Question

Begining of year 1

Issued 6,000 restricted share units and 10,000 stock options to employees. The shares are currently trading for $10 per share. The option exercise price is set equal to $10 and the fair value of each option is $3. The vesting service period for the restricted share units and stock options is 18 months.

Other information Given: At the end of year 2 employees exercised all of their 10,000 options. The fair value of the firm’s stock on this date is $19 per share. The firm’s stock had a value of $13 per share on June 30 of Year 2 when the restricted stock units and the stock options vested.

The firm expects all of the employees receiving restricted share units and stock options will remain for the 18 month required service period.

Pre tax accounting income year 1: $900,000

Pre tax accounting income year 2: $1,200,000

Tax rate 30%.

Please find the Taxable income, Deferred Tax liability and Deferred Tax asset for year 1 and 2 assuming no beginning balances?

(It is a part of an assignment in which there are lots situations given and we have to create a taxable income table and deferred tax liability/asset schedule)

Answer 1

YEAR 1

1. Calculation of Employee compensation expense:-

Vesting period = 18 Months

Fair Value of Option = $3

Fair value of share on grant date = $10

Option expense at year end or vesting period whichever is earlier= (Fair value of option* No. of options* period expired) /Vesting period - Option expense already recognised

Option expense at end of Year 1 = ($3 * 10,000 options*12 months) / 18 months

= $20,000

Restricted share units expense at year end or vesting period whichever is earlier= (Fair value of share at grant date* No. of units* period expired) /Vesting period - RSU expense already recognised

Expense for restricted share units at end of year 1 = ($10* 6,000* 12 months)/18 months

= $40,000

Total Employee Compensation Expense for Year end 1= $20,000 + $40,000 = $60,000

2. Calculation of Taxable income and Deferred Tax

Pre tax Accounting income year 1 = $900,000

Taxable income = $ 900,000 + $ 60,000 = $ 960,000 since tax deduction is allowed on vesting

Timing difference= $ 60,000

Deferred tax asset = $60,000 *30% = $18,000

YEAR 2

1. Calculation of Employee compensation expense

Option Expense = ($3 * 10,000 options * 18 months)/ 18 months - $20,000

= $10,000

RSU Expense = ( $10 * 6,000 * 18 months)/ 18 months - $40,000

= $20,000

Total employee compensation expense = $30,000

2. Calculation of Taxable income and Deferred Tax

Pre tax accounting income for year 2 = $1,200,000

Taxable income = $ 1,200,000 + $ 30,000 - ($60,000 + $30,000) = $ 1,140,000

Timing difference= $ -60,000 (Net)

Deferred tax Asset / Liability for year end 2 = $0