Question

Question Occupy Mall Street (Please I need a detailed explanation and also number Answers as to know which answer corresponds to each question)

Occupy Mall Street (OMS or the "Company") is a leading real estate management firm that owns and manages over 100 shopping malls across the United States. The Company went public in 2009 and experienced a continued increase in stock price through 2011. With the sustained growth of the business and rising stock price, OMS developed a practice of granting annual stock option awards to its executives at the beginning of each year.

On January 1, 2012, OMS granted 2,000 employee share options that cliff vest after a four-year service period, with an exercise price of $35 per share. Using the Black-Scholes pricing model, the Company determined that the grant-date fair-value-based measure of the awards was $20. On the grant date, the Company’s stock was trading at $35 per share.

On January 1, 2014, to provide additional retention incentive to its employees for the third and fourth years of service of the 2012 annual grant, OMS will change the terms of the award by modifying the exercise price to $20 per share. Using the Black-Scholes pricing model, management determined that the fair-value-based measure of the awards was $12 after modification and $9 before the terms of the award were modified. The modification did not affect any of the other terms or conditions of the awards.

Note that no forfeitures are assumed for the purposes of this case.

Required:

When answering each of the questions in this case (1 through 5), cite the relevant ASC to support your answers.

1. How much compensation cost should OMS recognize in each year of the award’s service period?

2. How would the accounting for these awards change if the modification to the terms (i.e., exercise price) of the award was made on January 1, 2017, after the awards have become fully vested?

Additional Case Facts: Assume the same facts as described above. However, the terms of the award also include a performance condition in which the awards will vest if cumulative net income over the four-year vesting period is greater than $10 million. On December 31, 2013, because of the loss of several tenants, projected cumulative net income over the four-year period had been revised down to $9 million. As a result, management determined that the performance condition had become improbable to achieve.

On December 31, 2014, management’s conclusion that the award’s performance condition was improbable of achievement had not changed. In response to this, management reduced the performance condition of the original award to $8 million of cumulative net income over the four-year period. Using the Black-Scholes pricing model, management determined that the fair-value-based measure of the awards was $12 upon modification. The modification did not affect any of the other terms or conditions of the awards; thus, the modification did not affect the option’s per-share fair-value-based measure.

Note that OMS had actually achieved $9.2 million of cumulative net income over the four-year period. Required: 3. How would the Year 2 accounting change if management determined that the performance condition was improbable of achievement on December 31, 2013? What would be the cumulative amount of compensation cost recognized?

4. How much compensation cost would management recognize in Year 3 and Year 4 if the December 31, 2014, modification resulted in the awards becoming probable of achievement?

Additional Case Facts:

Assume the same facts as described above. However, contemporaneously with the December 31, 2014, modification, OMS will lose a major tenant to bankruptcy; this loss will have a detrimental effect on the Company’s financial results for the year ended December 31, 2014. Even though OMS modified the options to reduce the performance target, loss of the significant tenant prompts OMS to maintain that the achievement of the performance target is improbable (i.e., the options are not expected to vest under the original or modified terms).

Required:

5. If the awards continued to be improbable of achievement after modification, how much cumulative compensation cost would be recognized through December 31, 2015? December 31, 2016?

Answer 1

OMS should recognize $10,000 of compensation cost each year during the award's service period. If the modification to the terms of the award is made after it has fully vested, no compensation cost will be recognized. If the performance condition is deemed improbable, OMS will recognize the cumulative amount of compensation cost for the service rendered to date, and if the modification makes the awards probable of achievement, $10,000 of compensation cost will be recognized in each remaining year. If the awards remain improbable after modification, the cumulative compensation cost recognized will be $15,000 through December 31, 2015, and $20,000 through December 31, 2016.

Step-by-step explanation:

1. How much compensation cost should OMS recognize in each year of the award’s service period?

According to ASC 718-20-35-2, OMS should recognize the compensation expense over the service period, which is four years in this case. The grant-date fair value of the award is $20, and there are 2,000 options granted, so the total compensation cost is $40,000. This amount should be recognized evenly over the four-year service period, resulting in $10,000 recognized each year.

2. How would the accounting for these awards change if the modification to the terms (i.e., exercise price) of the award was made on January 1, 2017, after the awards have become fully vested?

If the modification occurred after the awards have become fully vested, the accounting treatment will differ. Instead of recognizing compensation cost over the service period, the modification would be treated as an equity transaction. ASC 718-20-35-7 states that in this case, no compensation cost would be recognized for the modification.

3. How would the Year 2 accounting change if management determined that the performance condition was improbable of achievement on December 31, 2013? What would be the cumulative amount of compensation cost recognized?

If the performance condition was deemed improbable on December 31, 2013, ASC 718-20-35-8 states that OMS would recognize the cumulative amount of compensation cost for the service that has been rendered to date. Since Year 2 is the second year of the service period, half of the compensation cost ($10,000) would have already been recognized, resulting in a cumulative recognition of $15,000 by the end of Year 2.

4. How much compensation cost would management recognize in Year 3 and Year 4 if the December 31, 2014, modification resulted in the awards becoming probable of achievement?

If the modification resulted in the awards becoming probable of achievement, OMS would recognize the remaining compensation cost over the remaining service period. Since Year 3 and Year 4 are the third and fourth years of the service period, respectively, $10,000 of compensation cost would be recognized in each year, resulting in a cumulative recognition of $35,000 by the end of Year 4.

5. If the awards continued to be improbable of achievement after modification, how much cumulative compensation cost would be recognized through December 31, 2015? December 31, 2016?

If the awards remained improbable of achievement after the modification, ASC 718-20-35-7 states that OMS would recognize the cumulative compensation cost for the service that has already been rendered. This means that $15,000 would be recognized through December 31, 2015, and $20,000 would be recognized through December 31, 2016.

Answer 2

Through December 31, 2015, the cumulative cost would remain at $10,000 (Year 1). In 2016, there would be no additional cost recognized as the options are still improbable to vest.

Occupy Mall Street Answers:

1. Compensation Cost Recognition:

OMS should recognize compensation cost over the four-year service period for the fair value of the awards at the grant date ($20 per share). The annual cost would be $20/share * 2,000 shares * 25% = $10,000 (25% vesting per year).

ASC reference: ASC 718-10-30-2

2. Accounting with Modification after Vesting:

If the modification occurred after vesting, it wouldn't affect the accounting. The full compensation cost of $20 per share would have already been recognized.

3. Year 2 Accounting with Improbable Performance Condition:

On December 31, 2013, with the performance condition improbable, OMS should discontinue recognizing further compensation cost. The cumulative cost would be $10,000 (Year 1).

ASC reference: ASC 718-10-35-10

4. Compensation Cost with Probable Achievement after Modification:

In Years 3 and 4, OMS would recognize $12 per share based on the fair value after modification. The annual cost would be $12/share * 2,000 shares * 25% = $6,000 per year.

5. Cumulative Cost with Improbable Achievement after Modification:

Through December 31, 2015, the cumulative cost would remain at $10,000 (Year 1). In 2016, there would be no additional cost recognized as the options are still improbable to vest.

Note: Actual achievement of the lower target ($9.2 million) has no impact on the accounting since the modification rendered the options improbable to vest.