Textbook Problem

Performance-Based Share Option Compensation Plan On January 1, 2019, Pierce Company establishes a performance-based share option plan for its 80 top executives. The terms of the plan are that each executive is granted a maximum of 200 options alter completing a 3 year service period. The exact number of options granted, however, depends on the percentage increase in sales over the 3-year period. The terms are: (1) if sales increase between 0% and 3%, each executive is granted 90 options; (2) if sales increase between 4% and 6%, each executive is granted 140 options; and (3) if sales increase at least 7%, each executive is granted the maximum number of options. Each option entitles the executive to acquire one share of the company’s $10 par common stock at a price of $45. The options expire at the end of 4 years.

On the grant date, Pierce uses an option pricing model to estimate that the fair value of each share option is $15, 50. Pierce’s employee turnover rate is expected to be 16% over the service period. At the end of 2020, because of lower turnover, Pierce revises its estimated turnover rate to 14% for the service period. At the end of 2021, options vest for 68 executives. On February 3, 2022, 50 executives exercise their options when the market price of the company’s common stock is $62 per share. During the remainder of the year, the market price declines so that at the end of 2022 the other 18 executives allow their options to expire.

Based on a projection of past trends, on the grant date Pierce estimates that its sales will increase about 5% by the end of 2021. This estimate appears accurate through 2020. However, in the last half of 2021, sales increase so much that at the end of 2021 Pierce determines that its total sales have increased by 7% over the 3-year service period. All inventories are shipped by Pierce to its customers under FOB destination terms.

Required:

1. 1. Prepare a schedule of Pierce’s compensation computations for its compensatory share option plan for 2019 through 2021 (round all computations to the nearest dollar).
2. 2. Prepare Pierce’s memorandum and journal entries for 2019 through 2022 in regard to this plan.
3. 3. Show how the account(s) related to the plan is (are) reported in the shareholders’ equity section of Pierce’s December 31, 2020, balance sheet.
4. 4. Next Level Do you see any problems with the way the terms of Pierce’s compensatory share option plan are structured? Explain.