On January 1, 2021, Farmer Fabrication issued stock options for 100,000 shares to a division manager. The options have an estimated fair value of $6 each. To provide additional incentive for managerial achievement, the options are not exercisable unless divisional revenue increases by 5% in three years. Suppose that after one year, Farmer estimates that it is not probable that divisional revenue will increase by 5% in three years. Required: 1. What is the revised estimate of the total compensation? 2. What action will be taken to account for the options in 2022? 3. What journal entry will be needed to account for the options in 2022?

Answer and Explanation:

The journal entries are shown below:

1. The revised estimated amount of total compensation is

= 100,000 shares × $6

= $600,000

2. The action shows that the Farmer Fabrication cumulative effect for the year 2022 earnings            

3. The journal entries are shown below:

For the year 2022

Compensation expense

         To Paid-in Capital-Stock options $200,000

(Being the compensation expense is recorded) $200,000

For recording this we debited the compensation expense as it increased the expenses and credited the paid in capital as it increased the stockholder equity

The computation is shown below:

= $600,000 ÷ 3 years

= $200,000

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