Question

On December 1, Year 1, Fox Co. approved a plan to award 150,000 share options to 20 key employees. Effective January 1, Year 2, each key employee was granted the right to purchase 7,500 shares of Fox $2 par value stock at an exercise price of $36 a share, with a market price on that date of $32 a share. All share options vest at December 31, Year, the end of the 3-year requisite service period, and all expire on December 31, Year 11. Based on an appropriate option-pricing model, the fair value of the options on the grant date was estimated at $12 an option. On January 1, Year 3, five key employees left Fox. During the period from January 1, Year 5, through December 31, Year 11, 100,000 of the share options that vested were exercised. The remaining options were not exercised. What amount of the previously recognized compensation expense should be adjusted upon expiration of the share options?

Answer 1

The $150000 amount shall be adjusted in previously recognised compensation expense upon expiration of the share options.

Step-by-step explanation:

Compensation expense to be booked on December 31, Year 2:

The following expense shall be recognised in the accounts of the Fox Co as at December 31, Year 2 in respect of employee share options

7500*20*12*1/3=$600,000

In the above calculation, 7500 represents number of share options to be granted, 20 represents number of key employees to whom share options has been granted, 12 represent the fair value of the option at the grant dated and 1/3 represent first year of the 3-year requisite service condition for the exercise of share options.

Compensation expense to be booked on December 31, Year 3:

The following expense shall be recognised in the accounts of the Fox Co as at December 31, Year 3 in respect of employee share options:

7500*15*12*2/3-600000=$300,000

Since 5 key employees left at the start of year 3, therefore the number 15 should be used instead of 20 for the purpose of calculation. Also the 2/3 represents 2 years of the 3-year requisite service condition, therefore the expense recognised in Year 2 amounting to 600000 shall be deducted from the above calculation to give the amount required to be recognised as the expense in Year 3.

Compensation expense to be booked on December 31, Year 4:

7500*15*12*3/3-900000=$450,000

The 3/3 represents 3 years of the 3-year requisite service condition, therefore the expense recognised in Year 2 and 3 amounting to 900000 shall be deducted from the above calculation to give the amount required to be recognised as the expense in Year 4.

Overall expense of $1350000 (600,000+300,000+450,000) has been recognised in respect of the employees compensation for year 2, 3 and 4.

Since only 100000 options were exercised out of total 112500 (7500*15) options during the period from January 1, Year 5 to December 31, Year 11, therefore the previously recognised compensation expense shall be adjusted by following amount:

1350000-1200000(100000*12)=150000

The answer for the question is 150000