Question

On December 31, 20X0, Kessler Company granted six executives options for each to purchase 10,000 shares of the company's $10 par common stock at an option price of $50 per share (a total of 60,000 options). The options become exercisable on January 1, 20X1, and represent compensation for executives' services over a three-year period beginning January 1, 20X1. The Black-Scholes option pricing model determines the option fair value to be $1. Through December 31, 20X2, none of the executives had exercised their options, but one of the executives left the company during 20X2. What is the impact on Kessler's net income for the year ended December 31, 20X2 as a result of this transaction under the fair value method?

Answer 1

Total share-based compensation expense is measured at the grant date by multiplying the number of options by the fair value of each option. The annual share-based compensation expense is calculated by dividing the total share-based compensation expense by the vesting or service period.

The six executives were granted 60,000 options, each of which had a fair value of $1 as per Black-Scholes model, at the grant date. Total share-based compensation expense is $60,000 (60,000 options multiplied by $1). Total shared-based compensation expense of $60,000 divided by the three-year vesting period results in an annual share-based compensation expense of $20,000. Assuming none of the executives forfeits their options, but one executive left the company in 20X2. Now the total number executives to avail this option will be 5 and the number of options will be 50,000, and total share-based compensation expense is $ 50,000 (50,000 options multiplied by $1). Then one year compensation expenses will be $ 16667 ($50,000/3) .Share-based compensation expense of $16667 will be recognized at the end of years 1, 2, and 3. So this amount of $ 16667 will be the impact on Kessler’s net income for the year ended December 31,20X2 as a result of this transaction under the fair value method.