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Under its executive stock option plan, National Corporation granted 15 million options on January 1, 2021, that permit executives to purchase 15 million of the company’s $1 par common shares within the next six years, but not before December 31, 2023 (the vesting date). The exercise price is the market price of the shares on the date of grant, $32 per share. The fair value of the options, estimated by an appropriate option pricing model, is $4 per option. Suppose that unexpected turnover during 2022 caused the forfeiture of 5% of the stock options. Compute the amount of compensation expense for 2022 and 2023

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Answer:

Compensation expense for 2022 and 2023 are $12 million and $16 million respectively.

Explanation:

Total compensation expenses = Number of options × Option fair of value = 15 million × $4 = $60 million

Number of years the option is allowed to be exercised = January 1, 2021 to December 31, 2023 = 3 years

Annual compensation expenses = Total compensation expenses ÷ Number of years the option is allowed to be exercised = $60 million ÷ 3 = $20 million

That shows that $20 million is recognized as compensation expenses in 2021.

As there is a 20% forfeiture of the options due to an unexpected turnover, total compensation expenses reduces to:

New total compensation expenses = $60 million × (100% - 20%) = $48 million

Accumulated expenses in 2022 = ($48 million ÷ 3) × 2 = $32 million

Compensation expenses recognized in 2022 = Accumulated expenses in 2022 - Compensation expenses already recognized in 2021 = $32 million - $20 million = $12 million

Compensation expenses recognized in 2023 = $48 million ÷ 3 = $16 million

Therefore, compensation expense for 2022 and 2023 are $12 million and $16 million respectively.

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