Question

ABC Inc.

ABC Inc. (“ABC” or “the Company”), an SEC registrant, is a retailer that sells men’s and women’s clothing and accessories. As an incentive to its employees, the Company established a compensation incentive plan in which a total of 100,000 options were granted on January 1, 20X1. On that date (the grant date), ABC’s stock price was $15.00 per share.

The significant terms of the incentive plan are as follows:

• The options have a $15.00 “strike” or exercise price (the price the employee would pay to purchase a share of stock if the options vest).

• For the options to vest, the following must occur:

• The employee must continue to provide service to the Company throughout the entire explicit service period of five years (i.e., a five-year “cliff-vesting” award).

• The Company must achieve annual sales of at least $20 million during the fifth year of the explicit service period.

• The Company’s share price must increase by at least 25 percent over the five-year explicit service period.

• In addition, if the Company achieves sales of at least $25 million during the fifth year of the explicit vesting period, the strike price of the options will decrease from $15 to $10.

• The options expire after 10 years following the grant date.

• The options are classified as equity awards.

Additional Facts:

• Assume it is probable at all times that 100 percent of the employees receiving the awards will continue providing service to the Company as employees for the entire five-year explicit service period and that the five-year explicit service period is determined to be the requisite service period.

• On the grant date, ABC’s management determined that it is probable that the Company’s sales in year 5 will be $30 million, and therefore it is probable on the grant date that sales are greater than or equal to at least $25 million.

• The grant-date fair value of the options assuming a strike price of $15 is $8 per option. The grant-date fair value assuming a strike price of $10 per option is $12 per option.

Required:

1. As described above, on January 1, 20X1 (the grant date), $30 million of sales were probable for year 5. During years 1, 2, and 3, $30 million of sales for year 5 remained probable. At the beginning of year 4, management determines that it is probable that only $22 million of sales will occur for year 5. What are the proper accounting treatment and journal entries for each year?

2. Through the end of year 5, ABC’s share price remained at $15 and therefore the market condition was not met. What is the accounting impact of the market condition not having been met?

Answer 1

With help of Topic 718 as per FASB concept on Stock Compensation , I used my thought process to solve the above Question

Company ABC established a compensation Incentive Plan . As per plan 100, 000 options were granted on January 1, 20X1. On the date Grant ABC stock price $ 15/ Share .

Strike ( Exercise price) of the above option is - $ 15/share

Certain condition we need to follow here :

1. Explicit service period of 5 Year
2. Explicit service period , company must achieve annual Sales of $ 20 Mio
3. In the above duration , share price must increased by 25%
4. On the basis of Fluctuation in Sales achievement , Strike rate will change
5. Assume 100% employee will complete 5 Year of service
6. Grant date Fair value             - assuming strike price $ 15 is $8 per option and Grant date fair value – assuming strike price $ 10 per option is $12 per option .

Solution :

1. January 1, 20x1- The Grant date – No Journal Entry to account for
2. During 1 -3 Year Sales will be $ 30 Mio
3. Repeatedly, following terminology will appear while solving the above question – like Exercise Price , Exercise date , Fair value of Option , Grant date , vesting period etc .
4. End of 20x1 ( Dec ) – Fair Value - $ 12 per option . No of option to opt for = 100,000.

JE – Compensation Expense A/C Debit ---- - $2,40,000

             Additional paid up Capital Stock Option -$ 2,40,000

How to derive above number :

End of 20x1 ( Dec ) – Fair Value - $ 12 per option . No of option to opt for = 100,000.

Number of service period to complete – 5 year .

Compensation Expenses –( $12*100,000)/ Number of Year ( 5) – Earlier recognition of expenses ( Cumulative impact )

Year 2 – Continuation of Service + Meeting annual Sales number

5. Fair Value - $ 12 per option . No of option to opt for = 100,000.

JE – Compensation Expense A/C Debit ---- - $2,40,000

             Additional paid up Capital Stock Option -$ 2,40,000

How to derive above number :

– Fair Value - $ 12 per option . No of option to opt for = 100,000.

Number of service period to complete – 5 year .

Compensation Expenses –( $12*100,000*(number of Year) 2 )/ Number of Year ( 5) – Earlier recognition of expenses ( Cumulative impact )

( $ 12 * 100,000*2)/5-$2,40,000 = $ 2,40,000

Year 3 – Continuation of Service + Meeting annual Sales number

6. Fair Value - $ 12 per option . No of option to opt for = 100,000.

JE – Compensation Expense A/C Debit ---- - $2,40,000

             Additional paid up Capital Stock Option -$ 2,40,000

How to derive above number :

– Fair Value - $ 12 per option . No of option to opt for = 100,000.

Number of service period to complete – 5 year .

Compensation Expenses –( $12*100,000*(number of Year) 3 )/ Number of Year ( 5) – Earlier recognition of expenses ( Cumulative impact )

( $ 12 * 100,000*3)/5-$4,80,000 = $ 2,40,000

Year 4 – Suddenly change in revenue Number – Earlier till 3^rd year , revenue was $ 30 Mio bracket but in 4^th year , sharp down and revenue number would be $ 22 Mio. Due ti this change in Strike Price . We need to calculate $ 8 / option .

Compensation Expenses –( $12*100,000*(number of Year) 4 )/ Number of Year ( 5) – Earlier recognition of expenses ( Cumulative impact )

( $ 8 * 100,000*4)/5-$7,20,000 = ($80,000)

JE

            Additional paid up Capital Stock Option -- Debit-$ 80,000

                           Compensation Expense A/C Credit- $ 80,000