On January 1, 2010, Pierce Company establishes a performance based share option plan for its 80 top executives. The terms of the plan are that each executive is granted a maximum of 200 options after completing a three-year service period. The exact number of options granted, however, depends on the percentage increase in sales over the three-year period. The terms are: (1) if sales increase between 0 and 3%, each executive is granted 90 options; (2) if, instead, sales increase between 4 and 6%, each executive is granted 140 options; and (3) if, instead, sales increase at least 7%, each executive is granted the maximum number of options. Each option entitles the executive to acquire one share of the company’s $10 par common stock at a price of $45. The options expire at the end of six years. On the grant date Pierce Company uses an option pricing model to estimate that the fair value of each share option is $15.50. Pierce’s employee turnover rate has averaged 6% per year and, on the grant date it expects this rate to continue over the service period. At the end of 2011, because of lower turnover, Pierce revises its estimated annual turnover rate to 4% for the service period. At the end of 2012, options vest for 68 executives. On February 3, 2013, 50 executives exercise their options when the market price of the company’s common stock is $62 per share. During the remainder of the year, the market price declines so that at the end of 2013 the other 18 executives allow their options to expire. Based on a projection of past trends, on the grant date Pierce Company estimates that its sales will increase about 5% by the end of 2012. This estimate appears accurate through 2011. However, in the last half of 2012, sales increase so much that at the end of 2012 Pierce determines that its total sales have increased by 7% over the three-year service period. All inventory is shipped by Pierce to its customers under FOB destination terms.
1. Prepare a schedule of the Pierce Company’s compensation computations for its compensatory share option plan for 2010 through 2012 (round all computations to the nearest dollar).
2. Prepare the journal entries of Pierce Company for 2010 through 2013 in regard to this plan.
3. Show how the account(s) related to the plan is (are) reported in the stockholders’ equity section of Pierce Company’s December 31, 2011 balance sheet.
4. Do you see any problems with the way the terms of Pierce Company’s compensatory share option plan are structured? Explain.