Question

On October 1, 2018, Farmer Fabrication issued stock options for 180,000 shares to a division manager. The options have an estimated fair value of $5 each. To provide additional incentive for managerial achievement, the options are not exercisable unless divisional revenue increases by 5% in four 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 5% by the end of 2020.

Required:

1. What is the revised estimate of the total compensation?
2. What action will be taken to account for the options in 2019?
3. Prepare the journal entries to record compensation expense in 2019 and 2020.

Answer 1

1. What is the revised estimate of the total compensation?
stock options			180,000
Multiply: Fair value			5
estimate of the total compensation			900,000
2. What action will be taken to account for the options in 2019?
Farmer Fabrication will reflect cumulative effect on compensation in 2019 earnings
3. Prepare the journal entries to record compensation expense in 2019 and 2020.
Date	General journal	debit	Credit
2019	Compensation expense	450,000
	Paid in capital – stock options		450,000
	(To record Compensation expense.)
2020	Compensation expense	225,000
	Paid in capital – stock options		225,000
	(To record Compensation expense.)
Compensation expense For Year 2019 (900000*2/4)			450,000
Cumulative Compensation expense Up to Year 2020 (900000*3/4)			675,000
Less: recognized in earlier year			450,000
Compensation expense For Year 2020			225,000