Chapter 15, Problem 5P

1.

To determine

Prepare the schedule of Corporation P’s compensation calculations for its compensatory share option plan for 2016 to 2018.

Explanation of Solution

Share option plan: This is an option given to an employee to buy a certain number of shares of stock of the company at a pre-determined price during certain period of time.

Performance-based share option compensation plan: This is a type of share option plan which could be exercised when the performance target mentioned is achieved by the employees.

Prepare the schedule of Corporation P’s compensation calculations for its compensatory share option plan for 2016 to 2018:

Particulars	2016	2017	2018
Estimated (actual) total compensation cost	$145,824	$149,296	$210,800
Fraction of service expired	× 1/3 years	×  2/3  years	×  3/3 years
Estimated compensation expense to date	48,608	99,531	210,800
Previously recognized compensation expense	0	(48,608)	(99,531)
Current compensation expense	$48,608	$50,293	$111,269

Table (1)

Working Note 1: Compute the total compensation cost of options for the year 2016:

$\begin{array}{c}\begin{array}{l}\text{Total compensation }\\ \text{cost of options}\end{array}\}\text{ = }\left\{\begin{array}{l}\text{Fair market value per share × }\\ \text{Number of options expected to vest}\end{array}\right\}\\ \text{= }\left\{\begin{array}{l}\text{\$15}\text{.50 × }\left(\text{140 options}\times 80\text{ executives}\right)\times \\ \left(100\%–16\%\right)\text{retention rate}\end{array}\right\}\\ \text{= \$15}\text{.50 × 140 options}\times 80\text{ executives}\times 84\%\\ \text{= \$145,824}\end{array}$

Working Note 2: Compute the total compensation cost of options for the year 2017:

$\begin{array}{c}\begin{array}{l}\text{Total compensation }\\ \text{cost of options}\end{array}\}\text{ = }\left\{\begin{array}{l}\text{Fair market value per share × }\\ \text{Number of options expected to vest}\end{array}\right\}\\ \text{= }\left\{\begin{array}{l}\text{\$15}\text{.50 × }\left(\text{140 options}\times 80\text{ executives}\right)\times \\ \left(100\%–14\%\right)\text{retention rate}\end{array}\right\}\\ \text{= \$15}\text{.50 × 140 options}\times 80\text{ executives}\times 86\%\\ \text{= \$149,296}\end{array}$

Working Note 3: Compute the total compensation cost of options for the year 2018:

$\begin{array}{c}\begin{array}{l}\text{Total compensation }\\ \text{cost of options}\end{array}\}\text{ = }\left\{\begin{array}{l}\text{Fair market value per share × }\\ \text{Number of options actually vested}\end{array}\right\}\\ \text{= \$15}\text{.50 × }\left(\text{200 options}\times 68\text{ executives}\right)\\ \text{= \$210,800}\end{array}$

2.

To determine

Prepare Corporation P’s memorandum entry for the grant date and journal entries for 2016 to 2019 related to this plan.

Explanation of Solution

Prepare Corporation P’s memorandum entry for the grant date:

Memorandum entry: On January 1, 2016, the company granted performance-based compensatory share options to 80 executives. The plan allows each executive to exercise 200 options to acquire the same number of shares of company’s common stock at an exercise price of $45 per share and vest at the end of service period of 3 years. The estimated fair value of the options expected to be exercised is $145,824.

Prepare the journal entries for 2016 to 2019 related to the compensation plan:

Date	Accounts title and Explanation	Post ref.	Debit ($)	Credit ($)
December	Compensation Expense		48,608
31, 2016	Paid-in Capital from Share Options			48,608
	(To record compensation expense for 2016)

Table (2)

To record compensation expense for 2016:

• Compensation Expense is an expense account. Expenses and losses decrease Equity account. Therefore, debit Compensation Expense account with $48,608.
• Paid-in Capital from Share Options is a shareholders’ equity account. Since share options are granted, company’s stock amount has increased. Therefore, credit Paid-in Capital from Share Options account with $48,608.

