Chapter 15, Problem 4P

1.

To determine

Prepare the schedule of Corporation C’s compensation calculations for its compensatory share option plan for 2016 to 2018.

Explanation of Solution

Share option plan: This is an option given to an employee to buy a certain number of shares of stock of the company at a pre-determined price during certain period of time.

Fixed share option compensation plan: As the name implies, the compensation plan fixes the exercise price and the number of shares to be vested, on the grant date.

Prepare the schedule of Corporation C’s compensation calculations for its compensatory share option plan for 2016 to 2018:

Particulars	2016	2017	2018
Estimated (actual) total compensation cost	$41,405	$60,060	$95,875
Fraction of service expired	× 1/3 years	×  2/3  years	×  3/3 years
Estimated compensation expense to date	$13,802	$40,040	$95,875
Previously recognized compensation expense	0	(13,802)	(40,040)
Current compensation expense	$13,802	$26,238	$55,835

Table (1)

Working Note 1: Compute the total compensation cost of options for the year 2016:

$\begin{array}{c}\begin{array}{l}\text{Total compensation }\\ \text{cost of options}\end{array}\}\text{ = }\left\{\begin{array}{l}\text{Fair market value per share × }\\ \text{Number of options expected to vest}\end{array}\right\}\\ \text{= }\left\{\begin{array}{l}\text{\$16}\text{.25 × }\left(\text{40 options}\times 70\text{ executives}\right)\times \\ \left(100\%–9\%\right)\text{retention rate}\end{array}\right\}\\ \text{= \$16}\text{.25 × 40 options}\times 70\text{ executives}\times 91\%\\ \text{= \$41,405}\end{array}$

Working Note 2: Compute the total compensation cost of options for the year 2017:

$\begin{array}{c}\begin{array}{l}\text{Total compensation }\\ \text{cost of options}\end{array}\}\text{ = }\left\{\begin{array}{l}\text{Fair market value per share × }\\ \text{Number of options expected to vest}\end{array}\right\}\\ \text{= }\left\{\begin{array}{l}\text{\$16}\text{.25 × }\left(\text{60 options}\times 70\text{ executives}\right)\times \\ \left(100\%–12\%\right)\text{retention rate}\end{array}\right\}\\ \text{= \$16}\text{.25 × 60 options}\times 70\text{ executives}\times 88\%\\ \text{= \$60,060}\end{array}$

Working Note 3: Compute the total compensation cost of options for the year 2018:

$\begin{array}{c}\begin{array}{l}\text{Total compensation }\\ \text{cost of options}\end{array}\}\text{ = }\left\{\begin{array}{l}\text{Fair market value per share × }\\ \text{Number of options actually vested}\end{array}\right\}\\ \text{= \$16}\text{.25 × }\left(\text{100 options}\times 59\text{ executives}\right)\\ \text{= \$95,875}\end{array}$

2.

To determine

Prepare Corporation C’s memorandum entry for the grant date and journal entries for 2016 to 2019 related to this plan.

Explanation of Solution

Prepare Corporation C’s memorandum entry for the grant date:

Memorandum entry: On January 1, 2016, the company granted performance-based compensatory share options to 70 executives. The plan allows each executive to exercise 100 options to acquire the same number of shares of company’s common stock at an exercise price of $50 per share and vest at the end of service period of 3 years. The estimated fair value of the options expected to be exercised is $41,405.

Prepare the journal entries for 2016 to 2019 related to the compensation plan:

Date	Accounts title and Explanation	Post ref.	Debit ($)	Credit ($)
December	Compensation Expense		13,802
31, 2016	Paid-in Capital from Share Options			13,802
	(To record compensation expense for 2016)

Table (2)

To record compensation expense for 2016:

• Compensation Expense is an expense account. Expenses and losses decrease Equity account. Therefore, debit Compensation Expense account with $13,802.
• Paid-in Capital from Share Options is a shareholders’ equity account. Since share options are granted, company’s stock amount has increased. Therefore, credit Paid-in Capital from Share Options account with $13,802.

Date	Accounts title and Explanation	Post ref.	Debit ($)	Credit ($)
December	Compensation Expense		26,238
31, 2017	Paid-in Capital from Share Options			26,238
	(To record compensation expense for 2017)

Table (3)

To record compensation expense for 2017:

• Compensation Expense is an expense account. Expenses and losses decrease Equity account. Therefore, debit Compensation Expense account with $26,238.
• Paid-in Capital from Share Options is a shareholders’ equity account. Since share options are granted, company’s stock amount has increased. Therefore, credit Paid-in Capital from Share Options account with $26,238.

Date	Accounts title and Explanation	Post ref.	Debit ($)	Credit ($)
December	Compensation Expense		55,835
31, 2018	Paid-in Capital from Share Options			55,835
	(To record compensation expense for 2018)

Table (4)

To record compensation expense for 2018:

• Compensation Expense is an expense account. Expenses and losses decrease Equity account. Therefore, debit Compensation Expense account with $55,835.
• Paid-in Capital from Share Options is a shareholders’ equity account. Since share options are granted, company’s stock amount has increased. Therefore, credit Paid-in Capital from Share Options account with $55,835.

Date	Accounts title and Explanation	Post ref.	Debit ($)	Credit ($)
January  13, 2019	Cash $\left(100\times 10\times \$50\right)$		150,000
	Paid-in Capital From Share Options $\left(100\times 30\times \$16.25\right)$		48,750
	Common Stock $\left(\$5\times 3,000\right)$			15,000
	Additional Paid-in Capital on Common Stock			183,750
	(To record purchase options exercised by share option holders)

Table (5)

To record purchase options exercised by share option holders:

• Cash is an asset account. Since share options are exercised and shares are purchased for cash, cash is received. Therefore, debit Cash account with $115,000.
• Paid-in Capital from Share Options is a shareholders’ equity account. Since share options which are granted are exercised, the entry is reversed and cancelled for options exercised. Therefore, debit Paid-in Capital from Share Options account with $48,750.
• Common Stock is a shareholders’ equity account. Since share options which are granted are exercised and shares are sold, common stock amount increased. Therefore, credit Common Stock account with $15,000.
• Additional Paid-in Capital on Common Stock is a shareholders’ equity account. Since share options which are granted are exercised and shares are sold for more than par value, additional capital amount increased. Therefore, credit Additional Paid-in Capital on Common Stock account with $183,750.

3.

To determine

Prepare shareholders’ equity section that reporting the accounts related to compensation plan of Corporation C on December 31, 2017.

Explanation of Solution

Prepare shareholders’ equity section that reporting the accounts related to compensation plan of Corporation C on December 31, 2017:

Corporation C
Shareholders' Equity (Partial)
December 31, 2017
Contributed capital
Paid-in capital from share options	$40,040

Table (6)

4.

To determine

Identify whether there is a problem with the answer to requirement 3 and the eventual value of the vested share options. Explain the ways to avoid the problem, if any.

Explanation of Solution

Identify whether there is a problem with the answer to requirement 3 and the eventual value of the vested share options:

The problem was that the actual compensation cost in 2018 was more than the estimated compensation cost in 2017.

This is due to more number of shares granted for the increase in market share.

The ways to avoid the problem:

This problem would have been avoided, if less number of shares would have been granted as a performance based increase in market share.