Question

On January 1, 2018, Farmer Fabrication issued stock options for 420,000 shares to a division manager. The options have an estimated fair value of $10 each. To provide additional incentive for managerial achievement, the options are not exercisable unless divisional revenue increases by 2% in three 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.

Answer 1

Farmer Fabrication Requirement 1 In that case, in 2019, the revised estimate of the total compensation would change to $4,200,000 Options Expected to vest x Faor Value = Estimated Total Compensation 420000 x $ 10 = $4200000 Requirement 2 Farmer will reflect the cumulative effect on compensation in 2019 earnings. Requirement 3 Journal Enteries Date Particulars 2019 Compensation expense a/c Dr. To Paid in capital - stock options ([$4,200,000 x 2/3] - $0) = $2,800,000 Debit in $ Credit in $ 2800000 2800000 2020 Compensation expense a/c Dr. 1400000 To Paid in capital - stock options ([$4,200,000 x 3/3) - $2,800,000) = $1,400,000 1400000