In: Accounting
Fashion Inc. (“Fashion” or “the Company”), an SEC registrant, is
a fashion retailer that sells men’s...
Fashion Inc. (“Fashion” or “the Company”), an SEC registrant, is
a fashion 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, 20X0. On that date (the
grant date), Fashion’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, Fashion’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. What types of conditions are present in the
plan for the vesting of the units? Are they service, performance,
market, or “other” conditions?
2. How do the service, performance, and market
conditions affect vesting of the units? Of the various conditions
present in the awards:
a. Which affect the vesting of the award?
b. Which affect factors other than vesting of
the award and what is their accounting treatment?
3. As described above, on January 1, 20X0 (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?
Through the end of year 5, Fashion’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?