Question

On January 1, 2021, Ace Co issued stock options for 340,000 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 5% in three years. Suppose that Ace Co initially estimates that it is not probable the goal will be achieved, but then after one year, Ace Co estimates that it is probable that divisional revenue will increase by 5% by the end of 2023.

Required:

1. What is the revised estimate of the total compensation?

2. What action will be taken to account for the options in 2022?
3. Prepare the journal entries to record compensation expense in 2022 and 2023.

Answer 1

1. The revised estimate of the total compensation:

  = (Number of stock options issued*Estimated fair value of each option)

  =$340,000*$6

=$2,040,000

2. Ace company will reflect the cumulative effect on compensation in 2022 earning.

3. Journal entry to record compensation in 2022 and 2023

Year	General Journal	Debit	credit
2022	Compensation expenses ($2,040,000*2/4)	1,020,000
	Paid in capital- stock option		1,020,000
	(Being expenses for 2022 recorded)
2023	Compensation expenses(2,040,000*3/4 - 1,020,000)	510,000
	Paid in capital- stock option		510,000
	(Being expenses for 2023recorded)