What Types of Conditions Are Present in the Plan for the Vesting of the Units?

Questions and Solutions

1- What types of conditions are present in the plan for the vesting of the units? Are they service, performance, market, or “other” conditions?

The plan for the vesting of the units has presented different types of conditions.

The First condition is classified as service condition. It said that the employee must continue to provide service to the Company throughout the entire explicit service period of five years' service period.

The second condition is classified as performance condition. It said that the company must achieve annual sales of at least $20 million during the fifth year of the explicit service period.

The third condition is classified as market condition since it said that The Company’s share price must increase by at least 25 percent over the five-year explicit service period.

2- How do the service, performance, and market conditions affect vesting of the units? Of the various conditions present in the awards:

     a. Which affect the vesting of the award?

Vesting is a legal term that means to give or earn a right to a present or future payment, asset or benefit. It is used in reference to share option plan benefits when an employee accrues non-forfeitable rights over employer-provided stock incentives

A service condition requires employees to complete a specified period of service to receive the award. If a service condition exists, the company is permitted to adjust the number of share options expected to the actual number of investments vested. Thus compensation can be adjusted ( service condition is affecting vesting units) while no adjustments to compensation expense is permitted when market or performance condition exists because the market condition are reflected in the determination of fair value at the grant date (market and performance condition is not affecting vesting units).

According to the information we are given, for the equity award to be vested, all the three conditions (Service, market, and performance) should be satisfied.

     B. Which affect factors other than vesting of the award and what is their accounting treatment?  

If the service condition exists, the company is permitted to adjust the number of share options expected to the actual number of investments vested. Thus, compensation can be adjusted. The company should adust the estimate of compensation expense recorded in the current period (as a change in estimate). A company records this change in estimate bt debiting Share Premium- Share options and crediting Compensation Expense for the amount of cumulative compensation expense recorded to date. (thus decreasing compensation expense in the period of forfeiture).

FV of instrument at grant date can be affected by performance conditions that affect terms of the option (e.g. exercise price changes based on performance).    

3. As described above, on January 1, 20X1 (the grant date), $30 million of sales were probable for year 5. During years 1, 2, and 3, $30 million of sales for year 5 remained probable. At the beginning of year 4, management determines that it is probable that only $22 million of sales will occur for year 5. What are the proper accounting treatment and journal entries for each year?

If the Company achieves sales probably of at least $25 million during the fifth year of the explicit vesting period, the strike price of the options will decrease from $15 to $10. In addition, The grant-date fair value assuming a strike price of $10 per option is $12 per option, so the fair value of compensation expense is 1,200.000 (12 x 100,000).

Dec 31, Year 1

Compensation expense                                                       240,000

      Share Premium- Share options (1,200,000/5)                           240,000