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On October 1, 2018, Farmer Fabrication issued stock options for 200,000 shares to a division manager....

On October 1, 2018, Farmer Fabrication issued stock options for 200,000 shares to a division manager. The options have an estimated fair value of $6 each. To provide additional incentive for managerial achievement, the options are not exercisable unless divisional revenue increases by 2% 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 2% 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.

Solutions

Expert Solution

1.Revised estimate of the total compensation

The estimate of the total compensation would be:

                                               200,000 × $ 6 = $12,00,000

2.Amount of Expenses to be recognized in each Year

One-third of that amount will be recorded in each of the three years.

In 2018 = $ 12,00,000 x1/3 = $ 4,00,000

In 2019 = $ 12,00,000 x1/3 = $ 4,00,000

In 2020= $ 12,00,000 x1/3 = $ 4,00,000

3.Journal entries to record compensation expense in 2019 and 2020

In 2019

Employees Compensation Expenses A/c             Dr     $ 4,00,000

    To Employees Stock Option outstanding A/c Cr                         $ 4,00,000

(Entry to recognize the compensation expenses)

Profit and Loss A/c                                              Dr     $ 4,00,000

     To Employees Compensation Expenses A/c   Cr                         $ 4,00,000

(Transfer of Compensation expenses to P&L A/c)

In 2020

Employees Compensation Expenses A/c             Dr     $ 4,00,000

    To Employees Stock Option outstanding A/c Cr                         $ 4,00,000

(Entry to recognize the compensation expenses)

Profit and Loss A/c                                              Dr     $ 4,00,000

     To Employees Compensation Expenses A/c   Cr                         $ 4,00,000

(Transfer of Compensation expenses to P&L A/c)

ekkarill92 answered 9 months ago
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