On January 1, 2020, Orion Corp. granted an employee an option to purchase 5,000 of Orion's no par value common shares at $ 50 per share. The Black-Scholes option pricing model determined total compensation expense to be $ 220,000. The option became exercisable on December 31, 2021, after the employee completed two years of service. The market prices of Orion's shares were as follows: For calendar 2021, Orion should recognize compensation expense of
A) $ 0.
B) $ 50,000.
C) $ 110,000.
D) $ 250,000.

Question

On January 1, 2020, Orion Corp. granted an employee an option to purchase 5,000 of Orion's no par value common shares at $ 50 per share. The Black-Scholes option pricing model determined total compensation expense to be $ 220,000. The option became exercisable on December 31, 2021, after the employee completed two years of service. The market prices of Orion's shares were as follows:  For calendar 2021, Orion should recognize compensation expense of
A) $ 0. 
B) $ 50,000. 
C) $ 110,000. 
D) $ 250,000.

Quizplus · Accepted Answer

According to the statement given, the option became exercisable on December 31, 2021, which means the employee could start purchasing shares at the price of $50 each. Therefore, the intrinsic value of each option at the end of 2021 is the market price minus the exercise price, which is $70 - $50 = $20. Since the employee can purchase 5,000 shares, the total intrinsic value is $20 x 5,000 = $100,000.

The compensation expense recognized in 2020 is $220,000, which means that $220,000/5,000 = $44 is the fair value per option. Therefore, the total fair value of the option at the end of 2021 is $44 x 5,000 = $220,000.

The compensation expense recognized in 2021 is the difference between the intrinsic value ($100,000) and the fair value ($220,000), which is $220,000 - $100,000 = $120,000.

However, the compensation expense recognized in 2021 should be adjusted for the service period. Since the employee completed two years of service at the end of 2021, the portion of compensation expense recognized in 2021 is 2/3 x $120,000 = $80,000.

Therefore, Orion should recognize compensation expense of $110,000 ($0 + $80,000) for calendar 2021.