Auditing a startup's employee stock option expense under Ind AS 102 means first confirming a fair-value-at-grant-date valuation actually exists for every tranche of options granted, because the expense recognised over the vesting period is based on grant-date fair value, not the option's intrinsic value or its value today — a distinction many founder-run finance teams either don't know or treat as optional, which is the single most common reason startup ESOP expense is wrong, usually understated, in a statutory audit.
Fair value at grant, not intrinsic value, not current value
Ind AS 102 requires the total expense for an option grant to be fixed at grant-date fair value — typically computed using an option-pricing model (Black-Scholes or a binomial model) that factors in the exercise price, the current share price, expected volatility, expected life and the risk-free rate — and that figure is then spread over the vesting period. It is not revised later if the company's valuation rises or falls, and it is not simply the difference between the exercise price and today's share price (intrinsic value), which materially understates the charge for an at-the-money or near-the-money grant.
- 01Obtain the fair-value valuation report for each distinct trancheDifferent tranches granted at different times, with different exercise prices or vesting conditions, need their own fair value computed as of their own grant date — a single valuation applied across multiple grant dates is a red flag.
- 02Check the valuation date matches the actual grant date, or the board approval date if that governs grant date under the schemeA valuation obtained months after the actual grant, backdated for convenience, does not represent fair value at grant and should not be relied on as if it did.
- 03Test the volatility assumption against comparable listed peersAn unlisted company has no own share-price history, so volatility is usually estimated from listed peers — confirm the peer set is actually comparable in business and stage, not chosen to produce a lower expense.
- 04Recompute the vesting-period expense allocationConfirm the total fair value is spread over the actual vesting period with the graded-vesting method if tranches vest at different dates, and that forfeitures of unvested options are factored into the expense (reversing expense for options that lapse before vesting, not for those that lapse after vesting by non-exercise).
Modifications, repricings and cancellations
Startups renegotiate option terms fairly often — repricing after a down round, extending the exercise window, accelerating vesting on an exit event. Each of these is a modification under Ind AS 102 and generally requires recognising any incremental fair value created by the modification as additional expense, on top of (not instead of) the original grant-date expense. A repricing accounted for by simply restating the whole expense at the new, lower fair value is a common error that understates the cumulative charge.
| Event | Treatment to verify |
|---|---|
| Repricing (new exercise price, same employee) | Incremental fair value (new minus old, at repricing date) added as extra expense, original grant expense continues |
| Accelerated vesting on exit | Remaining unrecognised expense for that grant is recognised immediately at the acceleration date |
| Forfeiture before vesting (employee leaves) | Previously recognised expense for that grant is reversed |
| Lapse after vesting (employee doesn't exercise) | No reversal — the expense already recognised stands; this is not an 'un-grant' |
A startup that stops expensing ESOPs once a round of fundraising makes a scheme 'inactive' or informally frozen, without a formal cancellation or forfeiture, is understating expense — the obligation under Ind AS 102 doesn't lapse just because the company has stopped thinking about it.
Common practice, not a requirement
For an early-stage startup, the ESOP valuation is frequently the same 409A-style valuation or fundraising valuation already obtained for other purposes. Check whether it was actually built to produce a grant-date fair value per Ind AS 102's requirements, or whether it is being reused from a different purpose without adjustment.
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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