On January 1, 2013, Red 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. Red initially estimates that it is probable the goal will be achieved. Ignoring taxes, what is compensation expense for 2013?

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Compensation expense is determined as the fair value of the options multiplied by the probability that the performance condition will be achieved in the future. In this case, the fair value of options is $6 per share option, and the number of options is 200,000. Therefore, the total fair value of options is $6 x 200,000 = $1,200,000.
However, the options are only exercisable if divisional revenue increases by 6% in three years. Red estimates that it is probable the goal will be achieved. Therefore, the probability factor is 100%. Hence, the compensation expense recognized in 2013 is $1,200,000 x 100% = $1,200,000 / 3 = $400,000.