Case Study: Sooner And Later

On January 1, 2006 Sooner or Later Inc. granted $1,000 at-the-money employee stock options. To ensure that the company can afford to compensate their employees based on their financial performance the award will only be absolute if the revenue over the following three years is greater than 10 million dollars and if the employees are still employed with the company. Sooner or Later’s management believes that the company will have revenues in excess of 10 million dollars over the next three year period. According to FASB, Statement no. 123(R) A Corporation must use the fair value method to account for compensatory share option plans. Sooner or Later has two options: they can either use the grant date fair value of $9.00 or they can use the grant
The first being that the employee provides services to the company for three years. The second criteria is that the company attains a revenue target of 10 million dollars cumulatively for the following three years. Sooner or Later has met both of these criteria. The revenues from 2006 to 2008 are $11 million and their employees have provided services to the company for three years. Sooner or Later should use the grant date fair value of $6 when measuring compensation cost because the revenue target is factored into the fair value and the employees would be vested the award. A second reason the company should use the $6 grant date fair value would be because, “an award’s quantity may double, or an award’s contractual term may be extended, if a company-wide revenue target is achieved. (FASB code 718-10-55-64).” This option would seem very beneficial to the employees since the company reached their revenue target. This means the award granted would double in amount and the term of the contract would be
We believe this is true because as mentioned earlier, performance that affects only whether the employees are granted the award should be excluded from the fair value estimate. We also believe this because in order for the company to use the fair value determined by the valuation officials, the company must meet their revenue target in order for that value to be factored in. Although Sooner or Later was able to exceed their target by 1 million dollars for the following three years, that does not mean they will be able to achieve their goal every time. We also believe it is beneficial that performance or service conditions affect the award’s fair value because good performance can lead to extended contract term and doubled quantity. If the employees are making more money, they will be motivated to do their job and do it well. In the long run satisfied employees will help the company’s bottom line and help to generate more profits. Sooner or Later should recognize compensation costs associated with these stock options for three years, 2006-2008. According to our calculations below, $3,000 should be recognized in each of these years. | 2006 | 2007 | 2008 | Estimated Compensation ($9*1,000) | 9,000 | 9,000 | 9,000 | Fraction of year | *1/3 | *1/3 | *1/3 | Compensation expense to date | 3,000 | 6,000 | 9,000 | Previous compensation