Question

Stock Option problem

At the start of the year a business grants five key personnel 300 stock options each. The fair value (FV) of each option at the date of grant is 7.00. The options vest at the end of a 3 year period at which point the option holders can exercise their options. This means no partial vesting during the three year period; the options vest 100% at the end of three years. This will not change the allocation of the expense over the vesting period.

The exercise (strike) price is the same as the share price at the date of grant which is 20.00 and the par of each share is 1.00.

1. Record stock option compensation cost over the 3 year vesting period. Take the forfeitures into account as they occur. One employee leaves in year 2 and forfeits their options. One more employee leaves in year 3 and forfeits their options.

2. Assume in year 6, all the remaining options are exercised. Show the entry.

Answer 1

Here Given as follows,

Stock option grated - 300

Fair Value - 7.00

Vesting period - 3 year

Exercise (strike) price - 20

Price per share - 1.00

key personnel - 5

Solution for part 1

In order to record stock option compensation cost

Calculate stock option compensation for whole 3 year

Option vested = stock Option x key personnel

= 300 x 5 = 1500

Stock option option compensation cost = option vested x fair value

= 1500 x 7 = 10500

Calculate year 1 stock option compensation cost

whole 3 year stock option compensation vested = 10500

period completed= 1 year

stock compensation cost expense = total option vested x period completed / vesting period

= 10500 x 1 / 3 = 3500

Therefore for year 1 stock compensation cost expense = 3500

Hence in year 2 an employee leaves and forfeits his option  

Here as an employee leaves therefore their will change in total 3 year stock option vesting .

Option vested = stock Option x key personnel

= 300 x 4 = 1200

Stock option option compensation cost = option vested x fair value

= 1200 x 7 = 8400

Calculate year 2 stock option compensation cost

whole 3 year stock option compensation vested = 8400

period completed= 2 year

stock compensation cost expense = total option vested x period completed / vesting period

= 8400. x 2/ 3 = 5600

In year 1 we have expense = 3500

Therefore for year 2 stock compensation cost expense = 2100 ( 5600 - 3500)

Hence in year 3 an employee leaves and forfeits his option  

Here as an employee leaves therefore their will change in total 3 year stock option vesting .

Option vested = stock Option x key personnel

= 300 x 3 = 900

Stock option option compensation cost = option vested x fair value

= 900 x 7 = 6300

Calculate year 3 stock option compensation cost

whole 3 year stock option compensation vested = 6300

period completed= 3 year

stock compensation cost expense = total option vested x period completed / vesting period

= 6300 x 3 / 3 = 6300

In year 2 we have expense = 5600

Therefore for year 3 stock compensation cost expense = 2100 ( 5600 - 6300)

Solution for part 2

As we are assuming that all 6 options is been exercised and hence there is increase in cost of capital.

Here we exercised stock option vested = 900 ( see year 2 option vested )

Exercise (strike) price - 20

Therefore = 900 x 20 = 18000

Entry

Here as all employees has exercised the option therefore business will receive 18000 in cash and after deducting 900 i.e stock option vested remaining 17100 is an additional paid in capital of the business.

Cash A/c Dr 18000

To stock option vested A/c 900

To additional paid in capital of the business A/c 17100