Question

On January 1, 2018, Adams-Meneke Corporation granted 90 million incentive stock options to division managers, each permitting holders to purchase one share of the company’s $1 par common shares within the next six years, but not before December 31, 2020 (the vesting date). The exercise price is the market price of the shares on the date of grant, currently $20 per share. The fair value of the options, estimated by an appropriate option pricing model, is $2 per option. Management’s policy is to estimate forfeitures. No forfeitures are anticipated. Ignore taxes. Required: 1. Determine the total compensation cost pertaining to the options on January 1, 2018. 2. Prepare the appropriate journal entry to record compensation expense on December 31, 2018. 3. Unexpected turnover during 2019 caused an estimate of the forfeiture of 5% of the stock options. Determine the adjusted compensation cost, and prepare the appropriate journal entry(s) on December 31, 2019 and 2020.

Answer 1

Answer 1:

Total compensation cost on account of options on January 1, 2018:

(No. of options * FMV Of option) = (90 Million * $ 2) = $ 180 Million

Answer 2:

Compensation expenses for the year = total compensation cost / vesting period = $ 180 Million / 3 Years = $ 60 Million

Journal Entry:

Compensation Expenses                                              $ 60 Million

                Paid In capital from stock options                                             $ 60 Million

Answer 3:

Revised Compensation cost = 90 Million * 0.95 * $ 2 = $ 171 Million

Cumulative expenses to be recognized upto year 2 = $ 171 Million *2/3 = $ 114 Million

Expenses already recognized in year 1 = $ 60 Million

Expenses to be recognized in year 2 = $ 114 Million - $ 60 Million = $ 54 Million

Journal Entry:

31.12.2019	Compensation Expenses	54,000,000
	Paid In capital from stock options		54,000,000
31.12.2020	Compensation Expenses	54,000,000
	Paid In capital from stock options		54,000,000

Note: Since it is estimated that 5% of options will be forfeited so it means that only 85.50 Million options will be vested and expenses should be recorded only for those options. No retrospective effect is allowed so adjustments made in subsequent years.