Acct 592 – Spring 2006Prof. Teresa Gordon
SOLUTION
Example 3 – Options with Performance Condition
On December 31, 2011, Palouse Paper Products (PPP) issued at-the-money shares of options to its divisional executives at the rate of 10 shares for each $100 in annual salary. After vesting, the options can be converted one for one into the $1 par value common shares at any time through July 1, 2016. Options vest on December 31, 2014 if performance targets have been met by that date and the executive is still employed by PPP. On the grant date, the closing market price of PPP common stock was $30 and the fair value of the options was determined to be $12. The tax rate is 40%.
Under the program, a total of 75,000 options were issued to the 10 divisional vice presidents. Each option vests if the market share of a division’s product line grows by 10 percentage points by the end of 2014. Initially, the achievement of these “stretch” goals is not considered probable. The executive turnover rate is estimated at 5% per year.
Grant date 12/31/12 12/31/13 12/31/14 12/31/15 7/1/16
12/31/11
12/31/12Market Price PPP stock = $32
Options expected to be outstanding at 12/31/14 = 75,000 * .95 * .95 * .95 = 64,303
Percentage earned = 1/3(implied service period)
Achievement of performance goal – not probable
No compensation recognized
Toward the end of 2013, sales growth for several products makes achievement of goals probable. Vice presidents of those divisions hold 55% of the options. None of the vice presidents left employment during 2012 or 2013 so the expected turnover rate is lowered to 3%.
12/31/13Market Price $37
Options expected to be outstanding at 12/31/14 = 75,000 * .97 * .97 * .97 = 68,451
Percentage earned = 2/3(implied service period)
Achievement of performance goal – probable for 55% of options
Compensation recognized = 68,451 * $12 * 55% * 2/3 = $301,184
12/31/13Compensation Expense 301,184
APIC – stock options outstanding 301,184
Deferred tax asset 120,474
Income tax expense (deferred) 120,474
By the end of 2014, five divisions had achieved their market share targets, but one of the five vice presidents had been fired before year end leaving just 36,000 options to vest.
12/31/14Market Price $39
Options that vest = 36,000
Actual employee compensation = 36,000 * $12 = $432,000
Amount to recognize 2014 = 432,000 – 301,184 = 130,816
12/31/14Compensation Expense 130,816
APIC – stock options outstanding 130,816
Deferred tax asset 52,326
Income tax expense (deferred) 52,326
12/31/15Market Price = $40
No entry needed
6/15/16All options exercised when market price of PPP common stock = $43
Fair value included in equity = 36,000 * $12 = $432,000
Tax deduction = 36,000 * Intrinsic value of $13 = $468,000
6/15/16Cash (36,000 * $30) 1,080,000
APIC – stock options outstanding 432,000
Common stock ($1 par) 36,000
APIC – common stock 1,476,000
6/15/16Income tax expense (deferred) 172,800
Deferred tax asset (40% * $432,000)* 172,800
Current taxes payable (40% * 468,000) 187,200
Income tax expense (current) 172,800
APIC – excess tax deduction 14,400
* or $4.80 per share deferred taxes * 36,000 options exercised
Solutions to FAS123R Examples.doc as of 10/19/18Page 1