Date	Accounts title and Explanation	Post ref.	Debit ($)	Credit ($)
December	Compensation Expense		50,923
31, 2017	Paid-in Capital from Share Options			50,923
	(To record compensation expense for 2017)

Table (3)

To record compensation expense for 2017:

• Compensation Expense is an expense account. Expenses and losses decrease Equity account. Therefore, debit Compensation Expense account with $50,923.
• Paid-in Capital from Share Options is a shareholders’ equity account. Since share options are granted, company’s stock amount has increased. Therefore, credit Paid-in Capital from Share Options account with $50,923.

Date	Accounts title and Explanation	Post ref.	Debit ($)	Credit ($)
December	Compensation Expense		$111,269
31, 2018	Paid-in Capital from Share Options			$111,269
	(To record compensation expense for 2018)

Table (4)

To record compensation expense for 2018:

• Compensation Expense is an expense account. Expenses and losses decrease Equity account. Therefore, debit Compensation Expense account with $111,269.
• Paid-in Capital from Share Options is a shareholders’ equity account. Since share options are granted, company’s stock amount has increased. Therefore, credit Paid-in Capital from Share Options account with $111,269.

Date	Accounts title and Explanation	Post ref.	Debit ($)	Credit ($)
February 3, 2019	Cash $\left(200\times 50\times \$45\right)$		450,000
	Paid-in Capital From Share Options $\left(200\times 50\times \$15.50\right)$		155,000
	Common Stock $\left(\$10\times 10,000\right)$			100,000
	Additional Paid-in Capital on Common Stock			505,000
	(To record purchase options exercised by share option holders)
December 31, 2019	Paid-in Capital From Share Options $\left(200\times 18\times \$15.50\right)$		$55,800
	Additional Paid-in Capital on Common Stock			$55,800
	(To record the expired purchase options)

Table (5)

To record purchase options exercised by share option holders:

• Cash is an asset account. Since share options are exercised and shares are purchased for cash, cash is received. Therefore, debit Cash account with $450,000.
• Paid-in Capital from Share Options is a shareholders’ equity account. Since share options which are granted are exercised, the entry is reversed and cancelled for options exercised. Therefore, debit Paid-in Capital from Share Options account with $155,000.
• Common Stock is a shareholders’ equity account. Since share options which are granted are exercised and shares are sold, common stock amount increased. Therefore, credit Common Stock account with $100,000.
• Additional Paid-in Capital on Common Stock is a shareholders’ equity account. Since share options which are granted are exercised and shares are sold for more than par value, additional capital amount increased. Therefore, credit Additional Paid-in Capital on Common Stock account with $505,000.

To record the expired purchase options:

• Paid-in Capital from Share Options is a shareholders’ equity account. Since share options which are granted are expired, the entry is reversed and cancelled for options expired. Therefore, debit Paid-in Capital from Share Options account with $55,800.
• Additional Paid-in Capital on Common Stock is a shareholders’ equity account. Since share options which were granted earlier, the shares were sold for more than par value, additional capital amount increased. Therefore, credit Additional Paid-in Capital on Common Stock account with $55,800.

3.

To determine

Prepare shareholders’ equity section that reporting the accounts related to compensation plan of Corporation P on December 31, 2017.

Explanation of Solution

Prepare shareholders’ equity section that reporting the accounts related to compensation plan of Corporation P on December 31, 2017:

Corporation P
Shareholders' Equity (Partial)
December 31, 2017
Contributed capital
Paid-in capital from share options	$99,531

Table (6)

4.

To determine

Identify whether there is a problem with the terms of Corporation P’s share option plan are structured and explain the same.

Explanation of Solution

Identify whether there is a problem with the terms of Corporation P’s share option plan:

• Company P granted performance based share option plan on the basis of increase in sales.
• Company P shipped the inventory under ‘FOB destination’ terms, which means that sale of inventory is recorded when the inventory reaches the destination.
• The problem was that Company P recorded the sales of inventory before the inventory reached the destination, resulting in increase of sales towards the end of 2018, when the options would be exercised.
• Out of 68 options vested, 50 were exercised when the market price was $62, and 18 options expired due to decrease in market price. This resulted in increase of additional paid-in capital.