Before discussing the journal entries for ESOP, it’s important to understand what ESOP stands for – Employee Stock Option Plan. Under this plan, a company offers its employees the opportunity to become shareholders in the same company, motivating them to work diligently for the organization in hopes of receiving this valuable reward.
The following journal entries are recorded in the company’s books at various stages of ESOP implementation:
WHEN AN EMPLOYEE RECEIVES EMPLOYEE STOCK OPTIONS
Employee Salary/Reward Account Debit
Employee Stock/Share Option Account Credit
JOURNAL ENTRIES FOR ESOP
In this entry, the Employee Salary/Reward Account is debited because the company has granted shares as a reward, which is considered an expense for the company. Expenses are typically recorded as debits.
On the other hand, the Employee Stock/Share Option Account is credited because it represents an increase in the company’s liability. Any increase in liability is recorded as a credit.
WHEN THE COMPANY TRANSFERS THIS EXPENSE TO ITS PROFIT AND LOSS ACCOUNT
Profit and Loss Account Debit
Employee Salary/Reward Account Credit
This journal entry is made to write off the expense account associated with ESOP. It allows for the accurate representation of the company’s net profit.
By debiting the Profit and Loss Account, the company acknowledges that this expense has impacted its profitability. Simultaneously, the Employee Salary/Reward Account is credited, effectively reducing the associated expense.
WHEN THE COMPANY ALLOTS SHARES TO EMPLOYEES
Employee Stock/Share Option Account Debit
Share Capital Account Credit
This entry is significant as it signifies the moment when employees become actual owners of a portion of the company. By debiting the Employee Stock/Share Option Account, the company acknowledges the transfer of ownership from itself to the employees.
Simultaneously, the Share Capital Account is credited, reflecting the issuance of new shares to employees as part of the ESOP.
WHEN AN EMPLOYEE SELLS THEIR EMPLOYEE STOCK/SHARE OPTION RIGHT BACK TO THE COMPANY
Employee Stock/Share Option Account Debit
Bank Account Credit.
This journal entry records the sale of employee stock/share options back to the company. The Employee Stock/Share Option Account is debited because the liability created by the options is being removed from the company’s books.
On the other side, the Bank Account is credited because the company pays cash to the employee, representing a decrease in the company’s assets. Decreases in assets are typically recorded as credits.
These journal entries help ensure accurate and transparent accounting of ESOP related transactions, reflecting the financial impact of such plans on the company’s books.
ALSO READ