Question

Pastner Brands is a calendar-year firm with operations in several countries. As part of its executive compensation plan, at January 1, 2021, the company issued 320,000 executive stock options permitting executives to buy 320,000 shares of Pastner stock for $28 per share. One-fourth of the options vest in each of the next four years beginning at December 31, 2021 (graded vesting). Pastner elects to separate the total award into four groups (or tranches) according to the year in which they vest and measures the compensation cost for each vesting date as a separate award. The fair value of each tranche is estimated at January 1, 2021, as follows:
Vesting Date Amount Vesting Fair Value per Option
Dec. 31, 2018 25% $4.00
Dec. 31, 2019 25% $4.40
Dec. 31, 2020 25% $4.80
Dec. 31, 2021 25% $5.60

Required:
a. Determine the compensation expense related to the options to be recorded each year 2018-2021, assuming Pastner allocates the compensation cost for each of the four groups (tranches) separately.
b. Determine the compensation expense related to the options to be recorded each year 2018-2021, assuming Pastner uses the straight-line method to allocate the total compensation cost.

Answer 1

Answer:

Pastner Brands

a. Compensation expense related to the options to be recorded each year, allocated with separate tranches:

Vesting Date   Amount Vesting   Fair Value     Compensation

                                                     per Option         Expense

Dec. 31, 2018       25% = 80,000       $4.00            $320,000

Dec. 31, 2019      25% = 80,000        $4.40              352,000

Dec. 31, 2020     25% = 80,000       $4.80               384,000

Dec. 31, 2021      25% = 80,000       $5.60               448,000

Total                 100%   320,000                           $1,504,000

b. Compensation expense related to the options, allocated using the straight-line method:

= $376,000

Explanation:

a) Data and Calculations:

Executive stock options issued = 320,000

Options exercise price = $28 per share

Number of tranches for the options = 4

Number of options exercisable in each tranche = 80,000

Vesting Date   Amount Vesting   Fair Value     Compensation

                                                     per Option         Expense

Dec. 31, 2018       25% = 80,000       $4.00       $320,000 (80,000 * $4.00)

Dec. 31, 2019      25% = 80,000        $4.40         352,000 (80,000 * $4.40)

Dec. 31, 2020     25% = 80,000       $4.80          384,000 (80,000 * $4.80)

Dec. 31, 2021      25% = 80,000       $5.60          448,000 (80,000 * $5.60)

Total                 100%   320,000                      $1,504,000

Compensation expense, using the straight-line method = $376,000 ($1,504,000/4)