“Now what do I do?” moaned your colleague, Matt. “This is a first for me,” he confided. You and Matt are recent hires in the Accounting Division of National Paper. A top executive in the company has been given share-based incentive instruments that permit her to receive shares of National Paper equal in value to the amount the company shares rise above the shares' value two years ago when the instruments were issued to her as compensation. The instruments vest in three years. A clause was included in the compensation agreement that would permit her to receive cash rather than shares upon exercise if sales revenue in her division were to double by that time. Because that contingency was considered unlikely, the instruments have been accounted for as equity, with the grant date fair value being expensed over the five-year vesting period.

Now, though, surging sales of her division indicate that the contingent event has become probable, and the instruments should be accounted for as a liability rather than equity. The fair value of the award was estimated at $5 million on the grant date, but now is $8 million. Matt has asked your help in deciding what to recommend to your controller as the appropriate action to take at this point.

Required:

1. Obtain the relevant authoritative literature on accounting for a change in classification due to a change in probable settlement outcome using the FASB's Codification Research System. You might gain access at the FASB website (www.fasb.org). Explain to Matt the basic treatment of the situation described. What is the specific citation that you would rely on in applying that accounting treatment?

2. Prepare the journal entry to record the change in circumstance.