Chapter 5, Problem 25EP

(a)

To determine

Prepare journal entries to record compensation expense in relation with employee stock option plan, under IFRS.

Explanation of Solution

Share Based Payments:

Sometimes organizations offer to issue equity shares as a consideration, to employees or other parties such consideration is referred as share based payment. IFRS recognizes three types of share based payments that are, equity -settled, cash-settled or having choice of settlement.

Under IFRS, in case of modification in the terms of the plan, total compensation should not be lower than original compensation cost. Therefore, if due to modification, compensation decreases, then such modification is not considered.

Journalizing:

Journalizing is the process of recording the transactions of an organization in a chronological order. Based on these journal entries recorded, the accounts are posted to the relevant ledger accounts.

Accounting rules for journal entries:

• To increase balance of the account: Debit assets, expenses, losses and credit all liabilities, capital, revenue and gains.
• To decrease balance of the account: Credit assets, expenses, losses and debit all liabilities, capital, revenue and gains.

Recording compensation expense for year 1:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
	Compensation expense		10,000
	Share based payment liability			10,000
	(to record compensation)

Table (1)

• Since, compensation expense is an expense, expense is increased. Hence, compensation expense account is debited.
• Since, share based payment liability is a liability, liability is increased. Hence, share based payment liability account is credited.

Recording compensation expense for year 2:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
	Compensation expense		10,000
	Share based payment liability			10,000
	(to record compensation)

Table (2)

• Since, compensation expense is an expense, expense is increased. Hence, compensation expense account is debited.
• Since, share based payment liability is a liability, liability is increased. Hence, share based payment liability account is credited.

Recording compensation expense for year 3:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
	Compensation expense		10,000
	Share based payment liability			10,000
	(to record compensation)

Table (3)

• Since, compensation expense is an expense, expense is increased. Hence, compensation expense account is debited.
• Since, share based payment liability is a liability, liability is increased. Hence, share based payment liability account is credited.

Working Note:

Computation of compensation cost:

$\begin{array}{c}\text{Compensation}\text{cost}=\frac{\text{Number}\text{of}\text{options}\times \text{Fair}\text{value}}{\text{Vesting}\text{period}}\\ =\frac{1,000\times 30}{3}\\ =10,000\end{array}$

(b)

To determine

Prepare journal entries to record compensation expense in relation with employee stock option plan, under GAAP.

Explanation of Solution

As per GAAP, in case of modification, fair value as per modified plan is used to compute compensation expense.

Recording compensation expense for year 1:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
	Compensation expense		10,000
	Share based payment liability			10,000
	(to record compensation)

Table (4)

• Since, compensation expense is an expense, expense is increased. Hence, compensation expense account is debited.
• Since, share based payment liability is a liability, liability is increased. Hence, share based payment liability account is credited.

Recording compensation expense for year 2:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
	Compensation expense		8,666.67
	Share based payment liability			8,666.67
	(to record compensation)

Table (5)

• Since, compensation expense is an expense, expense is increased. Hence, compensation expense account is debited.
• Since, share based payment liability is a liability, liability is increased. Hence, share based payment liability account is credited.

Recording compensation expense for year 3:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
	Compensation expense		9,333.33
	Share based payment liability			9,333.33
	(to record compensation)

Table (6)

• Since, compensation expense is an expense, expense is increased. Hence, compensation expense account is debited.
• Since, share based payment liability is a liability, liability is increased. Hence, share based payment liability account is credited.

Working Note:

Computation of option expense:

$\text{Expense}=\left[\begin{array}{l}\left(\frac{\text{Number}\text{of}\text{options}\times \text{Fair}\text{value}}{\text{Vesting}\text{period}}\times \text{Expired}\text{period}\right)\\ -\text{Expense}\text{recorded}\text{earlier}\end{array}\right]$

Computation of Year 1 expense:

$\begin{array}{c}\text{Expense}=\left(\frac{\text{1,000}\times \$30}{\text{3}}\times \text{1}\right)-\$\text{0}\\ =\$10,000\end{array}$

Computation of Year 2 expense:

$\begin{array}{c}\text{Expense}=\left(\frac{\text{1,000}\times \$28}{\text{3}}\times 2\right)-\$10,000\\ =\$8,666.67\end{array}$

Computation of Year 3 expense:

$\begin{array}{c}\text{Expense}=\left(\frac{\text{1,000}\times \$28}{\text{3}}\times 3\right)-\left(\$10,000+\$8,666.67\right)\\ =\$9,333.33\end{array}$