Jensen Inc.  is a publicly-held company  and is a fashion retailer that sells men’s and women’s clothing and accessories. As an incentive to its employees, the Company established a compensation incentive plan in which a total of 100,000 options were granted on January 1, 20X0. On that date (the grant date), Fashion’s stock price was $15.00 per share.

The significant terms of the incentive plan are as follows:

• The options have a $15.00 “strike” or exercise price (the price the employee would pay to purchase a share of stock if the options vest).
• For the options to vest, the following must occur:
  • The employee must continue to provide service to the Company throughout the entire explicit service period of five years (i.e., a five-year “cliff-vesting” award).
  • The Company must achieve annual sales of at least $20 million during the fifth year of the explicit service period.
  • The Company’s share price must increase by at least 25 percent over the five-year explicit service period.
• In addition, if the Company achieves sales of at least $25 million during the fifth year of the explicit vesting period, the strike price of the options will decrease from $15 to $10.
• The options expire after 10 years following the grant date.
• The options are classified as equity awards.

Additional Facts:

• Assume it is probable at all times that 100 percent of the employees receiving the awards will continue providing service to the Company as employees for the entire five-year explicit service period and that the five-year explicit service period is determined to be the requisite service period.
• On the grant date, Fashion’s management determined that it is probable that the Company’s sales in year 5 will be $30 million, and therefore it is probable on the grant date that sales are greater than or equal to at least $25 million.
• The grant-date fair value of the options assuming a strike price of $15 is $8 per option. The grant-date fair value assuming a strike price of $10 per option is $12 per option.

Required:

As described above, on January 1, 20X0 (the grant date), $30 million of sales were probable for year 5. During years 1, 2, and 3, $30 million of sales for year 5 remained probable. At the beginning of year 4, management determines that it is probable that only $22 million of sales will occur for year 5. What are the proper accounting treatment and journal entries for each year?

Answer rating: 100% (QA)

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