On January 1, 2021, Farmer Fabrication issued stock options for 360,000 shares to a division manager....

On January 1, 2021, Farmer Fabrication issued stock options for 360,000 shares to a division manager. The options have an estimated fair value of $8 each. To provide additional incentive for managerial achievement, the options are not exercisable unless divisional revenue increases by 2% in three years. Suppose that Farmer initially estimates that it is not probable the goal will be achieved, but then after one year, Farmer estimates that it is probable that divisional revenue will increase by 2% by the end of 2023.

Required: 1. What is the revised estimate of the total compensation?

2. What action will be taken to account for the options in 2022?

3. Prepare the journal entries to record compensation expense in 2022 and 2023.

Solutions

Expert Solution

1. The total compensation will be no. of options multiplied by fair value of each option. As per accounting standard on share based payments (IFRS 2), the cost will be recognized over the vesting period.

Total compensation

360,000*8

equals

2,880,000

2. No expense was recorded in 2021 based on estimate that options will not be exercised. In 2022 based on revised estimate, options will be exercised. Hence we need to record the cost for 2 years now i.e. 2021 and 2022

(360,00082) / 3	equals	1,920,000

Journal entry		2022	2023
share Option expense (P/L)	Dr.	1,920,000	960,000
Equity reserve	Cr.	1,920,000	960,000

On exercise of options, equity reserve will be debited and equity capital will be credited with face value

per share. Any difference will go to additional paid in capital.

ekkarill92 answered 1 year ago

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