Question

On January 1, 2006, Zillionaire (the Company) issued to certain employees 1,000,000 equity-settled stock option awards. The employees will vest in differing numbers of options depending on the cumulative amount of net income the Company earns over the four fiscal years1 following the date of grant, and their continued employment with the Company. The exercise price of the awards is $31.50, which was the Company’s closing share price on the NASDAQ National Market on the date of grant. The Company accounts for the stock compensation awards based on the provisions of ASC 178. The fair value of each award, which was determined based on the Black-Scholes option pricing model was $8 at the date of grant. In order to align the employees’ performance with the performance of the Company, the Board of Directors of the Company included the following provision in each of the awards: Subject to Section 5.2(a) of the Zillionaire 2006 Stock Option Plan, the employee will vest in the awards in various percentages (refer to vesting schedule below) based on the amount of cumulative net income earned by the Company in the succeeding four-year period: Performance Condition Percent Vested Greater than $15 million, up to $20 million 25% Greater than $20 million, up to $23 million 50% Greater than $23 million, up to $27 million 75% Greater than $27 million 100% Based on its most current financial forecasts, the Company believes it will earn cumulative net income greater than $20 million, but not more than $23 million in the succeeding four-year period. As a result, the Company will base its estimate of compensation cost on 50 percent of the awards vesting (assuming no forfeitures). Required: • Issue 1: How much compensation cost would the Company have to record for the year ended December 31, 2006, in accordance with the principles of ASC 718-compensation-stock compensation? (Citation from ASC is required.) The first fiscal year is the year in which the stock options have been granted. Additional Facts: Assume the same facts in Issue 1 except that the Zilliionaire Stock Option Plan allowed employees to pay for the exercise of the stock options using the stock they will receive upon exercise of their awards, or by tendering options with an intrinsic value equal to the exercise price (net-share settlement). • Issue 2: How much compensation cost would the Company have to record for the year ended December 31, 2006, in accordance with the principles of ASC 718-compensation-stock compensation? Additional Facts: Assume the same facts in Issue 1 except that the Zillionaire 2006 Stock Option Plan permits settlement of the awards in cash instead of the Company’s own shares. The Company has concluded, and its auditor has agreed, that the awards are liability awards since they will be settled in cash. The fair value of each liability award at December 31, 2006, is $12. The awards essentially would meet the definition of a cash-settled stock appreciation right (SAR). SARs are awards enabling employees to receive cash, stock, or a combination of cash and stock, in an amount equivalent to any excess of the market value of a stated number of shares of the employer’s stock over a stated price (i.e., exercise price). If the SAR is payable only in cash, or payable in cash at the election of the employee, accrued compensation should be recorded as a liability. Since the value of the SAR is based on the market appreciation of the Company’s stock, total compensation cost is unknown for a SAR until it is exercised. Issue 3: How much compensation cost would the Company have to record for the year ended December 31, 2006, in accordance with the principles of ASC 718-compensation-stock compensation?

Answer 1

Solution 1
Stock option A	1000000
Exercise price	31.5
Fair value of each award B	8
Vesting - 50% (C = 50% x A)	500000
Compensation Cost for 4 fiscal years   D =BXC	4000000
Compensation cost for each year D / 4	1000000
Compensation cost to be recorded as on December.31, 2006	1000000

Solution 2
Compensation cost to be recorded as on December.31, 2006	1000000

Under grant-date fair-value-based measurement approach in ASC 718 compensation cost for a net-share-settled option is not premeasured unless

- Option is modified

- Other features in the option or SAR result in liability classification.

So, Compensation cost will not change for Issue 2.

Solution 3.

As re-classification into SAR has resulted into liability; calculation of Compensation cost needs to be reworked. Revised compensation cost would be as follows-

Stock option A	1000000
Fair value of each award B	12
Vesting - 50% (C = 50% x A)	500000
Compensation Cost for 4 fiscal years   D =BXC	6000000
Compensation cost for each year D / 4	1500000
Compensation cost to be recorded as on December.31, 2006	1500000