Alpha Ltd grants 100 options to each of its 50 employees on 1st January, 2006. The grant is conditional on the employees working for the company for the next 3 years.

Year                Actual employee departures               Expected employee departure

                                                                                    (over 3-year vesting period)

31/12/06          2                                                          12%

31/12/07          2                                                          16%

31/12/08          3

At the date of issue the fair value of each option is £14 and the exercise price is £40 per option.

The exercise price will drop to £30 per option if the company’s earnings increase by an average of 10% pa over the 3 year period. In this case the fair value of each option will be £18. It is expected that the required increase in earnings will be achieved.

Actual increases in earnings across the period are:

Year	Earnings increase
31/12/06	12%
31/12/07	13%
31/12/08	2%

Required:

(a) Explain why firms may wish to pay employees in shares in lieu of cash. (20 marks)

(b) Calculate the expense that would be recognised by Alpha Ltd for each of the 2006, 2007 and 2008 years. Demonstrate all your workings clearly.           

(c) Prepare the journal entries for Alpha Ltd. for the years 2006 and 2007. (10 marks)

Explain workings in detail.

Answer rating: 100% (QA)

A Stock options essentially pay for themselves by motivating employees to increase the value of the ... View the full answer