesting period and adjusting for actual forfeitures — is fully deterministic and should be recomputed in full, not sampled. Whether the valuation inputs at grant date were reasonable, and whether a condition is market or non-market, is a judgement call that the recomputation can only frame, not make.
This is practical guidance written for audit teams, not an authoritative statement of any standard or statute. Standards, forms and timelines change. Check the current text issued by the ICAI and the relevant authority before relying on anything here in an audit file.
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