Acct 592 – Spring 2011 Prof. Teresa Gordon

HOMEWORK CGraded Vesting

Merlin Manufacturing Inc. awards 400,000 options on March 1, 2010 to 50 managers (8,000 options each). The options were at-the-money on the grant date when the stock price was $39.00. The options vest according to the following schedule:

Vesting Date / Fair Value / Percentage Vested / Expiration Date
(all tranches)
March 1, 2012 / $9 / 25% / December 31, 2020
(or within 3 months of termination)
March 1, 2013 / $13 / 25%
March 1, 2014 / $18 / 25%
March 1, 2015 / $22 / 25%

At the grant date, the anticipated forfeiture rate is 2%. Round forfeiture estimates to whole employees so that you forecast eliminating all unvested options held by a terminated employee. The company has a calendar year fiscal year. It is not necessary to make quarterly entries. Assume the tax rate is 30% throughout the period. The common stock has a $5 par value. Information on forfeitures, exercise, and market values are presented below:

Vesting Date / Actual Options Vested / Market Value of Common Stock at Vesting Date
3/1/2012 / 98,000 / $48.00
3/1/2013 / 92,000 / $54.25
3/1/2014 / 82,000 / $49.00
3/1/2015 / 80,000 / $52.00
Exercise Date / Number of Options Exercised / Market Value of Common Stock at Exercise Date
12/5/2014 / 12,000 / $50.00
2/13/2015 / 18,000 / $55.00
12/10/2015 / 54,000 / $55.50
12/3/2019 / 268,000 / $62.00

After the first two tranches vest at 3/1/13, the company revises its estimated number of options expected to vest using a retroactive 3% turnover rate. (Hint: it may be easier to make the adjustment through the end of the previous year rather through 3/1/13. Doing it this way might make the recognition of compensation expense for 2013 simpler to compute since it would then be for a full year using the new number of options anticipated.)

Requirements:

1.  Assume that the company uses the straight-line attribution method permitted under SFAS No. 123R. Since the company does not keep track of the tranche from which each option originated, it chooses the first-vested, first-exercised basis to determine the fair value of options exercised - like the first-in, first-out inventory method. In other words, they are accounting for the four tranches as a single award.

2.  Assume that the company uses the graded-attribution method permitted under SFAS No. 123R. This is consistent with treating each of the four tranches as a separate award. The company keeps track of the tranches from which each option originated but you may assume that the actual exercises through 2015 are from the first tranche (to keep it the same as #1).

See illustrations that start at about ASC 718-20-55-25

You MUST include T-accounts with your solution so that both of us will know your journal entries accomplished the intended purpose.

Examples-FAS123(Rev2004) S11.docx as of 2/22/10 Page 1