On January 1, 2018, Black Inc. issued stock options for 200,000 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 6% in three years. Black initially estimates that it is probable the goal will be achieved. In 2019, after one year, Black estimates that it is not probable that divisional revenue will increase by 6% in three years. Ignoring taxes, what is the effect on earnings in 2019?

Question

Quizplus · Accepted Answer

In 2018, the estimate of the total compensation would be: 200,000 × $6 = $1,200,000
One-third of that amount, or $400,000, will be recorded in 2018. In 2019, the new estimate of the total compensation would change to zero. In that case, Black would reverse the $400,000 expensed in 2018 because no compensation can be recognized for options that don't vest due to performance targets not being met, and that's the new expectation. So, earnings are increased (reduction in compensation expense) by that amount.